How do you know how well you are doing?
Vladimir Sosovicka, responsible for portfolio management at CSOB dss, which has AUM of SKK1.7bn (€33.3m)
lovak law prescribes how the country’s pension funds should measure their performance. We must calculate the price of one unit of the fund on a daily basis. We evaluate our assets mark-to-market, then subtract the liabilities - for example, management fees - and the resulting net asset value is calculated in issued units. The performance is calculated as the price of the unit at the time, using the formula T1 divided by the price of the unit at time T0 and then annualised.
“All costs such as broker and custody fees must be paid by the company and not by the fund.
“Attracting and keeping clients in the divided Slovak pension market, where members until recently had the right to switch to another pension fund once a year without penalty, means that performance and the credibility of the company are the key issues.
“The law requires pension funds to have at least 50,000 members but for us the critical mass is 100,000.
“Over the last 12 months our conservative fund showed a return of 3.6%, the balanced fund 5.16% and the growth fund 5.46%.
“Our benchmarks combine standard equity, bond and money market indices. But our exposure to equities depends on the fund. Conservative funds are prohibited from
having an exposure to equities; they must be 100% in fixed income. That means the
current asset split in our conservative fund is 60% money market and 40% bonds. For the
balanced fund it is 30% money market, 56% bonds and 14% equity and in the growth fund it is 60% money market, 24% bonds and 16.5% equity.
“Slovak legislation limits our investment universe to standard plain vanilla stock exchange-traded instruments with investment-grade rating. At the moment, we are very conservative but our risk exposure will increase in the future. Over time I expect our equity positions to rise to 50-70% for the growth fund. From a long-term perspective the increased risk exposure will be beneficial for performance.
“We mainly focus on the asset side. All pension liabilities, which are paid after members reach retirement age, are managed by different companies such as commercial insurers. Members have to buy a legally defined minimum annuity at the end of their working life and can withdraw the rest as a lump sum. We only pay out earlier in the case of the death of an investor, when we would pay to their survivors what the investor had paid in plus the investment return, or if they switched funds. That means our inflow almost always outweighs the outflow. And that’s how we match short-term liabilities in an industry that is focused on the long term.”
Derek Scott, chairman of the trustees of the Stagecoach Group Pension Scheme, which has AUM of just over €800m
e measure performance as absolute return, net of costs and relative to liability funding requirements. What makes us slightly unusual is that we use money-weighted absolute rates of returns. It is more common to see time-weighted relative returns at pension funds.
“When the scheme started in 1987, the actuary assumed investment returns should be at least 9% per annum net of fees, pensionable pay increases should be held to 8% per annum or less and general inflation was assumed to be 6% or less. Over those 20 years we have achieved around 10% per annum net in investment returns, pensionable pay increases have averaged no more than 7% and general inflation has averaged under 4% - and yet, like many UK schemes, we have deficits to fund, partially due to changes in scheme mortality.
“Today the scheme actuary assumes a general UK inflation of slightly less than 3% per annum and says we need to average over 7% per annum in net investment returns and hold pensionable pay increases to less than 5%.
“In recent years we have realised more formally than we did in the past that we need to have a safety margin over the actuary’s assumptions because despite beating the assumptions of 20 years ago, we still need to do more from today. We cannot avoid market volatility but we try to reduce it over longer time periods.
“We have always looked at both liabilities and assets. Because we had a new and immature scheme from 1987, we were able to meet our short-term liabilities from contribution cash flows and still have net cash left over to invest. That is still the case, partially because annual contributions have gone up significantly.
“However, one of our margins of safety, the net cash left after paying short-term liabilities, has been reduced from its original multiples. We intend to compensate for that in the coming years by varying some of our investment mandates so that some of the investment income can be used to supplement contribution cash flows in order to more than cover the short-time liabilities. We also recognise some of the short-term financial and regulatory reporting issues facing our scheme sponsor so we are more open to hedging, for example overseas currencies, than we once were.
“In summary, our benchmarks are the cost of funding the liabilities with a significant safety margin on top. We use a blend of investment managers and our general indication of our margin of safety would mean needing average total investment returns of around 10% if the actuary assumes we need more than 7% per annum in net investment returns.
“As a UK scheme with UK liabilities we have a domestic bias in our public and private equity, bond, real estate, infrastructure and active currency investments. We believe that the traditional equity/bond emphasis is two-dimensional and we prefer to be more diversified and less fixed on proportions of equities to bonds and UK to overseas.
“We have 8-10% of assets in private equity, 8% in fund of hedge funds, 8-10% in real estate and infrastructure and only 3-5% in cash and active currency. The remaining 70% is in a mixture of global equity and bonds. Some of the managers are equity-only, while others are multi-asset.”
Tryggvi Tryggvason, CIO of pension fund Gildi, which has AUM of ISK205bn (€2.3bn)
celandic pension funds have to follow the same formula set by the financial authorities to measure their performance.
“We calculate our performance as a percentage of the average assets in the year. The formula is investment income multiplied by two divided by the average AUM assets of the year minus the income of the year. It provides an average return.
“Last year our total rate of return was 17.2% and the real return was 9.6%. On a five-year basis we have managed a real return of 11% per annum and a nominal annual average of 15%.
“Pension funds are competitive about their returns and are obliged to advertise the outturn in a newspaper very year. But funds cannot try to attract new members because the pension fund member joining is linked to their sector of their employment. So for example, we are mainly the pension fund for seamen and blue-collar workers. Only if a person changes the industry they work in can they change their pension fund.
“Our assets are split equally between bonds and stocks. Most of the bonds are Icelandic but our equity exposure is around 60% in foreign equities and 40% in domestic equities.
“We have a different benchmark for every asset class so we calculate our performance in every asset class. For our domestic stocks, for example, we use the Icelandic stock exchange’s ICEX-15 index, our foreign equity exposure is benchmarked to the MSCI World and we use the Tremont Investable Hedge Fund Index for our hedge funds.
“We generally have very little exposure to foreign bonds. The asset-liability study is an important tool for selecting the investment strategy that fits the fund and we do the study on an annual basis. The target is to select a strategy that adds value to the asset-liability ratio over the full investment cycle. It takes return and volatility of selected asset classes and growth of liabilities into account. We run simulations to choose a suitable investment strategy for the fund. Fundamentals such as law, age distribution, future cash flow, fund ratio and developments in contributions and benefits are implemented in our risk budgeting, while we construct our long-term strategic asset allocation. The fund is fully funded, has a strong cash inflow and young members. We expect the inflow to be bigger than outflow for the next 10-15 years, and that’s why we are able to take some risks with equities.
“We match our short-term liabilities according to Icelandic regulations. The regulations say that the gap between assets and liabilities can be no more than 10% over a one-year period or no more than 5% over a five-year period. If the assets rise above 10% we have to increase the benefits and cut benefits if the liabilities exceed the assets by 10%. We calculate the liabilities against the assets on an annual basis.”