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Italy: Restrictions, restrictions

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When it comes to asset allocation, Italian pension funds remain more restricted than their counterparts in the west of Europe due to the limits of legislation, writes
Nina Röhrbein. Italian funds also often have their hands tied by employees who make individual investment choices from a pool of guaranteed and balanced lines the funds are obliged to offer - that is, if they even join a pension fund

“Italian employees have not yet realised that the pensions provided by the first pillar will decrease drastically and therefore often prefer to keep their trattamento di fine rapporto (TFR) allowance - their annual severance pay - to be able to buy a house or pay unforeseen medical expenses,” says Fabio Carniol, retirement solutions director, Italy, at Towers Watson in Milan. “They are usually risk-adverse and like guaranteed lines. The success of individual pension plans, which are used mainly by the self-employed, is linked to the aggressive sales proposition of some networks of insurance tied agents, banks and with-profit insurance lines, in which pension funds cannot invest. Italians generally have become disaffected with mutual funds and other managed financial products during the last two years and have preferred to keep their money as cash or buy government bonds in spite of low yields.”

Often pension funds are just seen as another financial product. This is one of the reasons why total assets of Italian pension funds stand at only around 3% of GDP today, according to Claudio Pinna, managing director at Hewitt in Italy. “This signals that the pension funds are not in line with the needs of the employees,” he says.

As well as the choice and selection of the various investment lines offered in pension funds, legislation also has an effect on the pension funds’ asset allocation.

Amendments to existing legislation, such as decree 703/96, which restricts the asset classes in which Italian pension funds can invest, do not seem to be a priority for the Italian government in the short-term future.

The decree was due to be reviewed just before the financial crisis struck but the turmoil in the market following the collapse of Lehman Brothers, the credit crisis and now the European debt crisis, led to its postponement.

“We are waiting for a complete overhaul of legislation 703/96,” says Carlo Cavazzoni, global head of institutional sales at Generali Investments. “But the government is currently more worried about the financial crisis and probably will not review the decree until the worst of the crisis is over. However, we do expect the change in retirement age to go ahead as planned.”

In August 2009, a primary law on the indexation of retirement age starting from the year 2015 was introduced. The first extension of the retirement age will be limited to three months but after that there will be a revision every three years in line with the observed increase in life expectancy.

Decree 703/96 among other things also restricts exposure to emerging markets.
“So far Italian legislation does not allow significant investments in emerging markets by pension funds,” says Michele Boccia, responsible for the institutional development of the Italian market at Eurizon Capital Sgr. “They can only invest a small percentage of assets in emerging market equities provided that they are listed in an EU, US, Canadian or Japanese market.”

“This is a big pitfall because the market has proven that there is more value in emerging market debt and equity than, for example, in European equity or debt,” adds Renato Guerriero, head of the Italian branch at Dexia Asset Management.

“We have been very focused on Europe in the pension funds managed by us,” says Cavazzoni. “However, we and our clients have realised that more diversification in terms of international bonds is needed, so we started looking outside Europe as well. There are also client demands to raise equity quotas in the portfolios, especially in view of the fact that according to the mandates we manage we cannot invest in real estate or other alternative asset classes.”

The asset allocation of the new pension funds is typically based on balanced euro mandates with an equity allocation of 25-35%, according to Boccia. “But since the implementation of the guaranteed, TFR-replicating lines in 2007-08 we have witnessed a switch in investment from the balanced to the guaranteed lines,” he says. “This was also helped by the volatility of the equity markets in the past 18 months. As a result some of the pension funds now have a significant percentage of the new members in guaranteed lines.”

Pinna confirms the switch from investment lines with higher risk to the ones with lower risk and sees this as an ongoing trend but something that also meant pension funds lost out during the recovery of 2009.

According to Cavazzoni, around 80-90% of pension fund assets in Italy are invested in government bond and guaranteed lines. “When you have a guaranteed yield as well as the capital guarantee one of the things you can do when interest rates are low is to buy government bonds with a longer duration than the benchmark,” he says.

The fixed income portion mainly comprises European and in particular Italian government bonds. Due to rising concerns about Greek investments, asset managers such as Eurizon Capital have been asked to reduce their exposure to fragile-looking countries such as Portugal, Spain, Greece and Ireland. There is also renewed interest in corporate bonds, which can make up to 20% of total portfolio allocation.

