Power management

The ESB is a pioneer among Irish public sector schemes. Pensions manager Brid Horan talks to Fennell Betson
The ESB – the Electricity Supply Board – is practically part of the Irish national identity. Its roots go back to the founding of the Irish state in the 1920s, when it was set up to run the generation and distribution of electrical power. The origins of the ESB Pension Scheme are not quite as venerable, but still date back some 50 years, as one of the first public sector-funded defined benefit schemes. At the end of 1998, its assets stood at Ir£1.8bn (E2.3m) making it the biggest fund in the sector, if not of all Irish schemes.
But it is only in recent decades that the fund’s investments have been able to move away from the restraining hands of the relevant ministry and shifted gradually from being heavily invested in government gilts. “Since 1995 the trustees have full investment discretion,” says Brid Horan, general manager, pensions. Horan joined the Dublin-based scheme in 1997 from KPMG where she headed the firm’s pension and actuarial practice.
“Gradually, over the years there has been more use of external managers and more active management of the assets to avail of the freedom to grow the fund. Now we have a fully discretionary portfolio, where the trustees with expert inputs make the broad asset allocation decisions and then appoint the asset managers to implement these,” she says. The fund has already undergone two asset liability studies, the latest in 1998, finalised this year. “We regard these as ongoing processes. But the latest study pointed to a development of the previous strategy, with the continued dominance of equities as the main form of investment and the importance of property as a real asset.” At year end, some 23% of assets were in Irish and 50% in overseas equities, with 21% in domestic fixed interest, and the balance in real estate, forestry and venture capital.
“We also took a close look at the impact of the euro on the portfolio,” says Horan. Funds need to ascertain the extent that euro-equities could be taken as the domestic market. “It will take time before people fully recognise euro-equities as the domestic base. We expect that there will be heavier weightings in Irish holdings than the normal equities weighting would indicate. But funds will move more into euro-based equities.” The main driver in her view is the stock-specific risk in the Irish market, where the top 10 shares account for 80% of the market. The move from Irish equities is expected to be gradual but both trustees and managers recognise that EMU offers an opportunity to reduce this element of risk and to avail of greater sectoral spread than is available in the Irish market.
The ESB fund has reduced its domestic equity exposure from 29% at the end of 1997. It also increased its Euro-zone shareholdings by appointing a manager to manage this brief . “With Irish Life we designed a Euro-zone fund which is designed to track the DJ EuroStoxx.” The thinking is to give the fund the “ability to manage its exposure to this market very directly, rather than just to have it fall out of other decisions”. However, there is no automatic switch of what is taken out of the Irish market into the Euro-zone fund. “We decided to go the index route for the moment, but that does not mean we would not move into a more active mode in the future.”
This move was designed to boost the European exposure, which the fund had through the three external managers handling the overseas equities mandates, the Bank of Ireland AM and JP Morgan, with active briefs, and Barclays Global Investors with an indexed one. “The active managers are managing in the Euro-zone in line with their own investment views.” At the end of 1998, these managers’ portfolios were invested 39% in the US, 14% the UK, 20% Europe and 9% Asia including Japan, with the balance in other markets and liquidity.
Though reducing in size, the Irish equities portfolio still amounts to a substantial tranche of Ir£400m, handled by the Dublin-based ESB Fund Managers, a subsidiary of the ESB set up to enter the asset management market. The ESB pension fund has been its major fund client, but it is winning additional outside business. “They manage the biggest chunk of our assets. Our relationship is very good and very close and they have done very well for us,” says Horan. “They are an independent company and are a separate commercial entity, which provides us with a service. We have an investment management agreement with them and they act on a normal fee basis for us with agreed performance targets and we are not tied to them. We are very pleased to see that they have established their credentials with other clients as an independent asset manager.” This manager also handles the fund’s long term fixed income portfolio which is over Ir£200m. She adds: “We have instructed them that the fixed income portfolio can be Euro-zone rather than purely Irish as it had been in the past.”
The property proportion has been as low as 2% of the portfolio due to rapid growth of the fund. Horan expects the real estate component to increase over time, only as suitable opportunities occur. The portfolio is handled internally though a real estate specialist manager, Brendan Donohue. “Over the last few years, we have sold a number of properties and have a number of acquisitions lined up. We want to have a portfolio with a good mix of property types and locations, including non-domestic and with a focus on quality.”
Something less than 1% of the portfolio is in venture capital situations, with an even smaller proportion in the Irish Forestry Unit Trust.
With 8,500 active members and around 5,000 pensioners, the fund is still relatively immature, even though it has been established for such a long time. This enables it to make such a strong commitment to equities and real assets. Horan reckons the fund is one of just a handful of large Irish funds that have taken the specialist route. “Our move to indexation with Irish Life and BGI was a move to put in place an element of passively managed assets, but with the majority actively managed.” She does not think the fund would ever go to balanced managers. “When you do this, you are effectively saying that they can add to the performance significantly by the asset allocation decisions. We think the jury is still out on that.” Having adopted its long-term allocation strategy, the fund’s approach is to stick by it. “Unless you believe managers can add value, why move away from this strategy? Of course, within the active equity overseas portfolios, the managers are deciding on the geographical mix, even though they have a benchmark.” But she does acknowledge that there is also a tactical aspect to having the Euro-zone tracking fund.
The fund monitors its investment strategy on a quarterly basis. “We keep things very actively under review in light of market conditions. Our managers have three-year rolling targets, but returns are kept under scrutiny, and there is an ongoing dialogue with them on performance issues. We would not wait for any three-year magic period – it is an ongoing and inter-active process. All managers have an agreed benchmark, depending on their mandate. This is measured quarterly and while we wouldn’t be making any decisions on this basis, we certainly discuss things with them at least quarterly.”
Horan emphasises the contribution made by its long-standing relationships with Mercer as the scheme’s actuary and Bacon & Woodrow as investment consultants. “There is a key advantage for us in having an investment consultant to provide a direct focus on investment policy,” she says. But acknowledges that having separate firms could pose problems. “There is a very good working relationship between the trustees, actuaries and investment adviser, with everyone working together to develop policy. If that was not the case, having separate investment consultants to the actuaries could be a different thing.”
Under the legislation setting up the scheme, trustees and a superannuation committee oversee its operation. The trustees look after the investment and funding issues, while the committee oversees the benefits side, and both bodies have employer and employee representation. “There is a very strong partnership approach to the scheme and strong interest in all aspects of the scheme, as I find also among the members generally, when I go to our partnership groups around the country and with groups of pensioners.” Horan, together with pension services manager, Dave McCabe and a staff of 16 provide all support services for the scheme.
The scheme is on a sound financial footing – now. This is thanks to substantial capital payments by the ESB to the fund in 1996 and 1997 and strong investment gains, which eliminated any need for ongoing deficit contributions. The fund assets invested in line with the long-term strategy returned a sizzling 35.6% in 1997. The overall fund return in short-term assets accumulated at year-end 1997 as a result of the board’s capital payments, which were invested on a gradual basis. This effect persisted in 1998, though less pronounced, resulting in an overall return of around 17%, just below the average of Irish pension portfolios.
The fund is currently in balance, with a small surplus, says Horan. “The fund is very well positioned, going forward, as is our investment structure and current situation. It is very adaptable for the future,” she says. “We believe that the key to success is combining the appropriate long term investment strategy with continuous review, active management and a proactive approach to the changing environment.”