The high price of crude oil gave rise to considerable market uncertainty last year but the negative impact on demand was largely countered by lower long-term interest rates arising from growing financial globalisation, says José Luis Masferrer of pensions consultancy Buck Heissmann.
“The weighted average profitability of pension funds in Spain last year was a satisfactory 7.22%, which was more than double the inflation rate,” he adds. “But the structure of investment is conservative. According to data from the Spanish Association of Money Managers and Pension Funds, Inverco, 51% of pension fund portfolios were in fixed income, 22% in equities, 13% in cash and 14% in other asset classes.”
But Fonditel, the pension fund of Telefonica de España, pursued a much less conservative asset allocation strategy and reaped the rewards.
“Our result last year was mainly based on being overweight in equities while in fixed income we were slightly short duration,” says Valentin Fernandez, strategy director for institutional investor relations at Fonditel. “Both made positive contributions but the larger impact was due to the equities. Roughly speaking our return was around 13%, with 8% coming from equities and 5% from fixed income.” In 2004 its return was 6.39%.
Fonditel manages the portfolios for all the pension funds in the Telefonica group, and the asset allocation policy pursued depends on the risk profile of each fund, says Fernandez. “We have three individual plans open for everybody and we manage five corporate pension funds, with total assets under management of €6bn,” he adds. “Each fund has a benchmark and for the biggest, the Telefonica employees’ pension fund, it is 35% in equities and the rest in fixed income and cash, but elsewhere is 50:50. But the average portfolio allocation would be one-third in equities and between 5% and 8% in cash, and the rest in fixed income.” Europe has been the main focus for Fonditel investment, but it also looks further a field. “Around 80% of our equities exposure is in euro funds, basically through the Eurostat 50 which is our benchmark for equities,” says Fernandez. “But then the remaining 20% was seeking alpha value around the world, basically US and Japan.”
Japan was not in Fonditel’s benchmark, Fernandez adds, but it turned out to be a good bet. “We were overweight in Japan; we had around 10% of our exposure invested there, which was a very large proportion. And then its contribution was very strong, especially in the last quarter of last year. The Japanese market rose by something like 40%.”
And there have been other departures from the traditional asset allocation breakdown. “In recent years we have been increasing our allocation in the cash portfolio to alternatives - funds of funds, hedge funds, real estate funds - and the idea is to increase it over the coming years to around 15%,” Fernandez says. “In fact this is an initiative that is complementary for our strategy because they are not solely correlated with a traditional asset class and we are looking for returns or a Sharpe ratio very similar to our weight to do the investments. If we find some hedge fund or alternative funds which has a pattern in terms of risk return profile, similar to our way to do things and non-correlated to with a traditional asset class and preferably with a long-enough track record, then we will select it and add it to our portfolio. And that’s something that’s going to increase in the coming years.”
But Fernandez sees challenges on the horizon. “Now in Spain we are having a break in contributions to the individual pension funds as a result of reforms to personal income tax laws that will be announced later this year,” he says. “But next year we expect contributions to increase in terms of the total amount of investment.”
However, Masferrer is sceptical about whether there really has been a slowdown in contributions.
“Although this is the opinion of some pension funds, in our experience this was not the case in 2005. During last year those pension plans grew by 5.5% in terms of the number of participants and by 17.6% with regard to their assets. And according Inverco, the total assets at the end of the first quarter of this year amounted to €44.4bn while the figures to the end of the second quarter was €43.9bn, there being a similar number of participants at both dates. In any case according to the draft, the modifications anticipated by the new fiscal law would affect the tax treatment on benefits derived from contributions made after 1 January 2007 and will have no effect on benefits derived from contributions made during 2006 and previous years.”
But for Fernandez the key challenge lies elsewhere. “The Middle East crisis and the consequence for oil prices and the equity markets is the main risk,” he says. “Our view is that we could see a good rally for stocks in the coming weeks, and the alternative stock market is perhaps the first option.
“So for next month or so I think we should be a little overweight in equities. For fixed income we are thinking of extending the duration a little because we think that US bond yields are close to a peak, so if we see a strategy in terms of interest rates for the next month, especially in the US, we could see a good performance for bonds.”
And Masferrer is also optimistic. “There is a widespread conviction that the current instability in the financial markets is going to be prolonged due to the expectations of increases in interest rates,” he says. “Nevertheless, business balance sheets are healthy and for participants of individual pension plans and pension funds with a long investment period, this could be the opportunity to gradually increase their exposure to equities.”