As the cracks become more visible across the Belgian political landscape, Nina Roehrbein reports on how pension funds are dealing with their own volatility issues

Just as in other countries, funding levels of Belgian pension funds dropped during the financial crisis. However, the returns of the last two years helped push funding back to pre-crisis levels.

Short-term funding levels now stand at around 130% on average and between 106-110% for the long term, meaning underfunding is no longer a problem in the Belgian pensions industry, according to Karel Stroobants, an independent expert on the Belgian pensions industry.

Equity levels rose slightly on 2009 due to market movements and investors allocating the capital they had previously kept as liquidity. However, equity levels are not yet back to pre-crisis levels.

Euro-denominated government bonds dominate the fixed income portfolios, while equity portfolios tend to have an average split of 50% euro versus 50% non-euro investments with smaller funds mainly having euro exposure and larger ones having more global equity investments.

However, the difficulties surrounding sovereign debt in the euro-zone have resulted in a shift in the way pension funds look at euro government bonds. “They used to be seen as a risk-free harbour for pension funds that needed to cover their liabilities,” says Sven Schroven, in charge of investment consulting and manager in the retirement solutions department at Towers Watson in Brussels. “Now, there is a tendency to make a distinction between the top quality, AAA-rated and other European government bonds. This has yet to be reflected in major shifts in asset allocation but by default, euro corporate bonds are now viewed as a risk diversifier against euro government bonds rather than a risk contributor.”

According to figures compiled by Bank Degroof using Mercer data, allocation to investment grade corporate bonds in Belgium more than doubled from 7.2% in 2008 to 15.1% at the end of September 2010. Jan Longeval, managing director at Bank Degroof, which has around a quarter of all Belgian pension funds as asset management clients: “Most Belgian pension funds are currently re-running their ALM studies and given what happened over the past couple of years, these would advocate a less aggressive or more defensive asset mix. Corporate bonds would be the first asset class to benefit from this de-risking strategy.

“Belgian pension funds either favour a move towards corporate bonds because in the eyes of many investors today they look less risky than many euro-zone sovereign bonds or they are opening up their bond portfolios to invest in emerging market debt despite the potential liquidity issues. In addition, they will move towards an investment grade euro-zone government bond index, in which Greece no longer plays a part.”

Exposure to emerging markets - whether in bonds or equities - is increasingly under discussion in Belgium. However, only a few larger-sized pension funds have started to allocate to those regions.

Alternatives are still neither common nor popular among Belgian pension funds. “There is about zero interest in hedge funds today,” says Longeval.

“Institutional investors did not like them a few years ago and today, post-crisis, they are probably the most unpopular asset class among Belgian pension funds.”

Longeval also sees no interest in private equity except for infrastructure finance. In the wake of new ALM studies, a few pension funds have allocated money to commodities but they remain a marginal satellite investment for conservative Belgian pension funds.

“Investors generally have strong opinions about commodities,” says Longeval. “Some pension funds view them as a speculative asset class but others started to invest a couple of years ago.”

The upcoming change in international accounting standards (IAS) regulations may push plan sponsors towards an even more conservative investment approach for two reasons. “Companies that are concerned about volatility on their balance sheet will have opted for the deferral or corridor approach under the current IAS19 regulations, under which actuarial gains and losses are amortised and deferred in the future,” says Schroven. “These companies may now be forced towards immediate recognition on the balance sheet. Furthermore, current IAS19 rules allow companies with more dynamic asset allocations to assume a larger expected return on assets when determining the pension expense. This will not be possible anymore under the draft new IAS19 rules. Higher expected investment returns resulting from more dynamic investment strategies will no longer positively impact the pension expense, in other words, the income statement.”

Since a new law came into force on 27 October 2006 requiring a formal statement of investment principles (SIPs), risk management has been higher up many pension funds’ agenda in Belgium.

Investment principles
In many cases, SIPs have led to a more organised process and effectively established rules for investment policies, according to Schroven. Some pension funds have created formal investment committees that deal with the entire process, a risk management trend, which he expects to grow further. SIPs have also led to closer monitoring of the manager’s performance and investment risk. Board members receive more training with regard to counterparty risks, stocklending and other investment related issues.

Very few pension funds use some type of constant proportion portfolio insurance (CPPI). “The majority of portfolios are traditional long-only types of asset mixes therefore pension funds are not that open to more complex ways of dealing with risks,” says Longeval. “We have been advocating using structured products for the introduction of asymmetric risk profiles some specific risk but it remains just a couple of percent of the portfolio.”

Longevity is not a big issue in Belgium, as 95% of pension benefits are paid out as lump sums, meaning the longevity risk is taken by the retiree. It could become more of an issue if the government took legal initiatives to encourage pensions or penalise lump sum payouts.

The minimum return guarantee set by the Vandenbroucke law in 2004 - which needs to be provided at the time of leaving or retirement - affects only defined contribution and cash balance plans. “The actual cost of providing this guarantee over the long term is fairly limited,” says Schroven. “Nevertheless, companies that would struggle to free up cash to make up for shortfalls in the minimum return guarantee tend to push towards more conservative investments. Those employers can either buy a group insurance contract with the guaranteed return provided by the insurance company or invest more in bonds as part of a buy-and-holds strategy. The former removes a lot of the short-term risk but, depending on the case, may be a costly solution in the long term compared to the latter.”

Still the most frequent move in the market by Belgian, particularly industry-wide, pension funds today, according to Stroobants, is to buy annual insurance.

As 70% of all Belgian pension funds lack the scale to address their governance issues and operate efficiently, Stroobants believes they will either have to continue following the insured model approach, or be open to mergers into a multi-employer type of model.

“Even the large sector of local government employees in Flanders opted for an insured model, which given its size of more than 200,000 employees, was a surprise,” says Stroobants. “They all seem to prefer making a bet on the long-term solvency of the insurance company above the possible higher return and volatility of an investment through a pension fund. Recently a few sector pension funds, such as the one of the chemical sector, went to a government agency run insurer. The commercial insurers were not pleased with that new competitor whom they accused of unfair pricing for these deals.”

The tendency towards DC insurance solutions is one of the biggest challenges for the Belgian pension fund industry. “In addition, external factors such as changes to IAS19 and the minimum return guarantee make it harder for pension funds to compete due to the fact that they are required to report assets on a fair value basis,” says Schroven. “However, pension funds continue to be an efficient and competitive vehicle for pensions in the longer term, in particular for mid-sized to larger plans.”