Belgian pension funds are well funded, but their small size restricts their opportunities to diversify, according to Gail Moss
At a glance
• Belgian funds returned 4% in 2015, according to PensioPlus.
• Recent years have seen an increase in risk appetite.
• Funds face domestic and European regulation.
Two recent surveys showed Belgian second pillar pension funds keeping abreast of their own discount rates, with 2015 returns well over 4%.
Figures from PensioPlus, Belgium’s occupational pension scheme association, showed an average return of 4.4% for the 2015 calendar year, while the Mercer’s Pension Investment Performance Survey (PIPS), cited an annual median return of 4.9%, with 8.8% coming from equities and 0.5% from bonds.
However, in both cases, the funds underperformed 2014 – which saw double-digit returns recorded – and showed little innovation or shift in the main asset allocation categories.
According to PensioPlus, 45% was invested in bonds and 34% in equities, while the Mercer survey shows a split of 45.7% and 43.8% between bonds and equities respectively. Both surveys are based on 40 pension funds, but the samples are not identical.
“At present, we do not see a big shift in the general asset allocation of pension funds,” says Patrik Geldermans, senior officer, business development, at KBC Asset Management.
However, he says that the weighting towards bonds has been diminishing, in favour of cash and alternatives.
“The reason for this is clear,” he says. “The continuous fall in fixed-income yields makes bonds very expensive. Also, there is an expectation that this trend might reverse and cause losses. However, although reducing bond allocations is easy, it is far more difficult to justify increasing the weight in equities, as these are considered more risky.”
“The main trend for several years has been a shift towards riskier assets in general because of the very low yields from fixed income,” says Kristof Woutters, global head of investment solutions and financial engineering, Candriam. “Regulated discount rates for liabilities are about 3.5% to 4%, so they have been forced to move towards the riskier end of the spectrum to grow their assets by that amount, to avoid going into deficit.”
Within the equity space, Woutters says the main demand has been for European investments. “We are more positive on Europe than on international equities, as the US is further ahead in the economic cycle, so is slightly more expensive in price/earnings terms,” he remarks. “There is gradually increasing demand for emerging markets, but in the short term, the slowdown in these economies is discouraging investment.”
In fixed income, Woutters sees a shift along the spectrum from government bonds to investment grade corporate bonds, then towards high yield and emerging debt. “At the start of 2016, as markets reversed, there was a retreat into core holdings such as Germany and the US, but the long-term allocation to core bonds has decreased,” he says.
Geldermans agrees that investors are looking for higher yields, but remarks: “As these asset classes represent a substantially higher issuer risk, that is credit quality dropping below investment grade, the amount allocated to high-yield bonds is rather small. This is the case for most Belgian pension funds, given their small size.”
The Mercer figures support these observations. Government bonds slipped from an allocation of 25.7% to 21.8% between 2014 and end-2015, while corporate bonds rose from 17.6% to 19.2%. High-yield bonds made up 0.6% and 1.0% respectively.
Geographically, Woutters sees a short-term aversion to US corporate bonds because yields are still rising in response to the interest rate hike – unlike in Europe, where they have yet to start rising. “Furthermore, the US bond sector, especially high-yield, has been very much affected by the crisis in the energy sector as many high-yield bonds are exposed to the alternative energy sector. With oil prices going down, those companies are suffering a lot.”
But he continues: “This is just temporary, however. Those companies will deliver high returns later, giving a nice entry point for our clients. So we’ll see a shift from European to US high yield.”
Lack of alternatives
Unlike others, Belgium pension funds are not using alternatives to achieve yield.
Mathias Coumert, an investment consultant at Aon Hewitt, says: “There is an aversion to alternatives because people are very concerned that there is less transparency about their management than with traditional asset classes. They are also concerned about compliance with regulations. And there’s no appetite for derivatives among smaller pension funds, because they associate them with more risk.”
This highlights one of the problems with Belgium’s occupational pension fund sector: the small size of many funds means they are unlikely to possess the capabilities to give them confidence in venturing into alternative asset classes.
Only half of the funds in the PensioPlus sample have assets of more than €125m, for instance, with an average of €591m. But 14 others have assets in the €25m-125m range, while the remainder have portfolios worth less than €25m.
Coumert says: “There are a lot of small pension funds with limited internal resources involved in day-to-day management. So there’s no desire to change asset allocation, because it takes time to analyse the pros and cons for changing asset class or strategy.”
He adds: “Furthermore, there is often a need to improve the knowledge of financial markets within investment committees or the conseils d’administration [pension fund boards] which means they avoid implementing a sophisticated approach.”
Loans, however, are a potential growth area because capital adequacy rules for the banks have led to stricter lending requirements, and companies are looking elsewhere for finance.
