The National Pensions Reserve Fund was designed to help fund future government pension liabilities, writes Pádraig Floyd. How has it fared amid the chaos of the financial markets of 2011?

As part of a strategy to place the funding of public sector pension schemes on a more even footing, the government formed the National Pensions Reserve Fund (NPRF) in 2001.

The country was booming, the government was raking in cash and the roar of the Celtic tiger could be heard across the world. However, public sector pensions - and how to pay for them - had been such an issue for successive governments that a commission to investigate their future had been set up in 1996. Even then, it was clear the country faced an annual liability for pay-as-you-go (PAYG) pensions of between €5bn and €6bn by the middle of the century.

Rather than fully satisfy the future liabilities, the NPRF was designed to contribute as much as possible within prudent risk parameters set out by the commission running it, points out Joseph O’Dea, head of investment consulting for Ireland at Towers Watson.

“It was set up to offset a future part of the costs of pensions when the state had excess money available and the economy was healthy. It was never expected to meet more than about half of the liabilities, like a sovereign wealth stabilisation fund.”

Legislation in 2009 and 2010 gave the minister for finance a mandate to direct investments into the economy and to fund government spending.

This resulted in the split of the NPRF into two funds; the discretionary portfolio under the control of the commission and directed investments at the call of the minister for finance. At the same time, €10bn of the NPRF fund was used to fund the purchase of Irish banks and to keep these banks liquid.

This has left the discretionary fund in a reduced state, hovering around the €5bn mark, a fifth of the highs of a few years ago.

Its original remit was modified to outperform the cost of servicing government debt with a 75% likelihood over rolling five-year periods. Although the strategic asset allocation was always expected to outstrip such a benchmark, this has become of greater importance and in the past year, that allocation has been reviewed.

In line with latter day institutional investment orthodoxy, the NPRF’s strategy had been to diversify globally and it did not invest heavily in Ireland. At the end of 2010, the assets of the (then) almost €18bn discretionary portfolio were 55% quoted equities, 31% financial assets - of which 23% was cash - and 14.4% in alternatives. Of these alternatives, the lion’s share was spread across private equity (4.5%) and property (4.6%), while commodities had 2.5%, infrastructure 1.6% and absolute return funds 1.1%.

By the end of 2011, that had changed considerably. Quoted assets made up only 28.3% of the portfolio. There was also a sizeable allocation (6.2%) to put options, derivatives to offer equity market protection.

Allocations to bonds were down slightly, with no holdings in euro-zone gilts (though linkers were double the 2010 level at 1.2%) and cash was also down slightly to 19.3%.
What really changed in 2010 was that the NPRF was going to try something different and that would be in its alternatives allocation.

Having already sunk a king’s ransom into stabilising the banks, the government realised it would not be able to do it again and would have to stimulate economic recovery. That is not an easy task when you’re up to your eye in debt and the IMF is scrutinising your every move.

So it decided to direct 5% (€250m) of the discretionary fund into Irish infrastructure projects through a fund set up by Irish Life Investment Managers and managed by AMP Capital.

Economic growth is reliant upon good infrastructure and infrastructure investment is much vaunted by some of the world’s largest pension funds, for the risk return balance and ability to generate cash yields for the long term. The Irish government elected to use public assets to generate interest from private investors - such as pension schemes and insurers.

A countrywide project to install water meters has been committed to the scheme, but the reason it should succeed is the clear commitment from the government to mobilise public assets, says Boe Pahari, head of infrastructure, Europe, for AMP Capital.

Mobilising private capital makes sense, he says, because tax revenues from small populations don’t lend themselves to such large-scale investment.

“Countries like Ireland with relatively small populations will have to rely on creating world class infrastructure in order to compete and to promote long-term economic growth.”

The NPRF has committed to increasing its allocation to €500m alongside private investments. While the insurance companies may see it as an opportunity to gain access to kinds of returns that used to be available from government bonds, pension funds may take some convincing, says Samantha McConnell, CIO of IFG Ireland. “There are more than €70bn invested in Irish private pension assets, but most are not invested in the Irish market,” she says.

IFG itself sold all its Irish equities in 2009 and holds no Irish government bonds. McConnell feels sweeteners may be needed: “There would have to be government incentives for there to be investment in infrastructure.”

Even so, she believes the NPRF is pretty much a busted flush as its “the impact on the pensions black hole will be negligible” due to its impoverished state.