Broadening the perspective
Quelle année? Ah yes, 2004. A particularly good year. Now, more than a year on from the requests for proposal issued by the Fonds de Réserve pour les Retraites (FRR) the impact on the market is clear. A gradual maturing of attitudes and approach received a massive boost from the FRR so that the range of asset classes being considered by French institutions has broadened considerably and the methods used to select managers and monitor performance is leaps and bounds ahead of where it was two or three years ago.
Pay-as-you-go is the mainstay of France’s pensions landscape. “The cultural shift means moving from a position where the PAYG system had no tradition of long-term asset management,” says consultant Jean-Claude Angoulvant. “The FRR is a good example of capitalisation being practised within the PAYG system. It was an example of governance and that the management of reserves must be done by professionals.”
He adds: “And this was given added legitimacy because the FRR was initiated by a socialist government.”
A large part of the PAYG system is represented by institutions known as caisses de retraite (CdRs) which individual professions set up in the post-war years to provide additional retirement benefits for their employees. A number of these institutions belong to two federations, Agirc and Arrco. Agirc is the system of additional retirement provision for management which dates back to 1947; Arrco is a supplementary system for all founded in 1961.
Like the FRR the CdRs have been putting sums aside to provide for the impending demographic shock. And these reserves currently amount to more than E30bn. “Arrco-Agirc manages significant amounts,” says Angoulvant. “It encourages CdRs to pass their money to them to manage – either in-house or outsourced. The CdRs manage some assets themselves, usually bonds and some equities. The amounts managed are usually in the order hundreds of millions of euros – not badly but in a rather an amateur fashion. The growth in the sums involved makes professional management that much more necessary.”
In this regard the example of the FRR is critical. A survey of institutional investors conducted by Paris-based consultants Amadeis at the end of last year shows that 58% will be using the example of the FRR in formulating their own investment policies.
“The added value of the FRR is in open architecture, the long-term approach and asset allocation,” says Daniel Roy, CEO at Natexis Asset Management.
The French are gradually breaking with tradition, and not before time. “The French market is a fixed income market,” says Jean Pitois, head of institutional business France at Axa IM. “So the fact that the FRR invested more than 50% in equities was very new and had a great influence on the market.”
Perspectives are broadening geographically too. According to the Amadeis survey 34% of institutional investors plan to diversify into Japanese equities during 2006; 27% into emerging markets and 26% into US equities. Richard Pandevant, head of marketing and communications at Banque d’Orsay, a subsidiary of West LB notes: “The FRR has, to some extent, made it more official that French public money can be managed by foreign asset managers, which may, in return, further increase the use of RFPs by French institutions.”
Traditional investment practices are certainly on the decline with a significant switch from balanced with little margin to use of core satellite. “This justifies the use of real specialists – asset class by asset class,” says Pandevant. “I wish the FRR would go further into specialist management and that over the long term it might consider high yield, emerging markets, convertibles or even dynamic money market.”
But we should bear in mind that the case of the FRR is somewhat different from that of institutional investors such as the CdRs, with no payouts until 2020. “The FRR does know that time is its friend,” says Roy. “The CdRs are under short-term pressure due to being subject to annual financial reviews which may be adverse due to the long-term needs of clients. But the flexibility of the FRR is unique – they have 15 years.”
In terms of asset allocation the FRR presented to the market an opportunity to break from the balanced approach which had disappointed in 2000 to specialised mandates. “The FRR has provided education and an example of best practice,” says Christine Moser, head of sales for France at Crédit Agricole AM. “And because six or seven different classes are more difficult to manage there are requirements for increased professionalism both from the investors and from the asset managers.”
The general feeling is that because of the way in which the FRR approached the investment management community there is now more transparency and more structure in the market. “It is a good thing for the end user that other IORP are following these principles,” says Thierry Callault, head of the board of Ofivalmo Asset Management in Paris.
But some feel that the influence of the FRR on market practices might have gone a little too far: “The FRR award was so huge and some investors are using this model for much smaller amounts,” says Henri-Michel Tranchimand, head of institutional sales at Dexia AM in Paris. “This is a pain in the neck; we flatly refuse a smaller mandate if it is accompanied by a same amount of paperwork as for a E600m mandate. The burden is too heavy for the amount of business involved. But we feel that this will corrected in time.”
One of the key signs that professionalism among investors is growing is the increasing use of the RFP. “Five to 10 years ago the personal relationship with the asset manager was more important,” says Philippe Lecomte, managing director of Schroder IM in Paris. “Now the client looks at processes, expertise and track record through the request for proposal.”
The use of the RFP has increased dramatically and again one can see that the FRR had a key influence on the market. In 2003 there were around 70 RFP worth a total of E7bn, according to figures supplied by Dexia AM; in 2004 there were 100 worth E23bn – this included the FRR; in 2005 there were 140 worth E17bn.
The recent surge of the RFP has had an impact on the use of consultants. “Before 2003 market for consultants was non-existent,” says Tranchimand. “By contrast in 2005 consultants were used in 20% of all RFPs. We are hiring a team just to deal with the RFP and have dedicated other people in the same team to consultant relations.”