“Loans are interesting for long-term investors because they are illiquid, and therefore, less volatile,” says Woutters. “The big pension funds are really looking at this asset class, but it hasn’t been adopted yet on a large scale because it is much more complex than other assets and requires a longer learning curve. The extra yield is currently also not sufficient for the additional level of complexity.”
However, according to Geldermans, some pension funds are willing to adopt new investment techniques.
“Sponsors have to guarantee a minimum return of 1.75% on the premium, and that is why dynamic asset allocation is gaining momentum,” he says. “We expect this momentum to increase further, so long as fixed-income yields remain low. At KBC, we have witnessed additional inflows in this investment processes, such as constant proportion portfolio insurance (CPPI).”
Regulation not funding fears
One area relatively free from controversy at present is the issue of funding levels.
“Funding levels were 120% for 2014, the latest year for which data is available,” says Geldermans. “So the debate isn’t about funding levels, but regulation. We have an ambitious minister of pensions who is promoting many reforms in areas which affect pension funds.”
In the coming year or two, regulation will be the key influence on pension funds, he predicts. And it will not involve just domestic changes.
“European regulation will have an increasingly important impact on how pension funds are organised and invested,” Geldermans says. “Certainly, smaller pension funds are already seeing an increase in time spent on regulatory inquiries, which is putting pressure on internal processes and personnel.”
The future is a concern to Coumert, particularly on the investment front. “We’re expecting lower bond returns, while equity markets have become more volatile than in the past,” he says. “And while a number of pension funds are trying to diversify away the risk, for instance into international equities or credit bonds, some are not prepared for negative market returns and their impact on short-term minimum funding requirements.”
Coumert says the next step for pension funds will be to implement techniques relying on alpha in addition to beta, although he warns this will take time. “Alpha is a means that helps to protect against downside risk, but there are burdens in changing, because of transparency, regulatory compliance, internal resources and the financial background, and also confidence in the asset manager’s ability to generate consistent alpha.”
Meanwhile, Geldermans says that as the minimum guarantee, which also applies to insurance contracts, is low, pension funds might gain a competitive advantage as their asset allocation implies a higher expected return than the expected return from insurance contracts.
Belgium gears up for cross-border beauty parade
Last November, Belgium’s pensions minister, Daniel Bacquelaine, outlined reforms he intended to enhance Belgium’s appeal as a domicile for cross-border pension funds.
Belgium, along with Luxembourg and the Netherlands, is competing to attract the pension schemes – and the assets – of multinational companies that have decided to exploit the administrative efficiencies of a pan-European scheme.
Despite high-profile moves such as ExxonMobil, figures show that only a dozen cross-border funds are domiciled in Belgium, out of the total of 75 known to the European Insurance and Occupational Pensions Authority (EIOPA). Ireland and the UK combined are home to about 50.
However, while Belgian-domiciled cross-border schemes attract pension plans from different countries – sometimes with different pension regimes – many UK/Irish structures are merely ‘across-the-border’ funds.
In spite of the enthusiasm, convincing non-Belgian plan sponsors to come to Belgium and set up a cross-border OFP remains a challenge.
Kristof Woutters, global head of investment solutions and financial engineering, Candriam, agrees that Belgium’s cross-border vehicle, the OFP, has an attractive legal structure, but says: “When, for example, Dutch plan sponsors are considering moving their pension fund to Belgium, it is a very difficult decision, because they have to liquidate their Dutch structure. It is nothing to do with incentives on the Belgian side, it is more of a question of culture.”
He adds: “Furthermore, setting up a cross-border pension fund is a very complex exercise which takes a lot of time and effort. So only a handful of big multinationals are looking at it.”
A technical issue that applies to all cross-border IORPs is raised by Thierry Verkest, leader of AonHewitt’s international retirement practice in Brussels. “Until now,” Verkest says, “cross-border funds in Europe have had to be fully funded. So cross-border schemes in Belgium have to be fully funded in the same way as standard Belgian pension funds, but many companies can’t afford to put that level of cash into a pension fund as a single premium. We are working with a number of companies who have put potential transfers to Belgian on hold because of this.”
Verkest says AonHewitt has been lobbying the European Commission to allow pension funds to apply recovery plans for domestic funds (OFPs), instead. “We are expecting changes to the requirement that they have to be fully funded,” Verkest says. “That will really galvanise the cross-border market.”
He says one advantage Belgium has is that its pensions regulator is working to help sponsor companies put an OFP in place: “In other countries, regulators are not necessarily very interested in moving foreign pension arrangements there.”
Verkest concludes: “Cross-border pension schemes are a reality. They have worked perfectly well for a number of years, and that is why multi-nationals continue to expand their schemes to other countries.”