Italian asset managers are use to dealing with conservative, short-term investors. But the main impact of the financial crisis has been a switch of asset classes, finds Nina Röhrbein

Among the topics of conversation in the Italian asset management industry last year were the Bank of Italy governor Mario Draghi’s suggestion that banks and their asset management divisions be separated, an impending reform to relax the investment limits for pension funds, and the heavy outflows from mutual funds.

Fast forward a year, throw in a financial crisis and these issues are no longer pressing. Instead institutional investors seem to want to take a step back and hold onto asset classes they perceive as safe. And this has direct consequences for their asset managers.

While the talk of banks splitting from their asset management divisions has not completely disappeared, the process seems to be more a lot more subdued. So far Banca Monte dei Paschi di Siena is the only bank to have made such a move, although its newly created asset management division, Prima SGR, is still linked to large bank distributors.

The crisis also put the reform of decree 703/96 and its investment limits for pension funds on hold.

“The government does not want to introduce new rules in the current market environment that would allow investors to start using different instruments it cannot monitor and control,” says Carlo Cavazzoni, global head of distribution at Generali Investments. “But the reform could be introduced as early as next year.”

Italy’s famously conservative asset allocation and heavy investment regulation may have been criticised in the past, but it did limit the impact of the financial crisis on its institutional market.

“Closed pension funds are on average invested in traditional, balanced mandates, with 70% bonds and 30% equities and no exposure to alternative instruments or structured notes, which helped them in this crisis,” says Filippo Battistini, head of institutional sales of AXA IM Italy. “Pre-existing funds were protected by their large - up to 40% - exposure to direct property.”

“Because of its legal structure and conservative portfolio management the Italian system has proved to be quite resilient during the crisis,” agrees Paolo Moia, head of institutional clients at Eurizon Capital. “We, for example, did not have any exposure to asset backed securities or structured products and so our losses in the balanced management lines remained in the high single digits for 2008.”

Italian banks are said to have had little exposure to toxic assets due to their strict lending policies and have been perceived as relatively solid. Following last year’s the Lehman Brothers bankruptcy the Italian government announced it would guarantee bank deposits of up to €100,000 and offered Tremonti bonds - named after finance minister Giulio Tremonti - to banks in need. “But so far only one or two banks have asked for this help,” says Gabriele Miodini, head of Italy at Aviva Investors.

Italy’s crisis-related problems appear to be more linked to the lack of fiscal stimulus due to the country’s high debt and the lack of liquidity, according to Cavazzoni.

“However, some major problems could be caused by the unfolding crisis in parts of eastern Europe, to which some Italian banks are exposed,” says Battistini. “Italian banks have also been feeling the effects of increased global risk aversion, tighter credit conditions, falling asset prices and weaker demand as a result of the economic outlook.”
But the main influence of the crisis has been felt in the switch of asset classes.

“We have experienced more demand for detailed information and reporting,” says Marco Barbaro, Italy country head of BNP Paribas Asset Management SGR. “But most importantly we have seen a shift into less risky products such as monetary investments, government bonds and capital guarantees or protected solutions, although the profitability of these asset classes is generally lower than on riskier ones.”

But while the change in asset allocation is a global story, asset managers in Italy have an extra competitor to deal with: the trattamento di fine rapporto (TFR), the severance pay given to employees at the end of their employment. A 2007 reform allowed all employees to move their TFR to pension funds, but fewer than expected did so. Left with the company, the TFR receives a legally prescribed annual fixed interest rate of 75% of the inflation rate plus a 1.5% fixed rate.

“Employees compare pension fund returns to the TFR benchmark, which in recent years has been higher than the average market return,” says Claudio Pinna, managing director at Hewitt in Italy. “Every pension fund is legally required to offer a guaranteed line of investment, which replicates the TFR rate. And these low-risk investment lines have tended to be the ones chosen by pension fund members. Of course, this has influenced asset managers and the way they design products. Often asset managers try to guarantee a return too, a tactic, which is more connected to the short term than the long term. Ultimately, this means that pension fund members will lose out over the long term.”

“Although the assets in capital and return-guaranteed lines are still not as large as the those in standard products as they were introduced only two years ago, new flows are going massively into these new protected portfolios,” agrees Moia.

“And that is despite the coupons of guaranteed products being limited to 1.5-2% now, as nobody is willing to offer more than that,” adds Cavazzoni. He admits that Generali Investments runs a very prudent and defensive approach, both in fixed income and in equities, which he claims proved very effective in generating high returns during the market downturn.

Short-term view

Asset managers are also struggling to find enough interest for long-term products because employees have the right to transfer their pension fund individual account every two years.

“The client has no long-term view,” confirms Cavazzoni. “Even if the mandate is on a three- to five-year term, pension funds look for a positive result every year because to attract new members they have to demonstrate that they can provide a better result than the TFR. That means if asset managers fail to produce a positive result every year, they are likely to lose their mandate. Pension funds are also not yet ready to reinvest in equities. With the exception of hedge funds, they prefer alternatives such as real estate or infrastructure funds. Hence, we launched a 10-year infrastructure fund that provides a yearly coupon while at the same time mitigating the inflation risk over the long term.”