As are a number of their competitors in the market.
Regulation is also driving the move to greater professionalism. “There has been a big evolution in compliance,” says Moser. “CdRs have the obligation to report to their members; this creates a need for more expertise and hence costs so the need for professional managers increases.”
Furthermore if CdRs want to manage in-house they must have a management team that is approved by the regulator – the Autorité du Marché Financier (AMF) – in the same way as an external asset manager. “So in-house management is progressively disappearing,” Angoulvant notes.
The need for more professionalism is also driving concentration in the market. “The trend is for CdRs to merge creating bigger sums,” says Angoulvant.
In terms of risk management and control there is increasing sophistication in the market. “I used to believe that investors lacked risk management and control,” says Callault. “But over the past 12 months most clients have set up risk management tools; their boards of directors are more concerned about these. They ask more questions of their asset manager to ensure that product is in line with the ALM.”
But there is still some way to go. “In the area of risk control and management investors could do more – this is a serious concern,” says Angoulvant. “But they are heading in the right direction.
The increase in the use of the RFP and consultants is increasing client focus on manager performance. “As a result of the FRR the rotation of managers is higher than before the where investors are reviewing results after three years,” says Pitois. “Before managers were kept on for five years or more. This and the increase in outsourcing is creating a huge market opportunity.”
CdRs are subject to strict quantitative regulations in terms of the classes of assets that they can use. “So a lot of pooled vehicles don’t comply with CdRs,” says Nuno Teixeira, deputy managing director of Schroder IM in Paris . “Some CdRs may only invest in OECD equities. Asset managers will not create hundreds of model portfolios.”
Teixeira cites the example of a recent fixed income mandate with a benchmark of the Lehman aggregate index but at the same time it had to achieve at least achieve Euro Libor +150. “However, we couldn’t use derivatives and couldn’t go down to more than a certain level of rating on the corporate bonds,” he says. “But as concentration progresses among CdRs and mandates get bigger we would of course be willing to adapt.”
The CdRs are not subject to the European pensions directive because they are first pillar. “This is definitely not a good thing,” says Callault. “But I think the regulations will move towards the directive.”
There is a growing sentiment that quantitative limits are not practical. “If you cast in stone investment limits it will not be good for every situation,” says Pierre Bollon, chief executive of the French Association of Investment Funds and Asset Managers. “The liability position is moving; so the pension fund directive is a clear signal in favour of the prudent person as opposed to strictly pre-defined rules. So it would be good for the CdR.”
But more positively we can now observe a greater openness to Luxembourg-based products. “Ten years ago it was very difficult to penetrate the CdR culture with a Luxembourg-based product,” Teixeira explains. “Often it did not make economic sense to create a local fund which would make necessary a large team and the amount of business would be small. So the new acceptance of Luxembourg based products is very important for asset managers. The media has helped drive acceptance by ranking all authorised funds whether local or foreign.”
As elsewhere the current environment of low interest rates is creating major headaches for investors and managers alike. “The outlook for this year on the government bond market is 0-3%,” says Lecomte. “I am not sure that people will understand the impact when rates go in reverse. On average equity exposure is around 20%, but for the remaining 80% of assets nobody has any ideas. There is an issue in terms of culture: people have lived with 80% bonds for many years.”
Some 52% of institutional investors judged an increase in interest rates to be their most significant concern in terms of investment returns for 2006, according to the recent Amadeis survey.
Again regulation is a major issue. “CdRs have to have a big portion in bonds – Eurobonds on top of that,” Teixeira notes. “Meanwhile the regulator considers a global fund to be same risk whether hedged or not. So on the institutional side the regulations need to be adapted so that they can be exposed to new products.”
But there is word that the regulatory constraints imposed on the CdRs will change very soon. “Agirc-Arrco are imposing new regimes on the CdRs,” says Pitois. “These will bring in a more diversified and liberal policy with scope for hedge funds, real estate and international diversification,” he says.
The low interest rate environment coupled with low and unpredictable returns from equities has seen the emergence of absolute return products. “This is one of the biggest issues of the moment,” says Petiniot. “Investors look for bonds allocation and there have been RFPs for absolute return products with derivatives, not far from alternatives. Because we do not have evidence of how resistant they are to an increase in interest rates, clients have to have a thorough understanding of what they are for. But there has been a lot of interest in this area.”
There has been significant interest in absolute return products. “We experienced a surge since the first rate increase last September,” says Thierry Rigoulet, head of institutional sales for France at Fortis in Paris. But he notes: “Meanwhile hedge funds can only promote themselves to qualified institutions with the right expertise so they have not been as strong as other absolute return products.”
Absolute return has also been combined with fixed income. “CdRs are very interested in these ideas,” says Moser. “Regulations oblige them to hold 50-60% in bonds but one can combine fixed income with other asset classes like absolute return so the quota is met while the impact of the increase in rates is smaller.”
