Market deep in change
The current downturn in markets has presented Irish pension funds with what Nora Finn, chief executive of the Irish Association of Pension Funds (IAPF) calls the new ‘realism’.
Parodying the new ‘investment paradigm’ phrase that was banded about liberally just a few years ago, Finn says the new realism means greater evaluation of risk and how it is managed internally, as well as more emphasis on cost and ALM work.
“The larger Irish pension funds are setting up investment sub committees to look at all these issues. On top of that, the matter of the FRS17 accounting standard is preoccupying corporations and meaning that more company finance directors are getting involved in pensions decisions. There is also the issue of solvency requirements that were brought in under last year’s pensions amendment act (see box page 24).”
For Joe Byrne, deputy managing director at consultant Coyle Hamilton, this marks a significant change in emphasis for Irish schemes: “Previously a lot of pension funds were just following the herd and they weren’t really spending enough time looking at their portfolio and liabilities.”
One knock-on effect has been a greater emphasis on benchmarking among larger funds and a shift away from the traditional peer group comparisons.
Interestingly though, the ensuing drop in allocations to equities as a whole – averaging today between 50-60% (down from 70-75% four years ago) – has not seen a wholesale dumping of Irish stocks. The relative buoyancy of the Irish market over the last couple of years has meant that on average Irish pension funds still retain about 15% in domestic shares, albeit down from a more traditional 30% level.
Nonetheless, the disappearance in recent times of Irish stalwarts such as Eircom and Smurfitt from the Irish exchange, with many predicting that these exits will not be the last, will undoubtedly see domestic share investment bottom out.
As Anthony Gargan, chief manager, portfolio management, at AIB Investment Managers, jokes: “I guess if you were coming down off the moon you wouldn’t put 15% in Irish equities!”
Subsequently, the first port of call for Irish pension funds has been the bond market.
Tom Murphy, head of investment consulting at Mercer notes: “We are now certainly seeing pension funds shifting down the risk spectrum – the opposite to what they were doing three to four years ago. The bond exposure they are looking at is predominantly Euroland and over longer durations.
“On the introduction of the euro there was a quick switch to eurobonds and there is a move now to corporate exposure and here many funds are seeking passive exposures as there is not much opportunity set outside of this.”
The management of bonds then by asset managers in the market has, and will become, increasingly important in the coming months.
Gerry Keenan, director of investment development at Irish Life Investment Managers believes that innovations in the management of credits by different players will proliferate.
“It’s likely that we ourselves will tie up with someone to be able to provide corporate bond management and we will try to run an optimised index portfolio with credit rating skills down to around BBB. I think corporate exposure could go to about 7-8% of Irish pension fund portfolios.”
A further impact of the dip in equity allocations by Irish pension funds is that the portion invested in asset classes such as real estate has risen by default. Property now represents some 8-10% in the average Irish scheme – often directly held but with some exposure to European property funds.
While many in the market comment that they wouldn’t like to see the figure rise any higher, it seems legislation may have done their bidding for them. Government amendment to property stamp duty levels at the end of 2002 saw a rise from 6% to 9%, effectively capping the amount pension funds might invest.
Another area where Irish pension funds have sought exposure has been in forestry through the IFUT (Irish Foresty Unit Trust). To date this has mostly been made up of small allocations by some of the country’s larger funds, with experts noting that pension funds need to look closely at the methodology involved before making any commitments.
For alternative assets, however, it is a case of providers weathering the storm. If the larger Irish pension plans had begun looking seriously at hedge fund and private equity exposure in recent years, it is certainly not top of their in-tray pile today.
Pat Lardner, head of institutional business at Bank of Ireland Asset Management (BIAM) puts it succinctly: “Alternatives have a place but I think that where people are psychologically at the moment in terms of return/risk and questions on funding, it’s certainly not a priority!”
Few managers in the market doubt that interest in the area will regenerate, although most note that it will rely on the size of the pension fund.
And herein lies the rub with the Irish market. While the country does have a number of significant pension funds – indeed last year saw one of the world’s biggest institutional funds, the Irish National Pensions Reserve Fund (NPRF), undertake a comprehensive outsourcing programme – the bulk of the funds in Ireland are small, averaging at between e10-30m in assets.