Institutional investors currently prefer to maintain their liquidity instead of investing in asset management products, according to Battistini. That is why some competitors, especially asset management companies belonging to insurance groups, have started selling insurance policies linked to with-profits funds, the so-called gestioni separate, he says.

“Italian pension funds are still a new industry, which people have yet to fully understand,” explains Moia. “And so it is widely believed to be better to err on the part of conservatism, particularly in this period. However, at a certain point in the future pension funds will have to shift a gear and move away from protected portfolios again. But I think that moment is still years away.”

But not everyone agrees.

“Protected returns have been offered a lot in the past, especially wrapped within an insurance-type product,” says Miodini. “But investors have become a lot more concerned about costs, and insurance-type products with a guarantee are very expensive. And for us this has increased demand for absolute-return products.”

Pioneer Investments managed to recover around 70% of its credit crunch-related losses by the end of May, according to Monica Basso, head of institutional Italy at Pioneer Investments. It achieved this by maintaining its investments in equities, corporate bonds and other asset classes that it believed were significantly undervalued in late 2008 and early 2009. “In those mandates, we have been long equities since November 2008 when we positioned our sector allocation cyclically,” says Basso. “However, since May we have been selling equities again in order to reduce the risk.”

“Italian pension funds that are limited in their alternative investments, such as real estate, commodities, inflation-linked bonds, have been the big issue for us,” continues Basso. “However, even those that are allowed to invest in them often prefer traditional asset classes at the moment. We now have to find out whether this is a long-term trend or just a reaction to the new perception of risk. We then have to do our best to advise investors regarding the differences between the management of the savings and the management of retirement plans. But they already had the chance to see that having a little bit more risk in your portfolio from January can deliver good results.”

Cash to the market
By and large, pension funds have not significantly changed their strategic asset allocation in the wake of the crisis, according to Barbaro. Instead, they spent the first half of 2009 analysing the situation and monitoring the market. “Therefore, we may see some strategic changes in the second half,” he says. “A few pension funds have already increased their exposure to corporate and inflation-linked bonds. We have also seen more pension funds looking at our currency overlay offering, mainly to reduce overall risk, although there is also some limited interest in the active side of currency overlay. Apart from that, demand tends to be for balanced solutions with around 20% equities and 80% fixed income.”

AXA IM continues to push its alternative expertise onto the market, such as private equity and real estate. And Battistini says that where institutions are allowed to invest in them they have been a success. “It is too early for investors to return to equities though,” he adds. “They are still very risk averse. But with this approach they run the risk of missing out on the opportunity to recover last year’s losses in the equity markets. We have already been trying to convince pension funds to adopt a life-cycle asset allocation scheme instead of the traditional balanced management, particularly when they have a very young demographic profile.”

But some market participants are hopeful.

“Investors are looking at big-time opportunities, such as in distressed or dislocated asset classes, as interest rates have fallen,” says Paolo Sardi, CEO of ECPI, a provider of sustainability research and indices that is part of Milan-listed holding company Mittel.

“They have been busy restructuring problematic exposures over the last eight-to-12 months and are now looking where to invest their large cash allocation. So I expect investors to return to the market by the end of the summer.”

According to the local pensions regulator Covip, Italian pension funds lost on average 8.5% of their assets in 2008. Closed pension funds lost 6.3%, open pension funds 14.1% and individual pension plans 24.9%. “These figures are not bad compared with losses on the equity or even the bond markets,” says Battistini. “And overall subscription to Italian pension funds increased by 7.2% to 4.9m in 2008.”

But with the exception of bond-only allocations, all types of portfolios generated negative returns in 2008 compared with the TFR, which was revalued at 2.7% last year. 

Consequently, new measures need to be taken to better promote Italian pension funds, such as incentives and widespread communications strategies, Battistini believes. Some major pension funds have already been communicating with their members.

“But all pension funds need to become more transparent and disclose, for example, last year’s losses and what amount of benefits their members can expect when they retire,” says Miodini. “Although figures show more employees joining pension funds, education needs to improve.”

Total assets of Italian pension funds currently amount to only around 3% of the country’s GDP.

But Pinna still regards the Italian market as a good opportunity for foreign asset managers, especially in view of the €15bn yearly accrual of the TFR. “The challenge lies in moving this money to the pension funds, where it can be invested,” he says.

Nonetheless, many foreign asset managers recently retreated from the Italian market amid the crisis, according to Battistini, although he stresses that competition is still fierce.

But Barbaro believes that foreign competitors will remain interested in the Italian market, particularly in the more dynamic institutional market. “The challenge lies in the profitability,” he says. “Fees are low, and combined with the general conservative approach, they are even worse. However, with more diversification in asset classes and more involvement of consultants, this ought to improve.”