The progress of Pensioenfonds Metaal, the €331m pension scheme of Belgium's metal workers, illustrates the metamorphosis that many European pension funds have undergone as the size of their assets has increased.
As its assets have swelled six-fold, Pensioenfonds Metaal has made two major changes to the way its money is managed. The first change is to move from mixed to specialised investment management. The second change is to take charge of the overall direction of the investment management, rather than relying on consultants.
Pensioenfonds Metaal has come a long way in a short time. It was established in 2000 by the employers and trade unions of Belgium's metalworking industry, and currently provides complementary, second pillar, pension plans for more than 255,000 workers in some 8.800 metalworking companies.
Employers and employees are equally represented in the pension fund's advisory board. Five of the board members are chosen by Agoria, the employers' organisation, and five by the three metalworkers unions, CCMB, CMB and ACLVB.
The board also includes two independent advisers - the board president, Freddy Willockx, a former minister of pensions in the government of Jean-Luc Dehaene, and pensions consultant Karel Stroobants, who headed the VKG pension fund for doctors, dentists and pharmacists between 1993 and 2002.
The Pensioenfonds Metaal scheme is a contributory plan, with contributions paid solely by the employers. Contributions were initially set at 1% of gross wages and have since risen to the current level of 1.5%. The level takes account of the guaranteed minimum return of 3.25% a year that is required by the law on supplementary complementary pensions introduced in 2003.
The demographic profile of the scheme is young, and the average age of the metal workers in the plan is 39. This gives the portfolio the benefit of an enviably long investment horizon.
The plan's investment portfolio was set up in 2001 with an initial value of €50m. From the outset, the pension fund's advisory board considered bringing in specialised management. Yet the small size of the portfolio ruled this out initially.
To provide the necessary diversification and to boost competition, however, the advisory board opted for active balanced - or mixed - management, divided amongst four fund managers. All the assets were managed externally.
By 2004 Pensioenfonds Metaal's assets had grown to€200m, largely because of an annual inflow of €50m in pension contributions. To ensure that the growing fund achieved an optimal rate of risk/return, the advisory board, and its independent advisers, undertook a thorough investigation of the composition and management of the portfolio.
The result was two major changes in the way the portfolio was managed.
The first was a policy of in-house specialisation rather than outsourcing. Until the beginning of 2004, most of the financial responsibilities of Pensioenfonds Metaal were borne by an external consultancy firm. This situation changed in February 2004 when the fund hired a former portfolio manager of the Belgacom pension scheme, Greet Grauls, to the newly created role of finance manager. The in-house team now consists of a team of five that includes Greet Grauls, Kamiel Van Loock, the plan's managing director and Jan Frederickx, the operations manager.
The decision to take the direction of the pension fund in-house was prompted by a number of factors. The first was the importance of a meticulous follow-up process whereby the portfolio's risk-return could be monitored against the fund's guidelines.
This follow up process is carried out by Grauls in close collaboration with Van Loock. "Before, the custodian and asset manager was sent to a consultant who did an evaluation and who made a report directly to the board," says Grauls.
"Now we are screening the day-to-day management of the portfolios ourselves and also reporting to the board. We do the calculation of the performance in-house, the risk parameters, in fact, the entire monitoring."
The new arrangement has enabled more detailed reporting to the advisory board members, she says. It has also introduced the possibility of selecting specialist managers in-house.
The relationship with consultants also changed. The advisory board decided that, in future, the use of external investment consultants would be organised on an ad hoc basis. For actuarial and IT work, Pensioenfonds Metaal has maintained its relationship with Conac, the Brussels-based firm of consultants and actuaries. But in the area of finance - for example, conducting an ALM study - continuing partnerships with consultants have been scrapped.
The fund now chooses consultants according to their fitness for a particular purpose. Individual projects are placed with the consultant with the best credentials with regard to the level of service, pricing or other criteria, says Grauls. "We are not convinced that one consultant is able to do everything qualitative, so we are always in search of the best quality against price for the specific project."
This does not rule out the reappointment of consultants with whom Pensioenfonds Metaal has worked in the past, however. "We would not exclude Mercer for example, who we worked with previously for the selection of managers and what turned out to be a fruitful and pleasant cooperation," she says. The second major move by Pensioenfonds Metaal was the transition from mixed to specialist management. The main driver for this was the increasing size of Pensioenfonds Metaal's portfolio of assets.
The fund had already taken its first step towards specialist management in mid 2003 when it gave Alliance Bernstein the world ex-euro equities portion of the portfolio. "It was the first trial to work with specialist managers, and that trial turned out positive," says Grauls.
"We saw from the trial that it was easier for the follow-ups, so we were very pleased with that move. That's why early in 2005 we decided to manage the full 100% of our portfolio using specialist mandates."
An in-depth study by the in-house team endorsed this decision. "We adopted a number of criteria and looked at the possible advantages. We considered whether our portfolio was big enough, because it's not easy to find a manager who wants to manage only a few million in segregated accounts. We looked at the possibilities, and found there were no large obstacles to doing it."
Specialisation offers Pensioenfonds Metaal a number of advantages, says Grauls. It enables a more active follow-up and tighter control of asset allocation, and it optimises transaction costs. In the past, with four mixed portfolios, there was a risk that opposite transactions could occur simultaneously, and that one manager could be selling stock which another was buying.
