Pragmatic view on asset choice
The Brussels-based Suez-Tractebel pension fund realised it needed to review its strategic asset allocation in the context of two key issues. Firstly, developments in the equity markets in recent years have forced many investors to rethink their risk control and budget policies. Then the new IAS 19 accounting standard put added pressure on companies to look at the downside risk for their pension schemes in the short term, in conflict with their nature as long-term investors, Suez-Tractebel says.
Suez-Tractebel thus set two objectives for its new strategic asset allocation policy in early 2003: to construct a portfolio for a long-term investment horizon and to ensure the fund is less vulnerable to short- and medium-term economic and market crises.
Key to the new allocation policy is a broader diversification of risk premium sources. Suez-Tractebel says it will continue to use traditional asset classes, such as equities, bonds and real estate. Some, however, may be redefined and strengthened. New classes may also be introduced, including high-yield corporate bonds, emerging market debt, convertible bonds, hedge funds and private equity. Moreover, new objectives have been set for some asset classes.
Suez-Tractebel uses a three-tier pyramid model to illustrate its new strategic asset allocation. The base consists of the ‘stability zone’, accounting for 37% of the overall asset base and is made up of 85% Euro-zone and 15% US investment-grade bonds. The middle block amounts to 20% of Suez-Tractebel’s assets and is known as the ‘buffer’. It consists of three asset classes, 10% of which is real estate, 5% funds of hedge funds and 5% convertible bonds. The top tier is the ‘return zone’ and accounts for 47% of the asset base, including a 38% equity allocation. Private equity amounts to 5% of the equity element, whilst high-yield corporate bonds and emerging market debt each represent a further 5%.
The three tiers represent the basis of the fund’s risk profile analyses but having broad diversification among asset classes is not enough on its own. Suez-Tractebel says it considers segment and management styles and approach as well when determining risk levels. This has led to the quoted real estate element only being invested in property in Belgium, France and the Netherlands, since these markets are known for their relatively low-volatility and high- yield characteristics. For convertible bonds, Suez-Tractebel favours managers with strong downside risk control, such as those that limit the average delta of their products.
Suez-Tractebel says drafting the new strategy served to highlight its internal skills and abilities. This is particularly pertinent with respect to private equity and hedge funds, which have a very broad return rate among different managers. Suez-Tractebel, finding it difficult to select the best managers, decided to remain cautious and use funds of funds. Moreover, direct investments in hedge funds and private equity would require disproportionate resources in relation to their weightings in the overall portfolio.
The key to the new strategic asset allocation is pragmatism. Suez-Tractebel says it only makes investments once it is positive it has a thorough understanding of their risk profile and the best management approach. It then also eliminates all non-remunerated risks, such as currencies, against which it remains fully hedged, since these add volatility despite zero returns in the long term.
The new strategy implies a reduction in volatility of 200 basis points and expected returns have decreased from 6.25% to 6%. But these are only theoretical projections and it is only in the longer term that Suez-Tractebel will know whether it has made the right choice.
The new strategy gives Suez-Tractebel the opportunity to create a Sicav fund, to be registered in Luxembourg this autumn, to which it will transfer all pension fund assets. The Sicav will then be split into three sub-funds corresponding to the pyramid’s risk profile zones – high risk = return zone, medium = buffer zone, low = stability zone – in which the assets will be invested. The Sicav means Suez-Tractebel, being a multi-employer fund, can apply a specific asset allocation policy for each individual scheme it manages based on its characteristics, such as the maturity of its liabilities and risk tolerance. Each individual scheme will be able to grow its portfolio by the level of exposure it wants to in any or all of the three sub-funds.