A guarantee of limitations
Last month one of the most famous monuments in Belgium and star of the 1958 World Expo - the Atomium - re-opened after more than a year of renovation work. Newly gleaming in the crisp winter sunshine, this remarkable structure of giant interconnected mirrored spheres presents an enduring – though now freshly bolstered – image of modernity and optimism, of different elements working together harmoniously for the betterment of a whole that is greater than the sum of its parts.
So as it approaches its fiftieth birthday let’s hope that it can inspire the key players of Belgium’s pension fund investment scene.
The move by employers to DC schemes in an attempt to transfer risk to their employees assumed a new identity when the Vandenbroucke Law came into effect at the beginning of 2004 introducing a guarantee of 3.25% on employer contributions and 3.75% on employee contributions paid from that point.
“I don’t think it is reasonable to force the employer to guarantee a rate which is higher than the present risk-free rate,” says Hugo Clemeur, secretary general of the Belgian Association of Pension Funds (BVPI). “The system is not sustainable in its present form; the government should take into account the economic realities.”
Clemeur argues that the guarantee should be a rate equivalent to 60% of the long bond rate which applies in some other European countries. “The link between the minimum guarantee for pension funds and the maximum rate for life insurance should be cut and the rate should be allowed to fluctuate with the market.”
Part of the reason for the guarantee was to make the system as attractive as possible to workers and their representatives. But it also places the future of the pension system and the future of its asset management service providers in a straitjacket. “I don’t doubt that pension funds can achieve it in the long run – the problem is that the guarantee has to be paid every time an individual leaves the sector,” Clemeur continues. “It is a disincentive for new pension funds to start – this is the perversity of the system.”
The mood is one of frustration: “It might as well be a continual guarantee,” says Yves van Langenhove, head of institutional business for western Europe at Invesco, who illustrates the problem with Invesco’s own staff pension fund. He continues: “In principle one of the advantages of DC is that it offers investment choice. But the guarantee means that this choice is no longer possible. We used to have three options – an ‘aggressive’ fund with 75% equities, a less aggressive fund with 50% equities and a cautious fund with 20%. But from 2004 we did away with choice and replaced it with a balanced fund designed to achieve the 3.25% target with 20% equities – even though this route involves some risk. Otherwise we are giving a free call option to those who chose risk in their investment option. The implications of this for the asset management function are clear.”
The Fortis Investments staff pension fund is another that no longer offers choice of investments on account of the guarantee.
But is the situation as bad as all that? Francis Heymans, director of institutional sales and marketing at Petercam in Brussels sees things differently. “For pension funds the problem in the case of the guarantee is under-funding; yet the average fund has a funding level of over 130%,” he says. “Since the guarantee was introduced pension funds haven’t suddenly become more conservative.”
Maybe the Belgians are making life too difficult for themselves: “people can chose to leave money in the fund when they go; therefore it is not necessarily short term,” says Marcel Kunnen, relationship manager at Brussels-based Dexia asset management.
Food for thought?
Some argue that the guarantee will make sponsoring companies turn to an insurance company to take care of their pension arrangements. This in spite of the fact that in 21 years of BVPI statistics pension funds have returned an average of 7.9%; last year they returned 15.1%.
And this is also in spite of the fact that returns from insurance companies are likely to remain unexciting. “With the Belgian regulator (CBFA) watching closely, insurers will typically have to invest a great deal of the assets in fixed income, which will lower the expected return, given the interest rates of today,” says Michel Vanderelst, global head of institutional sales at Dexia AM. “If they do not, they do run too great a company risk , which the CBFA certainly will not accept.”
Chris Desmet, investment consultant at Watson Wyatt’s Brussels office explains that the guarantee makes even these relatively high pension fund returns almost irrelevant to some companies. “Scheme sponsors don’t look at the 15-17% returns,” he says. “That is what the employee gets; but the employer is more concerned with limiting his own cost and risk. So many companies buy a guarantee from an insurance company.”
Such a move presents a further important advantage for the sponsor company. One of the reasons DC schemes are attractive is that IAS19 only applies to DB schemes – in principle, at least. “But a guarantee does have to be shown in the balance sheet,” Desmet continues. “On the other hand, if the sponsor company can transfer the guarantee to an insurance company it can argue that it does not have a guarantee obligation any more so therefore there is no need to make a disclosure in the balance sheet, although IAS19 is not fully clear on this.”
Furthermore, for very small pension funds an insurance company can take care of everything, including the accountancy and other management functions.
Benoit Fally, managing director of State Street in Brussels believes that the insurance industry has a lot to answer for. “The insurance lobby in Belgium is very strong and has no interest in a strong asset management industry,” he says. “The 3.25% guarantee is the result of this; it is obvious that by introducing a guarantee many companies would choose an insurance company. The Belgian Association of Pension Funds is not as strong as the insurance lobby. So there should be more incentives to promote second pillar pension funds.”
