Gail Moss finds that despite healthy returns last year, 2017 will be more challenging for Belgian pension funds 

At a glance

• The equity allocations of Belgian pension funds are gradually rising.
• Diversification is seen as a way to protect against investment risk.
• Schemes are diversifying into high yield and emerging markets within their fixed income portfolios.
• Allocations to alternatives are growing, but slowly.

Although, Belgian pension fund portfolios have seen an incremental shift towards equities in recent years and there is an awareness that interest rates may rise, there have no been major changes to asset allocation.

Figures from PensioPlus, the occupational pension scheme association, show an average 40% allocation to equities at end-2016, with 45% in bonds, and 4% in real estate (see figure). This compares with 34% in equities, 45% in bonds, and 5% in real estate the year before.

While there appears to be no particular change in terms geographical bias, there has been a shift in the perception of Europe as a region, according to Kristof Woutters, global head of investment solutions and financial engineering at Candriam.

“Within equity, there’s a shift from looking at Europe versus the world ex-Europe, to the euro-zone versus the world ex-euro-zone,” Woutters says. “European pension funds always have a domestic bias but we no longer regard Europe as a domestic market because it includes the UK. So equities in European countries outside the euro-zone are regarded as international stocks. Furthermore, UK exposure is also being reduced. But it is difficult to say if it will be for the long or short-term.” 

asset allocation of belgian pension funds

Risk to the fore

Pension funds are finding a variety of ways to protect against risk. Mathias Coumert, an investment consultant at Aon Hewitt, says some are starting to think about increasing diversification to less conventional investments, such as from directional towards non-directional strategies or from liquid to non-liquid strategies. 

Gisèle Dueñas-Leiva, institutional sales director for Belgium and Luxembourg at Franklin Templeton Investments, notes the regulatory pressure on funds in terms of risk management, especially interest-rate risk. 

“Some of the pension funds with more than a 65% allocation to fixed income in their portfolios overall have been questioned by the regulator with regard to interest rate risk,” she says. “But, regulatory control focuses more on the short-term and long-term technical provisions to prevent funding deficits.” 

There are of course other strategies to manage interest rate risk, says Patrik Geldermans, head of institutional business development at KBC Asset Management. “One way is to close the defined-benefit pension scheme and open defined contribution schemes,” he says. 

kristof woutters

But in investment terms he says pension funds are looking more into alternative strategies, such as constant proportion portfolio insurance (CPPI) or minimum variance, to limit portfolio risk: “Still investing in traditional asset classes, CPPI techniques create a more asymmetric risk profile, reducing downside risks, while keeping the upward potential,” he says. “Increasing the equity allocation is also considered, but there is a preference to implement this through low volatility-strategies.”

Dueñas-Leiva says some are looking at risk overlay in tactical asset allocations to limit drawdowns. Woutters says funds with a short-term investment horizon are looking to downside risk control techniques. For example, those in a restructuring plan may be subject to a ratchet system, according to which coverage ratios may not fall once they have reached specific levels.

“Too much volatility in the market could deleverage the whole portfolio, so these techniques are seen as safe haven investments,” he says. “However, there are big opportunity costs, so they are really only for investors with a short-term investment horizon.”

Woutters also sees increased interest in environmental, social and corporate governance (ESG) investing as a way to protect against risks: “Pension funds have started to ask more questions about ESG. They realise that by implementing ESG they can reduce their risk profile.” 

Bond diversification

Meanwhile, looking specifically at fixed income, Woutters says the fear of rising rates is leading many funds to look at shorter duration bonds and change their benchmarks accordingly. A move away from government bonds towards high yield or emerging market debt has been in place for some years.

“Pension funds with more than a 65% allocation to fixed income in their portfolios overall have been questioned by the regulator with regard to interest rate risk” 
Gisèle Dueñas-Leiva

“Over the past few years, we have seen a trend of Belgian pension funds shifting their fixed income allocations towards corporate investment-grade bonds, and reducing government bond exposure, therefore taking credit risk,” says Dueñas-Leiva.

