Funds wary of asking for credit
Today’s Euroland reality of flat interest rates and spread convergence has focused ‘domestic’ Euroland pension funds on the challenge of boosting bond returns and coming to terms with the burgeoning credit market – now beginning to follow the lead of its big US brother.
However, for some the legacy of historical domestic government bond holdings will not be shaken overnight, while for others national restrictions still need to be adhered to. And even for more developed funds, enhancing bond returns is set be no walk in the park.
Klaus Kirchenhofer, head of portfolio management at the DM2.2bn (e1.1bn) pension fund of German chemical group Wackerchemie, says future bond issues were anticipated at the time of euro implementation, when the fund switched from domestic Pfandbriefe and Bund benchmarks to a broad euro market benchmark.
“This allowed us firstly to diversify into all the Emu nations and secondly opened up the market segments available from solely Bunds and Pfandbriefe to corporates and asset backed securities, etc. Since last year we have seen the yield benefits here.”
However, Kirschenhofer says the fund still has to deal with German VAG legal restrictions which only allow allocation to investment-grade bonds, meaning down to and including BBB ratings. “The regulations are not clearly defined, but we have interpreted this as investment-grade restrictions.” He adds that the fund is also restricted in investment, obliged to stay for the most part within the euro home currency, and he expects little change here. “It is possible to invest in high-yield and emerging market bonds, but we have to count this against our equity limits. We are fully invested in equities, so this would mean reducing our equity portion,” says Kirschenhofer.
Currently Wackerchemie has 10% of its 38% overall bond holding in corporate issues. All investment is outsourced with Credit Suisse, Dresdner, Merck Finck and Allfonds acting as the fund’s bond managers. And Kirschenhofer says the decision to diversify into credits is the fund manager’s. “It is up to them how they value the corporate portfolio and weight it, but it was nevertheless an important criteria for us in our manager selections.”
He says he expects the managers to up their exposure to corporate bonds in the future, but notes the need for further market development.
Petri Kallio, investment manager at the FIM3.7bn (e622m) Helsinki-based Eläkesaatio pension foundation for telecom group Sonera and the Finnish post office, says the historical legacy of the fund’s bond investment still weighs heavily on the current set-up, but that eyes are on the developing credit market. “The share of bonds in our portfolios has been pretty stable in the last couple of years. Most of the bonds we hold are Finnish government issues and were bought years ago. The large part of this is indexed, so as a result our Euroland bond portion is small.”
Kallio says the fund currently invests on an approximately 60–40 bond/ equity split, although he notes that the equity portion has gradually been increased and diversified into euroland since last year. He predicts a similar shift for the fixed-income portion in coming years. “The corporate bond market and the increasing issuance is a positive development and we will definitely be thinking about increasing that share of our portfolio either this year or next year.”
Daniel Voisey, senior financial adviser at the Brussels-based e1.5bn Tractebel pension fund, says the fund’s euro transition also served as a platform to examine corporate bond issues. “We have been moving bit by bit away from investment in Belgian government bonds towards the euro reference zone, and we have worked a lot on euro bonds and corporates in a rigorous fashion both on the ratings and sector diversification sides.”
Voisey says the fund is looking closely at issues of concentration in one issuer and how functioning in a particular sector can be analysed along with the credit rating. “Concentrations are proportional to the risks here.” He says that rating at the moment in the fund can be anything above and including AA– credit, but that Tractebel remains selective on the issuer. “We would do an analysis of spread rating, but given the size of the investment team here we also seek outside assistance from external credit analysts and together form an opinion on the issuer.”
Voisey points out that bond investment in-house is less important than that through external managers, adding: “I am a bond selection specialist looking at spreads and risk in what are fairly low-cost low-risk investments. My other hat, though, is to select specialist managers through which we can allow ourselves to go a little more aggressive and risky in the investment, as they are professionals. Either in Euro-zone or outside in high yield or emerging market debt we are quite conscious we cannot manage this level of risk, but we have to be able to select managers, follow them and see which will fit within the strategic asset allocation of the pension fund.”
Voisey points out that most of the Tractebel fund’s bond portfolio is focused on Euro-zone bonds (85%), with half of this in corporate issues. The remainder of the bond portfolio, he says, is in government bonds.
Around 15% is in bonds outside the Euro-zone with external managers and alternative investment, including emerging market debt, accounts for around 2.5%.
Voisey also notes a lack of clarity in the corporate bond approach today. “We are going more and more towards credit products, but there is still a problem of sectoral allocation due to the predominance of issuers in the telecoms, banking and financial areas. Apart from that there are few issues, but for the future I think we will be able to diversify the risk across the different sectors in the economy.”
Henk Boer, secretary to the investment committee at the Delft-based e1.6bn pension fund of Dutch scientific research group TNO, says the fund is also expanding its bond coverage, but leaving much to the discretion of its asset manager. “We expect interest rates this year to remain at their current levels or maybe just slightly higher, so the duration of our bond portfolio is still based on the benchmark – using the JP Morgan more maturity indexed government index.”
The fund’s bond holding is approximately e700m or 40% of the total portfolio and Boer says when TNO started considering credit exposure they discussed keeping it within the existing balanced mandate arrangement with manager ABN Amro.
“Last year we started with a credit portfolio of e50m – around 15% of our total bond portfolio invested with ABN Amro. We didn’t put out any special request to other investment managers. They have invested a lot in creating a team of people specialised in credits and we feel they will know what to invest in for the future.”
He says management is left to the manager, with the sole stipulation that the total portfolio on average must be of A quality credit rating. “There is no duration management in the brief and it is benchmark neutral. The manager can also invest in US dollar issues as long as the exposure is hedged to the euro,” he explains.
Boer says the fund manager has the room to look at high yield, but says the single A average makes this an unlikely choice.