ITALY - Italian pension funds have predicted that reforms expected to be approved by the second chamber of parliament this week - together with an investment law change scheduled for 2012 - will help local schemes to further diversify their portfolios. In an interview with IPE, the €1bn Fondenergia and the €250m PensPlan acknowledged that the changes expected for next year were likely to affect their strategies. But they said they planned to wait until after the reforms had come into effect before adjusting their asset allocations. Alessandro Stori, general manager at Fondenergia, said: "The fact the Italian government is seeking to increase by at least four years the minimum legal retirement age in future means the substitution rate would fall significantly. "Our aim is to maintain that substitution rate at around 100%. As early as January 2012, we will then analyse the effect of the first-pillar reform on this substitution rate and see what asset allocation strategy can be implemented." Michael Thomas, CIO at PensPlan, told IPE the pension fund would also keep a close eye on what the pensions watchdog (COVIP) introduced in the way of operating rules. Next year, COVIP is expected to review the investment law for pension funds - law 703 - and might add a 'proportion rule', under which local schemes would be able to adopt more active management strategies. According to both Stori and Thomas, pension funds would be allowed to diversify their portfolios by investing in asset classes they could "understand" and "manage", assuming those strategies had been approved by COVIP. Law 703, implemented in 1996, still represents one of the main constraints concerning investments in emerging markets and non-traditional asset classes. Thomas said: "The pension regulator has been working on the law for the past two years, and a new version is expected some time next year. "The current regulation only allows pension funds to invest a minor percentage of their portfolio in emerging markets, but the law is likely to open up to that extent. "In that case, we may decide to move more into countries that are currently offering a strong growth potential such as Japan and some Latin American economies." If investments in emerging markets are well researched and offer an attractive risk premium, as well as a satisfactory return on investment, PensPlan could see itself allocating more than 5% to the asset class in future, Thomas said. A revision of law 703 would also encourage further investment in alternatives, he said. "Investments in real estate vehicles in Europe would be, for instance, a very good diversification argument, as they provide high returns on a dividend yield," Thomas said. However, he insisted that the current sovereign debt crisis in Europe was not the main reason why PensPlan had decided to adopt a more diversified allocation strategy. He also said a potential downgrade of the euro-zone by credit agencies would not impact the scheme's plans, as it invests "independently". As opposed to PensPlan, a euro-zone downgrade could push Fondenergia to review its own investment rules, Stori said. "We are following this matter very closely," he added. "In the case of a downgrade of the euro-zone, we would consider potential changes in terms of investment principals and might change our minimum rating policy." However, Fondenergia, which holds a portfolio of A and AA rated government bonds, would analyse the situation country by country to determine whether or not the rating could be adjusted.