GERMANY - Record low Bund yields have very ambivalent effects on German institutional investors, increasing assets and liabilities at the same time, consultancies are pointing out.
Depending on the sample, exposure to bonds is between 60-85% of assets in German pension funds. A large part of this - 40% of assets and more - is invested in euro-denominated bonds including a large domestic portion.
Since the beginning of the year, yields on euro-denominated bonds have dropped significantly. For example, German Bunds have lost 90 basis points over the last seven months. This in turn has increased the market value the average pension portfolio, Alfred Gohdes, head of actuarial consulting at Towers Watson Germany, told IPE, although liabilities have increased at the same time.
Benedikt Kutschera, head of the manager selection team at Towers Watson's investment consultancy in Germany added: "There are effects on both sides of the accounts as this drop has also led to a drop in the discount rate [Rechnungszins] by approximately 75 basis points, which has in turn raised liabilities by roughly 10% or very roughly by about €22bn for the DAX 30 entities."
Gohdes and Kutschera agree that, given this steep increase in liabilities, and the expected more modest increase in market value of assets, the funding levels of liabilities can be expected to have declined. However, they do not expect the low interest environment to be a driver for more outside funding of pension liabilities in Germany while outside funding will remain a long-term trend.
Both see a definite trend towards liability-driven investment (LDI) - "but getting the timing right is difficult", according to Kutschera.
Low interest environments over the last years have also continued the trend towards more diversification in the fixed-income portfolios.
Carl-Heinrich Kehr, principal at Mercer Germany's investment consulting noted: "In general we see this broader diversification in the bond segment: Not only in credit but also in emerging markets."
He added real estate was also sought after as "alternative source for fixed income".
But Kutschera emphasised: "Diversification has certainly increased [in] government bonds, particularly from the euro area, and investment-grade corporate bonds will always remain major themes in bond exposures." Most German institutional investors remain risk-averse.
Towers Watson also sees interest in emerging market bonds mainly given the fact that global macro-economic balances have shifted.
"Interest is attractive in these areas and currency appreciation is likely - so these bonds are interesting options," Kutschera points out.
But just like high-yield bonds they will remain a diversification factor at currently only around 1% of the total bond exposure.