The additional diversification reduces the overall risk, and eliminates the risk of overlapping securities holdings.
Another advantage is that the fund's performance, the benchmark return and the funding ratio can all be assessed with simplified calculations, which benefits the follow-up of the risk-return.
Finally, the move to specialist mandates means that each individual asset class can be managed by the best-in-class candidate.
The in-house team at Pensioenfonds Metaal used Mercer Investment Consulting (Holland), in line with its new policy of ad hoc partnerships, to help select these candidates. Mercer's job was to help with the critical phases of the selection process - the drafting of a request for proposal, the final scoring of candidates and the drawing up of contracts.
As a first step in the transition process, the Pensioenfonds Metaal team put the performance of the five existing fund managers under the microscope. Following this scrutiny, they decided to retain two of the five existing stable of managers: Alliance Bernstein as fund manager for the world ex-euro equities module and AXA IM as manager of the European real estate equities' part of the portfolio.
They then invited the other three managers to put themselves forward as candidates for one of the remaining mandates - euro government bonds, euro equities and euro credits.
The search for a manager for the euro government bonds module of the portfolio was organised in house. ABN Amro - at that time still Corluy Effectenbankiers, a private bank based in Antwerp - was chosen from an investment universe of some 10 fund managers. The other two searches were organised through IPE QUEST.
"In spite of the rather limited scope of the mandates, the search here bore a rich harvest," says Grauls. Degroof Institutional Asset Management (DIAM) was chosen from a long list of 30 candidates to manage the euro equities' mandate, while Capital International was chosen from a long list of 34 candidates to manage the euro credits mandate. The contract negotiations were completed at the end of 2004 and the last stage in the change-over process - the transition of the portfolio - took place early in 2005.
The in-house team monitors the portfolio
movement daily. It will also assess the manager's performance thoroughly over periods of at least three years, unless the circumstances in the market or the manager's performance makes an interim assessment necessary, says Grauls.
The current asset allocation of the pension fund is 45% euro government bonds (passive portfolio - benchmark Citigroup EGBI), 15% euro credits (active portfolio - benchmark Citigroup Eurobig ex-EGBI) 20% euro equities (active portfolio - benchmark MSCI EMU) 15% world ex-euro equities (active portfolio - benchmark MSCI world ex-EMU) and 5% european real estate equities (active portfolio - benchmark Citigroup European Immo).
This asset allocation differs little from the asset allocation of the original fund, which was 40% equity and 60% bonds. The large exposure to fixed income stems from the advisory board's decision to opt for a relatively defensive asset allocation, since in the initial stages of the plan the pension fund had no reserves and equity market valuations were high.
The main changes since then have been an exposure to listed real estate since the end of 2002 and an increase of the ex-EMU equity portion in the middle of 2004. At the end of every month, the eventual and available additional contributions are invested to bring the portfolio's asset allocation as close as possible to the strategic asset allocation.
The pension fund has also imposed a disciplined system whereby asset class exposures are kept within certain prescribed limits.
"The pension fund has set out specific boundaries for each asset class.
At the end each quarter, there is an assessment of whether or not these boundaries have been breached," Grauls explains. "If they have been breached, the pension fund will actively rebalance the portfolio by selling equity in favour of bonds and vice versa. This has never happened up to now."
The boundaries have been set to take account of the respective volatility of each asset class, she says. "Obviously equities are more volatile than bonds, so the equity part of our portfolio has larger boundaries within which it can fluctuate. We monitor these boundaries closely. If we deviate too much from our strategic asset allocation, we will re-balance by selling equities, for example, to buy bonds.
"Otherwise there is a risk that we will deviate too much from our long term course.
"It is not the purpose to rebalance too quickly following a temporarily sharp move on the markets. That would cause unnecessary transaction costs. Therefore, besides boundaries in function of the respective volatility, we do consider the average portfolio movement during the quarter instead of considering only one point in time - the quarter end."
The first ALM study for Pensioenfonds Metaal was carried out in 2000, just before the plan was set up, and implemented in a collaboration between Conac and Pragma Consulting.
Currently the in-house team is updating the study, in co-operation with Conac and the current investment managers. In the future, the pension fund plans to update the ALM study more frequently, says Grauls. "We are now in the first stage of the ALM where we are looking closely at the behaviour and duration of our liabilities. In the second stage, we will be looking at the asset side."
Depending on the outcome of the current ALM, the pension fund will consider either adding new classes for investment or enlarging/narrowing portions of the portfolio, she says. This will be a big exercise in the coming months.
One constraint is the size of the fund. "Given the still relatively small size of the portfolio, the pension fund has to take into account whether meaningful investments in extra asset classes can be made," says Grauls.
It is the advisory board's policy to invest through segregated accounts rather than funds, mainly for reasons of transparency and flexibility.
"We only have segregated accounts at this moment. So if it is not possible to further diversify our portfolio through segregated accounts, we will open new discussions about whether we will or won't invest, for example, through pooled funds."
The operations section of Pensioenfonds Metaal has also been set up in co-operation with Conac, which provided the IT platform for the management of the individual pension plans for all metalworkers who are members of the scheme.
Each September, members receive an annual benefit statement by mail which them with up to date information on their individual pension scheme.
Pensioenfonds Metaal decided to outsource this operation to a mailing company because of
the scale of the operation. All other administrative and operational tasks are handled by the in-house team.