Nina Röhrbein spoke with Hans Wilhelm Korfmacher, managing director at WPV about the pension fund’s highly diversified investment strategy.
Along with the rest of the industry, professional pension schemes for liberal professions, the Versorgungswerke, are known for their conservative investment strategy.
Nevertheless, at the country’s pension fund for auditors and chartered accountants - the Versorgungswerk der Wirtschaftsprüfer und der vereidigten Buchprüfer (WPV) - diversification lies at the heart of the investment strategy.
Although it serves employees of a particular profession, WPV is a first pillar and not an occupational pension fund, substituting the statutory old-age first-pillar pension for its employed and self-employed members. It also provides widow pensions and invalidity benefits.
WPV was founded in 1993, initially only to serve as a regional superannuation fund for the federal state of North Rhine-Westphalia. Separate agreements with 14 other federal states followed to cater for the highly mobile auditing workforce.
WPV does not fully guarantee its benefits. But as a hybrid scheme, it has a benefit plan in place that allocates certain pension rights to its members based on today’s assumptions.
As one of almost 90 Versorgungswerke in Germany, WPV has to follow a fundamental internal rate of return, also known as a hurdle rate (Rechnungszins) of 4%.
However, with a view to the changing interest-rate environment, 10 years ago the pension fund decided to lower the hurdle rate to 3% for the coming 10 years.
In each annual review that followed, WPV continued to back its decision for a 3% rate for the coming 10 years, before the rate will eventually return to 4%.
“In the current low-interest-rate environment, it is challenging, particularly as we are a fast-growing pension scheme, to generate 3% from our conservative and cautious asset allocation,” says Hans Wilhelm Korfmacher, managing director at WPV. “Another challenge is the increasing longevity of our members.”
Six years ago, the pension fund implemented new mortality tables that predict an additional life expectancy of four years among freelance professionals such as WPV’s members compared with the average population.
The scheme is a young one. Due to the high contributions and relatively low current pay-out level, the pension fund is growing quickly. This is why Korfmacher expects WPV’s invested assets to double to €4bn by 2020.
For the past 10 years, WPV has undertaken annual asset liability management (ALM) studies with help from an external consultant. This year, the scheme ran two ALM studies in order to benefit from a second opinion. While the second ALM study did show deviations from the first, it did not question the first model overall.
“The second ALM study essentially confirmed the results of this year’s first study,” says Korfmacher. “It came up with slightly different asset classes and approaches, which we used as a reason to review our investment model. We re-thought how to structure the investments within the various asset classes, and are fortunate to be able to make structural changes with incoming contributions, interest and returns, without having to sell our old investments.”
WPV’s executive board decides upon the strategic asset allocation based on the results of the ALM studies. Diversification is the key component of its investment strategy.
However, WPV’s diversification is not expressed by asset class alone - it is reflected through sector, region, investment vehicle, different investment styles, managers and strategies.
Since it has never invested in peripheral euro-zone bonds, the majority of its portfolio, around 60%, has been allocated to core government bonds, covered bonds and privately placed hold-to-maturity instruments (Schuldscheindarlehen).
The fund has undergone a seismic shift over the last decade with regard to its core bond portfolio. “Some years ago it was common to buy hold-to-maturity instruments from banks in good faith,” says Korfmacher. “Investors were also able to buy German covered bonds without intensive due diligence on their actuarial reserves; in today’s post-crisis environment this is no longer possible. Therefore, we have almost stopped buying hold-to-maturity instruments from banks. Instead, we focus on zero-solvency loans - in other words, credit to institutions where we do not need to provide risk capital. This essentially means bonds from the German government, government-related institutions and covered bonds.”
WPV’s core bond portfolio mainly holds registered bonds (Namenspapiere), which are held at book value in the balance sheet.
“Falling interest rates have ensured that marked-to-market performance in recent years has been good, meaning that all pension funds have reserves at present,” says Korfmacher. “Once interest rates start to rise they will begin to melt. However, any negative reserves would not make a difference for WPV, because its reserves are, to a large extent, German buy-and-hold assets that are kept until maturity.”
About 40% of WPV’s portfolio is managed like a multi-strategy fund of funds. By and large, it is a mix of emerging market debt, corporate bonds, equities,real estate and alternatives. In recent years, the pension fund has expanded its exposure to real estate, emerging market debt and corporate bonds.
“We have especially been shifting toward real assets,” says Korfmacher. “Since 2008, for example, we have invested in renewable energies. We even bought our own photovoltaic solar energy plant in 2008, the Energiepark Waldpolenz near Leipzig in eastern Germany. And we continue to think about opportunities in infrastructure. Generally, there is no asset WPV will not look at. If the risks and returns are weighted favourably, we will consider investing in it.”
WPV spent a lot of time focusing on how its equity portfolio could reduce market risk to the lowest possible level, while at the same time preserving its risk budget and return objective targets. This analysis resulted in a new approach, and WPV is now diversifying its equity investments according to geographies, investment styles, strategies, market-risk exposures, liquidity profiles and managers.
This analysis also suggested allocations to alternative investment and absolute-return strategies. As a result, listed equity long-only, listed equity long/short strategies and private equity now make up the three components of WPV’s equity portfolio.
Overall, the equity portfolio is managed in an undogmatic and pro-active manner. To ensure investments adhere to this strategy, in the liquid equity portionWPV seeks only highly liquid strategies fund structures that do not impose lock-ups and which cannot easily impose restrictions in times of stress.
Nevertheless, in typical German fashion, WPV still has a low, currently 5%, allocation to equities. The pension fund is trying to raise this figure in the medium term, although Korfmacher expects the exposure to remain below 10%.
Similarly, WPV is trying to expand its allocation to alternative investments. At present, exposure to asset classes such as private equity is small. Real estate investments, however, already make up 13% of WPV’s asset allocation.
In the past, WPV’s real estate investments were managed externally through Spezialfonds or stakes in funds. However, this is, in part, about to change. “We are in the selection process of an individual fund, a master structure, for which we plan to buy real-estate assets directly, either by ourselves or with external help,” says Korfmacher. “It will give us much more influence in investment decisions. However, the management of our real estate and alternative investments overall will continue to be outsourced.”
One of the most unusual additions to WPV’s investment portfolio was its student-loan programme, which it started in 2007 and has now grown to €10m. WPV grants loans to a company, which finances the course fees for students at private universities. Following completion of their degrees, the students repay a percentage of the actual income they earn over a specific period to the company. To safeguard the eligibility of the loans as cover funds, the concept for the investors includes both a repayment of the principal sum and a minimum interest rate. But the actual yield of the financial investment is determined by the income situation of the university graduates.
“We were the first institutional investor in Germany to start up this student loan programme, a reverse inter-generational contract, with a private business school,” says Korfmacher. “As an institutional investor, we were initially cautious, which is why we hedged our exposure to the student fund with a trust mandate, which ensures us a guaranteed minimum rate of return of around 3%. But we hope this investment will generate 6-7%. In addition, it provides negative correlation with other asset classes and offers a way for WPV to contribute positively to society.”
Last year was the second time the pension fund did not report an investment return of 4%. However, the returns do not equal the pension fund’s investment performance.
If WPV’s asset growth exceeds the hurdle rate in one year, additional returns can be either distributed or put aside as hidden reserves (stille Reserven). If returns fall below the hurdle rate, for smoothing purposes the pension fund can either dip into previously accumulated reserves or define them as undisclosed negative reserves (stille Last) according to German commercial code HGB.