On the Record: Are you restructuring your asset allocation?
Edwin Meysmans - Managing director
• Location: Brussels
• Assets: €1.5 bn
• Members: 15,000
• DB-Pension scheme for employees of the KBC banking group
”We are undergoing the triennial review of our strategic asset allocation and asset-liability strategy, which will be completed before the summer. We aim to design a long-term strategy that has a time horizon of 10 years, but we must take into account the current dynamics of the market.
In terms of our long-term assumptions, we expect a normalisation of interest rates and inflation and expect returns from the equity markets close to historical levels (7% nominal and 5% real). We do believe, however, that the conditions over the next three years will not be ‘normal’, primarily due to quantitative easing (QE) in Europe. Therefore, we are making changes to the portfolio. This is meant to give us support over the short term, but it does not overshadow the importance of our long-term assumptions.
For the next three years, we believe interest rates and inflation will hardly change, and the expected returns from all asset classes will generally be below historical levels. We expect a 3% return for equity and real estate.
These lower expected returns affect our hedging strategy, and we are changing that accordingly. The hedging strategy has been static until now, whereby we would want to hedge 70-75% of the liabilities at all times. Including leverage, this means investing 40-45% of the portfolio in LDI [liability-driven investment] assets. We are moving towards a more dynamic hedging strategy, where the hedging level will reflect the current interest rate and inflation expectations.
If interest rates rise, we will increase our hedging level, and vice-versa. It is likely that in the short term we will reduce the hedging to 30%. As far as the 10% of assets that are freed from the hedging portfolio, we have no appetite to raise our exposure to equities, which is already between 35% and 40% (although we may increase the allocation to smart beta).
Our real asset exposure is 12.5% and we will raise that to no more than 15%, as we are wary of increasing the portion of illiquid assets. Hedge funds and commodities are asset classes we do not invest in at the moment. Therefore, that 10% will go into our fixed-income portfolio, which is invested in corporate credit, emerging market debt and high yield. We will also consider alternative fixed income – for instance loans, which look interesting due to their interest-rate sensitivity profile. ”
National Employment Savings Trust (NEST)
Mark Fawcett - CIO
• Location: London
• Assets: £786m (€1bn)
• Members: 2.9m
• UK government-backed defined contribution master trust
”There has been no change to our strategic asset allocation recently. However, we have just appointed Amundi to manage an emerging market debt (EMD) portfolio for us, and so we will shortly be incorporating an allocation to EMD into our strategic asset allocation, as we are seeing value emerge in this asset class.
We look at ways to invest that reduce portfolio volatility. This is partly about encouraging our members, particularly our younger ones, to continue saving in the early years, as well as seeking to shield all of our members from the most dramatic falls. We reduce portfolio volatility by using our risk budget carefully and by diversifying portfolios across asset classes. However, as we have an investment belief that investment risk is usually rewarded, we don’t try to make tactical calls on market volatility.
As part of our asset allocation cycle, we regularly assess where investment opportunities lie and evaluate the most attractive asset classes based on valuations set against market and economic conditions. However, we invest strategically and for the long term. This means we don’t try to adjust portfolios based on short-term market moves.
At the moment, we are about to start adding emerging market debt to portfolios. The mandate we have given to Amundi is a flexible one to invest in local and hard currency sovereign bonds as well as corporate credit.
We already have significant weightings in developed equities and property. Value is also beginning to appear in credit and emerging market equities.
We do not do tactical asset allocation. However, we do seek to manage risk dynamically. For example, we have recently adjusted our duration risk by reducing exposure to long-dated Gilts (both traditional and index-linked). We see Gilts as being overvalued and unlikely to generate sufficient returns for our members at current levels, particularly relative to other asset classes.
We do not believe there is value in economic forecasting. We prefer to highlight where we think the economic risks are and work out whether they are priced in and how to manage them.”
Marcel Andringa - Executive director, asset management
• Location: Schiphol
• Assets: €41.5bn
• Members: 141,000 (active), 167,000 (retirees), 309,000 (deferred)
• Second-pillar scheme for the metal industry
”Our strategic asset allocation has not changed over the past six months. In mid-2015, PME established its new long-term strategic asset allocation, and we worked out how to implement it this year based on our 2016 annual asset allocation plan. The market developments since mid-2015 do not affect PME’s long-term asset allocation strategy. PME expects a ‘silverlocks’ environment for risky assets for the next couple of years. This implies positive returns but with sizeable volatility due to high uncertainty around the European economy and central bank policy, as well as low market liquidity. However, we do not expect a bear market.
Given the high level of uncertainty, PME does not want to increase the risk profile of the portfolio, either in terms of asset allocation or interest rate hedging.
With regard to the strategies we favour, within our matching portfolio we have a preference for European investment grade credits and Dutch mortgages. In the return portfolio we favour European equities and real estate.
PME does not do tactical allocation. We limit ourselves to applying the strategic allocation in a dynamic way. This implies evaluating whether the strategic mix is still fit for the economic and investment regime (the base-case scenario), or if measures need to be taken to protect the portfolio against negative scenarios. PME does not act on short-term market moves or valuation changes, as long as these fit within the base-case range.
Our base-case scenario is a slow healing process for the economy after the financial crisis, where growth and inflation remain low but recover, and central banks support the economy with loose policy. This is a supportive environment for risky assets, in which funding ratios should recover.
We see a number of risk scenarios surrounding the base case though. The most important ones currently are: a hard landing in China; deflation in the European Union; global stagnation, market overheating and, more recently, Brexit.
We do not expect any of these risk scenarios to materialise in 2016. However, the clustering of these risk scenarios around our base case makes us less comfortable than before with being overweight the return portfolio versus the strategic neutral weight.”
Interviews conducted by Carlo Svaluto Moreolo