But other managers are more upbeat and believe that the higher returns offered by pension funds are a significant attraction. “The feedback we receive from the larger funds is that they don’t plan to move to insurance companies in spite of IAS19,” says Stéphane Detobel, head of business development for Benelux at Crédit Agricole AM in Brussels. “Due to good performance of pension funds our large clients don’t have a problem.”
While some countries have introduced market rates for the valuation of pension fund liabilities, Belgium sticks to a fixed rate. Not only that, pension funds may use a rate of up to 6%, well above the risk-free rate.
“Using rates that are too high means that a pension fund will have the wrong idea of the available buffer and a wrong asset allocation as a result,” says Peter De Proft, CEO of Fortis Investments in Brussels. “There are some assumptions which are just too high.”
So are pension funds that use a rate of 6% storing up problems? “Funding rates would be impacted enormously if pension funds were to move their valuation of liabilities to 4%,” notes Van Langenhove. “But the 6% rate has the advantage that the fund can continue a more aggressive strategy and in the long run it will have higher returns.”
The market rates that have been introduced in the Netherlands have their opponents in Belgium. “If we have a variable rate we introduce volatility in the liabilities which adds another dimension that has to be managed, creating unnecessary cost,” says Fally. “So I am in favour of a fixed rate which could be reviewed, say, every three to five years.”
Another issue that is influencing asset allocation is the increasingly important subject of diversification. “Larger funds looking for diversification in private equity, hedge funds, emerging markets and commodities go for a foreign boutique player,” says Desmet. “Local players offer these but to a lesser extent – some pension funds think they don’t have the experience of foreign managers. Meanwhile the many small funds in Belgium are too small and lack the expertise to pursue diversification.”
Kunnen counters the claim: “You underestimate the professionalism of Belgian pension fund administrators, their consultants and their asset managers,” he says. “There is sufficient choice in well performing funds and processes available for each asset class. We believe this is true for local players… and our successes abroad clearly demonstrate our expertise.”
Olivier Lafont, head of institutional client and relationship management at Fortis Investments notes: “we are offering asset classes like US equities, convertibles and emerging fixed income through centres located around the world.”
Their foreign competitors are recognising their efforts: “Pension funds will look at locals as well if they offer the product,” says Detobel. “Between them the local players can offer nearly everything, with the exception of global tactical asset allocation, currency absolute return or commodities. So it is no longer a matter of local versus foreign managers.”
Perhaps it is more of an issue of size rather than local versus international. “When we started the institutional business six years ago our weaknesses were that we were small and unknown,” says Ivan Nyssen, CEO of Capital at Work Group. “For those reasons large pension funds would not give us a mandate. Size is less and less of a problem but it is still an issue – for the really big Belgian pension funds we are still too small. Our main challenge is to become bigger and better known.”
In some markets local managers have developed by focusing on those asset classes where they believe they are competitive and forming partnerships with ‘best in class’ managers of other asset classes so that they can offer their clients a complete product portfolio. This hasn’t happened in Belgium. “Local providers will only sell their own products,” says Fally. “It is a give and take thing; I think they should be more open because they cannot do everything themselves. KBC is probably the most closed of all the Belgians.”
So are we likely to see a more open approach in the near future? Nyssen thinks not. “The big local banks have a very strong grip on the retail business which helps them dominate the institutional market,” he says. “What helps them is the demand for the capital guarantee – investors are not so interested in specialist foreign managers. In terms of open architecture we are just at the beginning compared to other countries.”
What is offered as ‘actively managed’ in Belgium has been described as the equivalent of little more than enhanced indexing in the UK. “This is due to the mutual fund structure in Belgium,” Desmet explains. “If the guidelines are very dedicated many pension funds won’t use them. So they set up more flexible arrangements but with a lower tracking error so people will buy in to them, so in reality it is enhanced even though it is offered as actively managed.”
He adds: “To avoid this more sophisticated pension funds will ask the manager to pursue an active strategy and gives a minimum rather than a maximum tracking error. Managers are so scared of deviating from the benchmark that they have to be forced.”
But perhaps things are improving here too. “We are more aggressive and use tracking errors of 5-7% in equity mandates,” says De Proft. “The average mandate in the Belgian market is more passive than in the UK – indeed sometimes we get feedback that we are being too active. But today there is much more maturity among clients in the market.”
But one manager believes that the fault lies with the pension funds. “They must take more control,” says Van Langenhove. “They must give a clear mission to the manager and use a few managers so that they can compare. If manager has an easy client who is pleased with benchmark returns why should they take risk? The pension fund manager should say: ‘this is your risk budget – use it!’”