She also sees funds investing in new fixed-income sub-asset classes or geographies to limit risk: “For example, some of the larger players in the market have been diversifying out of the euro-zone and looking into US investment-grade credit and US high yield, US short duration or global aggregate strategies.” 

Coumert observes interest in emerging market, high yield and inflation-linked bonds. “In some cases, the use of packaged investment solutions such as multi-asset credit makes sense as there is a specialist in charge of managing the sector exposure,” he affirms.

A large pension fund presence at a 2016 Institute of Belgian Actuaries’ seminar on negative long-term interest rates demonstrates an awareness of the interest-rate risks in bond portfolios, according to Geldermans. 

“But of course, solutions are very scarce,” he observes. “Shortening duration is not an option, as this increases the mismatch between duration of liabilities and assets. Also, the current yield of short duration bonds is negative. Non-investment grade bonds are sometimes added to the portfolio. However, this is not a wider trend.”

No alternatives? 

Alternatives are a standard way to boost a portfolio and increase diversification. “We are noticing that there is more appetite for alpha strategies, multi-asset or even some liquid alternatives, and non-liquid strategies [such as] real assets, than in the past,” Coumert says. “This is the case for the Aon multi-employer offering, where multi-asset investments are part of growth assets.”

A few large funds are increasing their investments in specific areas. “This includes allocation to infrastructure and real economy projects,” says Dueñas-Leiva. “We have also seen some impact investing, which is supporting local job creation in Belgium.”

However, Woutters says alternative allocations are increasing only incrementally given the small size of Belgian pension funds. “[Alternatives] are exotic and complex with a long learning curve,” he says. “That, and their relative illiquidity makes them difficult asset classes in the current market.”

“Alternatives are not yet breaking through. This asset class is seen as being too diverse, too risky, too opaque, and too expensive” 
Patrik Geldermans

Geldermans agrees: “Alternatives are not yet breaking through. This asset class is seen as being too diverse, too risky, too opaque, and too expensive. Also, because of the relative small size of the average pension fund, this asset class is only invested in by the top three pension funds, with assets in excess of €1bn.” 

“We believe that in this market environment it is getting harder and harder to find low-risk returns, although it largely depends on what you see as risky,” says Dueñas-Leiva. “Traditionally, fixed income is seen as a less risky part of the portfolio, while alternatives have been perceived as riskier.” 

“Diversification to alternatives, such as real estate and private equity, is still relatively limited in their [pension funds] portfolios,” she adds. “Traditional hedge funds still remain out of favour, as they have not recovered from their ‘risky’ reputation post global financial crisis.”

Dueñas-Leiva sees no large-scale changes in the way Belgian pension funds invest. However, she says the largest funds have been exploring alternative beta solutions as the market becomes more aware of the underlying factors of risk.  

“We have seen interest in strategic beta portfolios as they help meet investors’ desires to pursue better risk-adjusted returns than with traditional cap-weighted indices,” she says. “There is curiosity about the multi-factor approach as it can mitigate the cyclicality of individual factors.”

Equity boosts returns for Belgian pension funds

Belgian pension funds had good news recently in the form of an increase in average nominal returns from to 5.8% for the calendar year 2016 compared with 4.4% for 2015 (figure). This makes a real return of 3.65%, according to the latest PensioPlus survey of 52 participants. It takes average nominal returns over the five year period to the end of 2016 to 7.97% (6.62% in real terms). The ten-year average return is only 4.41% nominal (2.47% real).

average nominal and real returns

Mathias Coumert, an investment consultant at Aon Hewitt comments: “At this stage, and given the good rally in equities, pension funds posted positive and satisfactory returns in 2016. [This year] will probably be much more challenging. That’s why investors are discussing integration of these less conventional investments either in asset-liability management studies or in the portfolio construction.”