The consultation process during the preparation of legislation to implement the EU pension directive has given the industry an opportunity to lobby the authorities on a number of issues.
“The process appears to have been a success,” says, says Kurt Bednar of Mercers in Vienna.
The main issue centred on a requirement for pension funds to give a minimum return guarantee, which was resented by the funds as reflecting an unwanted element of government interference. And when the draft legislation was issued in February it allowed employers to opt out of the system.
“This will save them money,” says Bednar. “Most employers have indicated an intention to opt out, although only about 20% have so far done so despite there being bonuses for those who decided early because they could get back the minimum guarantee fee for 2004 from their pension fund. The next deadline for notification will come at the end of November and the labour market estimates that around 95% of employers will tale advantage of the opt out, meaning that the whole system as we have known it for years will change.”
The guaranteed return was 50% of the secondary market return less 75bps averaged over the previous 60 months. “It was a very complicated formula,” says Bednar. ”It became a problem two-to-three years ago when everyone was under water and the minimum interest was not achieved for the 60-month period. At the pension fund sponsors were not willing to pay so they lobbied parliament to change the law.”
“The opt out is certainly affecting us,” says Günther Schiendl, head of investments at APK Pensionskasse. “Initially, it involves a lot of communication and explanation, so I think we will see a partial opting out, with generally the better informed decision makers being the more likely to opt out because they see the long-term costs of the associated guarantee. In addition, there is a connection between opting out and the prudent person rule coming into effect via the EU pensions directive because if a plan’s members decide not to opt out of the minimum guarantee then the prudent person rule cannot be implemented in their plan.”
Schiendl accepts Bednar’s estimate that 95% will take advantage of opt out but has reservations about the timing. “In the longer term that looks reasonable,” he says. “But somehow the decision-making process is slower than we wish.”
But the move will be reflected in changes to pension fund asset allocation. “If there is no need to guarantee then there will be fewer investment restrictions,” says Schiendl. “The factor of which I’m not definitely sure is whether the impact on the real life investment strategies is really so substantial given that the interest rate environment exerts a much more forceful influence that this guarantee.”
In 2004 58% of APK’s portfolio was in fixed income and absolute return “with absolute return playing a minor part”, notes Schiendl, 34% was in equities, 3% in real estate and 5% in money market plus. “Our average plan performance was 7%,” he says. “We had a good performance from bonds but the driver was the equity portfolio, which showed a return of almost 11%, and this made a substantial contribution to the overall performance. Our equity portfolio is 50% Europe and 50% world ex-Europe, so basically it’s a global portfolio with an underweight US.”
Designing a fixed income strategy in current conditions is problematic. “Interest rates are low all over the world, and although people have been talking about rising interest rates for the past three years, in fact the opposite happened, says Schiendl. “It looks as if inflation is creeping up in the US and this makes the situation quite tricky because if interest rates rise you make a loss or at least earn nothing on basically two-thirds of your portfolio and if rates fall further and your duration is too short will loose out to the competition.”
Further, the relatively high return targets APK has inherited from the past are exacerbated by current bond yields, says Schiendl. “In Europe these are now some 3.0-3.3%, which means that to achieve our target returns we have to take on risk, and this mainly means equity risk.
“Over the past two or three years we have implement our own risk management and tactical asset allocation overlay,” Schiendl adds. “This means that we have taken over the task of market risk management in equities, fixed income and currency. So we do not see our role solely as an asset allocator but as an asset allocator and risk manager simultaneously. This certainly involves a higher degree of short-term asset allocation switches.”
APK lost its position as Austria’s largest pension fund when towards the end of last year the e2bn multi-employer Vereinigte Pensionskassen and the e1.2bn banking and insurance sector pension fund BVP-Pensionskassen merged to become VBV-Pensionskasse AG.
Industry sources suggest that the merger appears to have been driven by the schemes’ common shareholders, including Erste Bank and other players in the loan and savings sector, rather than representing a move to consolidation in the pensions industry. “Sometimes you wonder why they actually did it because a lot of their investment philosophies were quite different and they now have to come to a conclusion of which one to follow now,” says one. The scheme now covers approximately 40 different funds with half of them going into some asset classes and the other half were not. For example, only those that were formerly part of BVP are invested in commodities.
“Currently the two funds are running more or less separate investment strategies,” concedes Martin Cech, senior investment manager at VBV. “The intention is that they will grow together through synergies.”
In 2004 VBV‘s average allocation was 58% for fixed income and variable-coupon bonds, 34% for equities, 5% cash, 3% in real estate though funds and 1% for alternatives, essentially meaning fund of hedge funds. The average performance was 7.7%.
“In addition we are picking out some strategies – which might be arbitrage, emerging market strategies and currency trading strategies – which we put on top of our long equity and long-bond portfolio, but which we don’t put under the heading of alternative,” Cech says. “Instead, we see them more as a complement or as an addition to the equity, bond or money market plus portfolio. So, were we to do a recalculation I assume the figure for alternatives would be something in the region of 5% or so.”
Cech says that there have been two major changes to VBV’s asset allocation over the year. “We modified our fixed income strategy by building up what we call our absolute return portfolio, which is intended to generate a return of money market plus 200 bps. And on the equity side we increased our allocation to Asia. This was done through funds. And I think we will carry on with increasing our allocation to Asian equities.”
Like Schiendl, Cech is concerned about the interest rate outlook. “We have a two-tier strategy on the bond side,” he says. “On the one hand we do not expect a dramatic rise in interest rates, so here we are going forward with, let’s say, a normal fixed income strategy. But on the other, we have an alternative strategy in place should interest rates rise.”
And he sees other challenges on the horizon. “Competition in the Austrian multi-employer pension fund sector has traditionally been very intense, and both last year and this we have been successful in attracting new business. But the European pensions directive opens up a new front as it allows insurance companies also to offer a pension product. However, it will not be until the first quarter of next year that we will have an idea of whether this will have any real impact.”
Nevertheless, Cech says that he is not really concerned by this prospect. “Our main challenge remains meeting return requirements of some 5-7% given money market rates of 2% and bond yields of 3.5% while at the same time undertaking the difficult task of rebuild funding levels after the market downturn at the beginning of this decade,” he says. “Some plans have funding levels below 100.”
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