Playing it safe

Nina Röhrbein interviews Bernard Caroyez of the Belgian pension fund Pensio B

In 2004, the Vandenbroucke law came into force in Belgium to strengthen the second pillar, creating a framework for all types of occupational pensions, including sector-wide pensions.

Before that, the Belgian construction sector distributed some of its reserves to retiring workers. But as this practice did not conform to the new Organisations for Financing Pensions (OFP) system, in 2007 a new sector pension fund called Pensio B was created.

Today, the fund covers all of the construction sector’s blue-collar workers. Pensio B also manages the liabilities and operations of the transport and logistics sector, which has approximately 50,000 workers – however, it is not responsible for the assets of that sector.

The pension fund is legally required to produce an annual minimum return guarantee of 3.25%. There are discussions to lower this rate, but the unions are one of the many parties against the proposal as pensions are perceived as a deferred revenue part of the wage package.

Insurance companies and pension funds, however, cannot guarantee 3.25% in the current yield environment without taking on risk. This is particularly difficult because the main principle of Pensio B is to keep risk and volatility at the lowest possible level.

The typical Belgian pension fund has an average allocation to equities of 35-37% – Pensio B’s current equity exposure amounts to less than 14%.

The fund’s first ALM study took place until 2009, but it is now only weeks away from approval of its second ALM study, which is expected to make further changes.

Following the second ALM study, Bernard Caroyez, investment manager at Pensio B, expects greater exposure to riskier assets.

“The figure is likely to increase because it is simply impossible for us to maintain our current strategy and generate our return targets in this low interest rate environment,” he says. “However, due to a general consensus with regard to our risk profile, I expect the exposure to equities to remain significantly lower than those at other Belgian pension funds.

“Our directors are not keen on taking too much risk. Ideally, they would like to have a linear increase of the assets, but as we have to value everything according to market value a smooth increase in assets is impossible. However, until now, due to the limited exposure to equities, not overly long durations in bonds and our specific allocation to insurance products, we have managed to keep volatility at a reasonable level of less than 4%.”

And with the help of its buffer – which currently stands at around 15% – the pension fund has always managed to generate its minimum guarantee, except in 2011. Should it fail to hit its target at any point despite its buffer, the sponsor would need to make up the deficit at the end of that year.

“But, of course, our challenge is to generate more than the required minimum target return each year,” insists Caroyez. “Until now we have had a return target of 4.3% in order to limit the expected volatility to 4.8% but this will be reviewed as part of the new ALM study. The idea to build up a buffer was a good idea when interest rates were high but at present this is almost impossible without taking further risk. Due to the low-yield environment and our investment policy focus on managing risk rather than increasing returns, I expect the new figure to be slightly below 4%. Still, we are in a better position now compared to when we first started to deal with constraints in the form of the potential IORP II directive, low interest rates or socially responsible investment (SRI) constraints, the latter of which we progressively include in our bond and real estate investments.”

The higher return target is a result of the prudent-man principle, with the directors preferring to build the buffer slowly. Once the buffer is deemed sufficient, Caroyez expects the strategy to be reviewed again.

Pensio B’s strategic asset allocation consists of 14% equities, 50% bonds and 6% real estate, with the remaining 30% in insurance-related products.

“It is atypical for pension funds to have contracts with insurance companies, and we were probably one of the first in Belgium to invest using insurance companies in 2008, in other words mixing a majority of bonds with equities,” says Caroyez.

“We decided to go for a CPPI product initially because we wanted to minimise downside risk and did not know what our long-term strategic asset allocation would look like. It was easier to have one product where we could delegate the tactical asset allocation decisions to the CPPI manager. The main reason to work with an insurance company was that pension funds in Belgium have to report their investments at market value but insurers can report part of their investments, the acquisition value for held-to-maturity bonds, in book value, which reduces some volatility in our figures. With this insurance product, we also have the possibility to take some money back if we needed additional liquidity and it creates an asymmetric source of return.

“Today these contracts are almost impossible to agree as insurance companies no longer want to guarantee a minimum rate of return as high as 3.25%,” says Caroyez. “Therefore the new strategic asset allocation is likely to phase out our current insurance products. We will not cut our exposure from 30% to zero immediately, we will reduce our allocations gradually and if we see insurance opportunities in the future we will still take them into consideration. If not, we will look for other asset classes with a similar profile, such as private placements or loans to companies with solid fundamentals.”

Pensio B undertook its first private loan in 2011.

“This loan has been generating a good return for us,” says Caroyez. “At the end of 2011, Belgium had no government, which is why back then 10-year rates for loans stood at around 5%. We managed to get a very high rate of return on this private loan to a solid Belgian company.”

The majority of the pension fund’s fixed income assets – 60% – are in corporate bonds, with the rest made up of government bonds. The overwhelming exposure to government bonds, around 80%, is to Belgian bonds and a handful of covered, agencies and supranational bonds. Only a small minority is allocated to emerging markets through a hard currencies, fixed duration fund hedged back into euro.

“But due to the low interest rates and our approach of investing through directly and not via funds, it will be difficult to continue this strategy we have used since 2010,” says Caroyez.

As it is underweight the financial and automobile sectors, Pensio B does not perceive any of the main bond indices meaningful enough to follow as a benchmark.

On the corporate side, Pensio B mainly invests in diversified investment grade bonds and denominated in euro, not in high yield.

To protect against any potential drawdowns, the pension fund can use futures to protect both bond portfolios against interest rate rises.

The pension fund’s equities portfolio is global. Initially it only invested in euro-zone equities before gradually diversifying according to the MSCI World All Countries index benchmark, with a particular focus on North American equities. The weightings of these are also likely to change with the new strategic asset allocation, which should be approved at the end of May.

“We want to support Belgian industry through our real estate investments. In other words, almost all the real estate and infrastructure we invest in – and 100% of all non-listed property – is located in Belgium,” says Caroyez. “Some exceptions to this are the open-ended collective investment schemes, the Belgian REITs (SICAFIs), through which we have some listed real estate and infrastructure exposure to France, Germany and the Netherlands. We are authorised to invest up to 20% of the real estate portfolio in neighbouring countries.

“Today we are much more prudent regarding counterparties and very strict on the ratings, which is why we have no high yield and almost no exposure to emerging market debt. This is why we also concentrate on local investments, particularly in real estate, but also in other asset classes. In other words, if we have the opportunity to invest domestically we will do so as we prefer to invest in what we can see or be more informed about, than something which is at the other side of the world.”

Overall, Caroyez expects the exposure to bonds to decrease and allocations to equities and real estate to rise with the new asset allocation.

“At present there is a contradiction between the 3.25% minimum return we legally need to achieve and the investments that our risk profile is allowing us to undertake,” says Caroyez. “Because of this, we need to change the opinion of the board to allow us to take slightly more risk, which is quite a challenge.

“The other paradox is that the regulator wants us to invest with a short-term vision to avoid drawdowns and underfunding, whereas the European Commission wants to promote long-term investing and pension funds to be long-term lenders while at the same time penalising investments in equities, private equity, real estate and high-yield bonds. The challenge is to find a balance between these different factors.”


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