When interest rates are low the answer is to diversify. “People have not bought equities in 2005,” says Roy. “The asset class that has benefited has been real estate due to low return on fixed income and the reluctance of the French to buy equities because of being risk averse.” Indeed according to the Amadeis survey only 13% of investors were concerned about a fall in real estate values in 2006.
The attitude of French investors is also a constraint. Pandevant suggests dynamic money market as a solution to the interest rate problem. “Is that unambitious?” he asks. “It’s just the French market. If you target a return above 10% with alternative techniques then nine out of 10 investors would consider it to be too risky.”
With this backdrop the Amadeis survey makes interesting reading. The survey states that 34% of institutional investors wish to diversify into alternatives during 2006.
SRI is also acquiring new importance in the market. The Amadeis survey shows that 51% of investors plan to incorporate SRI into their investments at some stage in the future. “Investors are becoming more concerned about governance and proxy voting and sustainable management,” says Pitois of Axa IM. “Until last year they were just thinking about it, now they are actually considering issuing SRI RFPs. Corporates and Agirc-Arrco are important forces here and the FRR’s SRI RFP last year gave new growth to the market.”
Overall the competitive landscape is changing as the big local players see their traditional domination of the market being progressively eroded, particularly where equities are concerned. “Many institutional investors think that big players are more benchmarked and less active,” says Petiniot.
Pitois goes further. “People consider that there has been a failure of the big five in delivering results. They have not been using the risk budget and have delivered less than the benchmark. Investors have been changing their managers and their consultants.”
Moser takes a similar line. “Through FRR’s example, the use of foreign managers by investors is quite normal today whereas it had been the exception in the past,” says Moser. “Now investors are more interested in performance. As a result foreign managers have a 20% share of the market today compared with near zero a couple of years ago. The boards of the CdRs are more open to the debate; until recently they gave mandates to French managers primarily for their performance but also for political reasons.”
The local players need to respond robustly. “The foreign and smaller provider deliver better performance than established players,” Roy notes. “The larger players have to reorganise their business model. The right approach is multi-boutique.”
RFPs and consultants have helped to open up the market. “It puts asset managers, on a level playing field,” says Tranchimand. “In the past quite a lot – maybe half – of decisions were made based on relationships. Now it is more like 30%. This makes the market more objective and performance-based.”
In addition to the influx of foreign managers local boutiques have also been successful. “They were able to make good returns on the back of the equity market and with the development of core satellite, Naïm Abou-Jaoudé, head of alternative investments at Dexia AM in Paris, notes. “Investors are using foreign managers and boutiques for the satellites while the large French players provide the core.”
According to the Amadeis survey 40% of institutional investors believe that a small asset manager could add value whatever the asset class and a further 21% believed that they could add value particularly in equities.
Another area of market growth - albeit modest in AUM terms so far - is the so-called ‘épargne salariale’ or employee savings which was boosted with the launch of new long-term retirement products that came into being at the beginning of 2004 following the Loi Fillon of the previous year.
According to figures supplied by the AFG by the end of last year they represented E329m under management, up 49.5% on the position at the end of last August. Some 2,333 Perco had been signed by the end of last year of which 90 were intercompany (PERCOI). This represents 23,169 companies - an increase of 93% in the second half of last year - and 587,046 employees.
The épargne salariale are now more interesting for asset managers as a result of the separation of account administration and investment management. “When administration and investment were bundled the very large banks and insurance companies dominated because the foreign players didn’t have the necessary infrastructure,” says Teixeira. “The fact that they are now separate means that we can compete on the investment side.”
Callault notes: “Epargne salariale is not progressing because the French government decided to allow participants to spend some of it to boost the economy.”
Sentiments are mixed. “We are pleased with the quick start of Percos,” says Bollon. “Nevertheless some improvements could be made to facilitate this strong development.”
At present an employer can offer the scheme to the employees who can either enrol or not as they wish. “In order to increase take-up we are lobbying government to suggest that the agreement could include automatic enrolment with the option to opt out,” Bollon continues. “We are also suggesting that if an agreement is not reached between the employers and employees that the management could offer the scheme anyway. In that case, there would be no automatic enrolment, of course.”
The épargne salariale poses challenges in that the financial management, account administration are very specific. “Some providers have merged their administrative capabilities,” says Roy. “Another challenge is that more and more is invested in the equity of the sponsoring company which necessitates the use of structural notes; however this is an investment banking product.”
The intercompany PERCOI are becoming increasingly popular. “It is the best way to organise the business because the costs are shared,” says Roy. “We need more of these, but for status reasons some want to keep their own fund so they may not be ready to share. It is a challenge to convince them to share.”
The disadvantage is that it is a long term obligation. The disadvantage with_PERCO is that it is a long term obligation. “It will remain a small market currently E60bn - because people don¹t like to pay money in that they will only see again and as life annuity when they retire.” Angoulvant refers to this as the “double tunnel” effect.
But even though amounts are small PERCO is important to asset managers. “Asset managers are interested because the companies are big and the funds will grow,” says Petiniot.
The makings of another Grande Réserve, perhaps?