This in turn continues to dictate the scope of their investment, as Byrne at Coyle Hamilton points out: “The fact that most funds in Ireland are small means that they still opt for a balanced portfolio mix. However, for the really big funds there has been a much greater emphasis on investment specialisation of late.”
He explains that this specialisation has taken a standard core/satellite route with the use of consensus type funds to dampen down volatility, a factor that he suggests is pushing indexation exposure within Irish funds up towards the 30% levels of the UK market.
This has certainly been good news for Bank of Ireland, which in 2000 set up a passive joint venture with State Street. BIAM, which today manages some e13bn in Irish institutional money, has enjoyed healthy domestic institutional business flows in recent years. The firm has also exported its model to notable effect in the US – a strategy that has earned the plaudits of its peers, many of whom acknowledge that they too have to expand their business overseas to remain competitive.
Lardner at BIAM, says that in recent months the bank has launched a number of sectoral passive funds, which he believes reflects where investor demand is headed in this area.
“The venture with State Street is going well and we are seeing that our presence and knowledge of the customer base and their scale and knowledge of indexation is a strong thing to bring to customers, particularly when you are getting into more bespoke functions.”
While the much-lauded NPRF outsourcing last year may not have impacted directly on the strategy of Irish pension funds, its impact looks certain to be felt over time.
Murphy at Mercer comments: “The knock on effect of the NPRF outsourcing is that it is seen as a flagship, state-of-the-art scheme: an example to trustees of what they could be doing.”
For Murphy, the implication in this is a gradual move across the board from balanced to specialist. This in turn is increasingly bringing in non-Irish managers – mostly from the US and the UK – who after the huge NPRF outsourcing are now on the marketing trail for further assets.
The evidence backs this up. There are now 19 non-Irish managers in the market, he says. “Last year I should say that these foreign managers picked up around half of all the institutional business that was out there in the Irish market.” The bulk of these overseas managers appear to be touting an aggressive single style approach, but it is finding favour as the alpha generator for a burgeoning number of Irish pension schemes.”
Byrne at Coyle Hamilton explains: “Firms like Capital International and Wellington have come into the market managing global equity mandates. Five to six years ago you wouldn’t have seen them here, but that has changed now and they keeping the local guys on their toes. That is not to say that there aren’t a number of Irish managers performing well. On top of that you again have to remember that the global equity approach only really works for a certain size of fund.”
Byrne believes though that it won’t be long before this product is increasingly directed at the mid-size (e50-200m) and smaller funds: “As a foreign manager, if you’re on the ground and you’ve got a bit of business coming in then you are prepared to take on more assets. A lot of these houses previously wouldn’t consider asset pools below e50m, but they are actively courting the same funds now.”
Similarly, Byrne believes that smaller pension funds looking for the type of specialisation adopted by the NPRF may look to the multi-manager approach: “This could become popular because in reality the choice of managers in the Irish market is relatively limited.”
Both SEI and Russell are active in the Irish market and Irish Life’s two-year old multi-manager programme has won DC pensions business and will target the DB market next year. Keenan at Irish Life believes that 10-15% of the Irish pensions market could eventually go this way.
Another reason for the success of the foreign players though has undoubtedly been the poor performance of some of their local rivals. The disparity in returns between the top and bottom Irish managers over the last three years has been striking.
For one of the smaller players in the market, Montgomery Oppenheim, this poor performance amongst some firms is endemic of a market where changes still need to be made and opportunities are rife.
Kevin Gallacher, head of business development at Montgomery Oppenheim, which manages some e800m in Irish institutional money, says he believes the firm differs by being “very definitely” an active manager.
“We don’t look at the peer group when we manage money. We have a global sector approach to portfolio construction, which has stood us in good stead in times of both value and growth stock outperformance.
“A lot of people in Ireland are disenchanted with what in effect is closet or quasi active management, where they are paying active fees but the managers have very tight asset allocation ranges, which in turn has lead to a herding of performance. That was fine when markets were returning 20% per annum, but when markets are falling the difference between 3% and 5% is marked.”