“Some pension funds have even changed the benchmark of their bond investments from a JP Morgan government bond index to an aggregate one which includes corporate investments,” says Boccia.

Monica Basso, head of institutional Italy at Pioneer Investments, has witnessed a high level of risk aversion by closed-end contractual pension funds over the last 18 months although the specific behaviours are very different. “Some of them have shown a lot of interest in passive strategies, some in quantitative strategies, while others try to separate the beta from the alpha with some sort of risk management overlay,” she says.

“Within each investment line some deviation allows the asset managers to reduce or increase equities,” adds Guerriero. “But there has not been a revival of equity investments because apart from the very difficult moments during the crisis when pension funds were allowed by the regulator to hold more than 20% in cash in order to limit the damage provoked by the stock market, the decisions of the asset managers managing the lines have been more or less in line with their strategic asset allocation.”

In general, pension funds try to avoid negative returns and protect the downside through a high weighting of bonds or through a risk overlay. They aim for a performance higher than that of their main competitor, the TFR, which is always 1.5% plus 0.75% of Italian inflation.

“At the moment, pension funds, especially the closed end ones, are risk cautious and do not want to take any exposure to peripherals or other countries,” Cavazzoni assesses.”Therefore, the asset allocation of the various investment lines remained stable during the last 18 months. In investment lines where they can take more risk, they have started to buy more international bonds from European or OECD countries, such as certain Asian countries or the US, the latter particularly due to currency depreciation. The increase in international bonds happened at the expense of domestic ones, however any such investments are quite limited in terms of number and assets. At the end the asset allocation depends on what investment lines the employees choose and not the pension fund itself.”

According to figures by MEFOP, the association for the development of the Italian pension fund market, the asset allocation of Italian pension funds remained similar between 2008 and 2009. “In 2009 we started to invest in investment grade corporate bonds in order to diversify more and generate higher returns,” says Cavazzoni. This is the only move employees accept, particularly when investing in large companies with solid balance sheets.”

But while Italian investors may worry about the risk of other government bonds, they tend to underestimate the risk relating to their own country. “There has always been a home bias and they are not at all scared by the risk of Italian government bonds,” says Guerriero. “If something goes wrong nobody will blame them because they were investing in their own country.”

As a whole the Italian asset management industry has always been very focused on risk. Pension fund managers had very binding risk measures in place and made use of tracking or semi-tracking errors.

There is also more awareness of credit and counterparty risk in addition to traditional risk management.

But risk management has never been as important as it has been for pension funds in other countries, says Pinna, due to the fact they are generally passive investors who like to invest according to a specific benchmark. “Most of them select their money managers and consultants based on cost, not on the quality of services,” he says.

“However, now a need for asymmetric risk profiling has emerged,” says Guerriero. “The pension fund of the energy sector Fondo Energia, for example, has appointed a risk overlay manager to limit the risk exposure in its equity and currency holdings. The largest pension fund, Cometa, has also hired a risk overlay manager to deal with its currency risk.”

A further trend in the Italian asset management industry is the slow spread of lifecycle strategies across individual pension plans, open-end pension funds and industry-wide pension funds.

Only six open-end pension funds and 20 individual pension plans offered at least one lifecycle programme at the end of 2008.

“Following the moral persuasion by the regulator Covip and the Bank of Italy, the first industry-wide pension fund - Previmoda - began to offer lifecycle programmes in the last quarter of 2009,” says Carniol. “Some pre-existing pension funds have also started to think about it.”

Changes are also slowly beginning to emerge in other areas.”While the investment consulting market in Italy is still dominated by local players because of their low level of fees, there is a flight to quality, a trend which was started by the big banking foundations which is now also spreading to the big pension funds,” adds Carniol. “The financial crisis has been showing weaknesses and perceived conflicts of interests of local lower cost investment consultants and is probably opening the doors of the Italian market to another model of investment consulting which includes international consultants.”

Generali Investments focuses on guaranteed mandates at the moment.

“In the last two to three years some insurance companies reduced the pricing regardless of the cost of the capital to insure,” says Cavazzoni. “But the imminent introduction of Solvency II will require them to have more capital as a guarantee, which allows us to become more competitive and potentially win more mandates.”

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