Belgian institutions still need to have something to hold on to, it seems. “When institutions here talk to us they are preoccupied with the benchmark,” says Nyssen. “We don’t use a benchmark but they want us to introduce one. So while we never reason using a benchmark we always present with one to reassure the client. Investors often prefer to feel that they are doing what everybody else has done - then nobody will lose their job.”
This may have something to do with the fact that, in spite of the low interest rate environment and the increasing potential for absolute return products, some of the more specialist products like hedge funds are making slow headway in the Belgian institutional market. Desmet points out that “Belgian pension funds and particularly the smaller ones dislike black boxes and seek transparency and stability. On average the larger pension funds have between 2% and 3% invested in hedge funds.”
It seems that Belgians are looking at hedge funds but they need to see a track record. “So it is more marginal than in other countries,” says Lafont. “By nature Belgians are very conservative and want to see something working successfully first before they try it.”
Often the problem for the smaller funds is, as Van Langenhove explains, the need to convince the board of the sponsoring company. “Funds are always more ambitious at the beginning of the year in terms of investing in alternatives like private equity and international real estate; if we do a correlation with the position at end of the year we see that the reality has turned out to be much less ambitious.”
The relatively small size of pension funds in Belgium makes mutual funds a popular choice – according to figure supplied by Capital at Work some 71% of Belgian funds are invested in mutual funds. The most popular mutual fund vehicle is the SICAV, not only because it provides a means to diversify for even the smallest funds but also because it is tax efficient.
Low fees are also an issue in the Belgian market. “Local managers offer very low fees but foreign managers are starting to undercut just to get a foothold in the market,” says Desmet. “Furthermore, even though pension funds say that fees are not the most important criteria when selecting a manager, often it comes down to fees.”
“Consultants should tell their clients that they would be better served if fees were not the only criteria,” says Detobel. “We know that if the fund is around €x25m AUM and we are looking at a global mandate it will come down to fees. We are losing on fees and that is frustrating.”
He adds: “Fees in Belgium are ridiculously low. Local managers are trying to keep market share; it may also explain the tendency of some of them to offer enhanced indexing – after all, you get what you pay for. We don’t want to compete for 10bps. But fortunately larger pension funds are willing to pay for expertise.”
The comparisons with other countries provide for interesting reading. “Belgian pension funds should be aware that quality has a price,” says Heymans. “A European equities mandate in UK would be priced at 40-60 bps; in Belgium the price is more like 20-40 bps. A euro corporate bonds mandate would cost 30-40 bps but here the price is more like 20-30 bps The priority in Belgium seems to be market share and that has to end.”
But maybe foreign managers are also responsible for the fees situation. “Fees are very low and it is true that some foreign managers are offering under cost,” says Fally. “We have lost some deals, notably against Vanguard where they offered for a ridiculous price.”
He adds: “Sometimes local managers make a bundled price for several products. Therefore as a foreign manager we are at a disadvantage.”
The competition is hotting up, as can be seen by the level of interest from foreign managers even in smaller mandates. “It is not unusual to have 50 participants applying for a mandate of €20m,” says De Proft. “The market is getting more international. But the Anglo Saxon managers have trimmed their fees to participate here.”
There is certainly a lack of sophistication when pension funds assess a potential manager. “Pension funds are too focused on past performance when selecting a manager,” Desmet explains. “The marketing boys always talk about the past returns but the pension fund should look at the risk profile of the fund’s liabilities and what returns can be expected in the coming year. Pension funds don’t always see the added value of this. First comes the ALM and the strategic allocation, if they are done at all. After that the manager selection is conducted quickly, although the strategic allocation is the most important.”
New expected legislation means that pension funds will have to become more expert in assessing their managers. Each pension fund is to have a statement of investment principles (SIP) to be reviewed every three years.
“Some pension funds used to stay with the same manager forever but now they will be forced to look at their investments because they will have to document performance,” says Desmet. “And this means new opportunities for the market.”
But he adds that it is not all good news. “Some will say that the new legislation produces too much administration so let’s go to an insurance company. We have had that reaction from two pension funds.”
But are the authorities laying down rules that are being observed already? De Proft thinks so. “I would not say that some Belgian pension funds do not look at performance,” he says. “They are not blindly staying with the same manager – that is a thing of the past. Indeed managers can lose mandates here for reasons other than performance.”
De Proft refers to a survey carried out around a year ago which found that the main reason for changing manager is that the relationship manager leaves; performance was second.
Real estate has shown a steady increase in importance. At the end of 2004 it accounted for 6.7% of total pension assets compared with 4.5% at the end of 2002, according to BVPI figures. “Pension funds prefer indirect real estate because the quoted value is important for valuation purposes,” says Clemeur. “But it is not very well developed asset class in Belgium; unresolved is the real value of real estate as a tool of diversification.”
With steady growth of sector funds which, according to Desmet, “will become significant – billions of euros – in the future”, the Belgian market is not short of future potential. An open, unfettered approach by government and industry players alike will be key to maximising it.