Keenan also believes that many managers in Ireland are under a lot of pressure, adding that bar one or two, most may actually be losing money at present in asset management. He believes this is tied in with the fact that some Irish managers are continuing to plough the balanced furrow rather than specialise.
“The move away from traditional balanced products means that others are struggling for product. I think you can draw comparisons to the UK market where the balanced managers just kept going and going until it got to late to react and they lost business.”
Gargan at AIB disagrees, however, on the projected pace of change. “The latest figures show that the Irish pension fund market is valued at around e44bn. That’s not a big number and therefore the number of mandates that come on stream that are going to warrant full scale specialisation is going to be limited.
“The market still has a predominantly balanced approach and while I think we will see more specialisation, if you look at the thousands of Irish pension funds then I think there is only a minority pursuing this. I don’t see it as a pressing concern for the majority. You need to have significant amounts of assets to get the benefits from specialist management.”
Nonetheless, Gavin Caldwell, chief executive at KBC Asset Management in Dublin (formerly Ulster Bank Investment Managers), concedes that the increased competition requires Irish managers to operate at what he calls “international standard” to survive. There is no domestic protection anymore. This means you have to come out and compete.”
Caldwell claims that the change of ownership of the firm will help it realise its goals: “As part of NatWest we didn’t have the opportunity to expand our business beyond the Irish market and that is why the change of ownership was good for us. Under KBC AM we have strengthened our investment process and we are also marketing to the US, in particular with EAFE products. We are absolutely committed to doing that.
“Asset managers in Ireland need to consider themselves as global managers with a base here, rather than just Irish managers managing Irish assets.”
Significantly in Ireland, however, the battleground for pension assets is still the DB arena.
Finn of the IAPF says that the DB pensions philosophy still holds sway in Ireland due to the partnership approach of unions and employers. “I think you can say that there is a new trend towards DC amongst new companies, but DB plans still represent something like 85% of the Irish pensions landscape and I don’t see that changing too much.”
Certainly there are very few DB schemes being created. Of the 13,500 pension plans that gained approval in 2001, only 61 were DB.
Byrne at Coyle Hamilton notes that those DC schemes that have been introduced are still at an early stage of development, however: “There are increasing numbers of DC plans, but very few fund choices within these. It’s nowhere near as sophisticated as DC in the UK, for example.
“There is no reason why there shouldn’t be more choice coming here, which would mean more managers and multi-manager products perhaps. The amount of potential DC assets, however, might be too small a pot for the international players to target directly, although they may sit behind some of the major international insurance companies.”
Another area of potential business for market participants could be the new PRSA accounts that will be approved this year (see box).
The question that begs then is just how the Irish institutional asset management market is going to look down the line. Gerry Keenan at Irish Life says he expects to see further consolidation amongst Irish and overseas players. “The issue for Irish managers is whether this will see them lose their niche market in Ireland. Personally, I don’t expect to see too many players surviving in the market as they are. There will be new alliances and I think the Irish market will also resemble the UK in a few years, with many more specialist players.”
Byrne at Coyle Hamilton, adds: “I can see a situation where one or more people will fall out of this market. For example, we could certainly see some consolidation in the life sector and I can see a situation where some of the UK owned life insurers will shift their Irish business back to the UK.”
Lardner at BIAM believes that the market downturn has signalled a wholesale change in the way pension funds consider their asset managers: “The days of just giving money to managers is gone. Pension funds are now looking at resources, stability, and the breadth of business within a manager as a mark of how it competes on a regional/global basis.”
Going forward, he believes the key to success in the market will be scale: “Managing the assets and performance has been important over the last few years. Managing the business has been just as important though because this is an industry where your revenue is cyclical and your costs are largely fixed. I think that for the Irish fund management industry the biggest challenge is to reach the scale that will allow you to have the infrastructure you need to manage money within reasonable cost parameters.”
Keenan sums up with a nod to both realism and hope: “We are deep in the pace of change at the moment. This does not mean the Irish market is not a good place to be – it is, it just means that it is not the same market it was five years ago.”