Case Study: Pegaso diversifies
As Pegaso reviews its asset allocation, increased diversification and alternative investments are key topics of discussion
- Global government bonds, US corporate bonds and EM equities recently introduced.
- Board has decided fund should have ability to invest in alternatives.
- Pension fund to mull adding illiquid assets when current external mandates expire.
Italy’s Fondo Pensione Complementare Pegaso, the contractual pension fund for employees in the utilities sector, has cautiously moved towards new asset classes over the last two years. This has been in response to the historically low interest rate environment. The fund could expand its investment universe still, in time for the renewal of its external investment mandates.
The pension fund offers members three different investment strategies, which consist of different asset allocations, carrying varying levels of risk.
The guaranteed option (comparto garantito) is composed of 95% bonds and 5% equities; the balanced line (comparto bilanciato) consists of 69% bonds and 31% equities, and the dynamic line (comparto dinamico) has 53% of assets in bonds and 47% in equities, according to December 2016 figures.
The fund completed its most recent asset allocation study in 2014. However in 2015, its board of directors acted on a proposal from Pegaso’s own working group on financial management. It decided to conduct an appraisal of its investment portfolio in the light of reduced five-year yield expectations.
The fund’s consultant, in conjunction with its finance department, assessed salary replacement rates for its members, and confirmed that rates would be more than 75% for most of the profiles analysed. However, the study found that there had been a 1-2% reduction in coverage since the 2014 study, and a fall in the likelihood of achieving the pre-established social security objectives that had been agreed upon in the 2014 study.
PEGASO key data
- Pension scheme for employees of public utilities and member firms of the Federutility
- Assets: €915m (end 2016)
- Members: 31,032 (end 2016)
- Founded: June 1998
- Location: Rome
But, after taking other factors into account, such as the time horizon, the income and social security positions of the members, the inflation and income assumptions, the replacement rates and target returns set out in the 2014 analysis were confirmed, says Andrea Mariani, Pegaso’s director general.
“The investment policy was therefore revised with the aim of avoiding any significant change to the sub-funds’ risk profiles, and to the type of mandates under management,” he says.
“Various hypotheses have been discussed and evaluated, including the addition of new asset classes,” Mariani says. “We have done simulations to do with this and developed statistics on risk-return parameters that would result”.
“These have shown an increase in the expected return with a less-than-proportional rise in volatility, and an increase in duration.
“The shortfall has also been improved under the revised investment policy, and the probability of achieving negative returns has fallen by 37%,” Mariani says.
Pegaso’s analysis has also illustrated that the maximum loss in case of negative performance has decreased by about 10% as a result of the investment policy changes.
“Expectations on replacement rates improved with the new management guidelines, and most of the profiles examined exceeded the overall coverage target set in 2014 of 75% of the last gross salary,” he says.
At the end of the process, Pegaso’s board of directors decided to introduce several new asset classes:
- Global government bonds ex-Japan – seen as a tactical opportunity, this asset class has been incorporated within the benchmarks for the balanced and dynamic investment lines;
- US corporate bonds — this asset class has been included in the balanced line;
- Emerging market equities — included in both balanced and dynamic lines.
As well as this, Pegaso’s directors also opted to increase the weighting of euro-denominated issuance in the corporate bond allocation.
In order to comply with the 2014 forecasts, currency exposure has to be maintained within a 30% limit, he says, which means using a hedged global developed market equity index for one part of the overall portfolio.
The directors also decided to expanding the pension fund’s investment universe to stimulate active management by granting managers more scope for tactical investment within high-yield bonds, emerging market government bonds and commodities, says Mariani.
In the next few months, Pegaso’s external asset management mandates are due to expire, and this, will return the focus to asset allocation.
“We will assess whether the investment universe should be expanded further, and look at illiquid asset classes in particular,” he says.
The fund will scrutinise the structure of the existing mandates to see if they need to be changed, and the aim will be to award the resulting mandates by the end of the first half of 2018, he said.
Pegaso’s directors have also decided that the fund should have the ability to invest in alternatives, such as private credit, infrastructure, private equity, real estate, Mariani says, though he adds that the characteristics of these investments pose challenges to the current structure of the fund and the duties of its trustees.
“If it is decided to introduce some of these instruments, then decisions will have to be made about which ones are to be included, to what extent, and not least, the investment model that is to be used,” he says.