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Impact Investing

IPE special report May 2018

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Proving FRR's credentials

Almost five years after its creation, the French Fonds de reserve des retraites (FRR) has experienced only one full real year of financial management, in 2005. Let’s remind a brief history of the FRR.
France, like many others, has to face a retirement problem with its existing system being unable to match the needs of an aging population. According to the government’s pensions advisory council (the Conseil d’orientation des retraites, COR), pensions spending will rise from 12.8% of GDP in 2003 to 14.4% by 2020.
Several reforms have reduced retirement promises and increased compulsory contributions to the Social security system, French first pillar for private sector pensions. But it will not be enough. To fill the gap, the reserve fund has been created by a law passed on 17 July 2001, with the goal of reaching a total asset of e150 bn by 2020 to cover the expected deficit of the national PAYG
system.
The first 18 months where dedicated to giving birth to the FRR as an entity, with the creation of its board of directors only taking place in late November 2002. The next big steps of building investment guidelines and selecting managers took place in 2003 and 2004. This process and the results it generated could only be assessed after a first full year of operational management in 2005.
Overall, the FRR’s achievement is satisfying and demonstrates its great professionalism, even if a number of uncertainties remain about its development perspectives, especially given its ambitious goal.
To better understand how professionally the FRR has been conducted, one has to look back to its genesis, notably the most delicate phase of selecting money managers and allocating mandates. To this regard, the 400 firms which participated to the beauty contest to get one of the precious mandates are certainly among the best informed to assess the quality of their selectors’ job. Let’s start from the beginning.
When the FRR was created, some feared this first national funded retirement system could have been taken hostage by political pressures. In France, funded pensions funds have a reputation of being capitalist tools threatening employment in companies they invest in and destabilising the more socially perceived pay-as-you-go retirement system. To avoid this suspicion, the FRR could have derailed from its objective with protectionist or biased investment rules like financing unprofitable industries to save jobs. It has not been the case. First, the investment target of the fund is widely diversified with 55% allocated to equities, of which 38% to Euro-zone equities but no specific portion to French companies, and 45% in bonds of which 38% in Euro-zone bonds.
Even better, according to all professionals either from French banks or foreign institutions, the FRR has not shown any national preference in its managers selection process. Of course, the role of the French Caisse des Dépôts is worth reminding. The CDC has been chosen to overview the administration and custody of the FRR, and to manage short term money market investments. But that’s nothing outrageous as it has always been CDC’s role to assume such tasks as the state’s private financial arm, managing holdings in partly privatised firms or social housing plans.
Otherwise, it would be hard to suspect any French preference in anything regarding purely financial aspects of the FRR as the whole selection process had been designed with Anglo-Saxon standards and executed by an international consulting firm which has retained an important number of foreign asset managers.
The consulting firm in charge of organising the request for proposal and reviewing the tender offers was no other than Mercer Investment Consulting, which was itself retained for the job after an RFP. The FRR being a public body, it has to follow strict procedures under the French Procurement Contracts Code to hire any contractor. But in practice, professionals estimate that the consultant selection relied primarily on high level relations. The consultant being selected, it has worked out with the FRR what experts in Paris qualify as “the most draconian process ever seen”.
On the last day of July 2003, the FRR sent a public “Call for tenders notice” to the Official Journal of the EU to grant 27 mandates together with 12 stand-by mandates allocated over twelve asset categories, for a total indicative amount of e16bn. It was the beginning of a long process to select three dozen winners among 400 candidates.
First, all interested companies had to submit their applications within six weeks, in the middle of the summer. After reviewing the applications with Mercer’s help, the FRR defined the eligibility of asset managers allowed to participate to the second stage of the selection process.
In this second phase, the FRR wanted to sent RFPs to the selected candidates starting in November 2003 and to take final decisions within the first quarter of 2004. “The whole process took months and put an incredible pressure on marketing people participating to the tender offer, reminds one of them. It was a marathon during the second half of 2003 then a sprint in the first weeks of 2004 when we had to work day and night including week ends to finish in time.”
Given the burden of work to be done to get among the finalists without even being sure to be selected for a mandate, some asset management firms simply decided not to participate from the beginning. “We knew it would take a load of time and energy and we didn’t have sufficient human resources at our marketing department in France to put them on this job at the cost of other tender offers we would have had to let go”, said a manager of tender offers for the subsidiary of a British insurance group.
Another reason mentioned by almost all professionals, even some of those who have won a mandate, is that the margins where too thin and that working for the FRR might not be profitable enough given the pressure to lower management fees and the exceptional quantity of work required by the FRR. Within professional circles it has been heard that a manager had agreed to lower its fees to seven basis points, no more than 0.07% to obtain a mandate in government bonds.
1, it doesn’t need so much skill and time to manage a e1bn government bonds portfolio thanks to liquidity and hedging tools available in futures markets. But managing the money is said to be only the visible part of the iceberg in the work needed to satisfy an FRR mandate’s requirements. “The real hassle will rely more on the reporting side, said a marketing professional involved in the process. The reporting standards are onerous compared to the average institutional mandate, especially in terms of performance attribution, the level of details to be given and the work to get there is a nightmare.”
The other side of the coin is that performance monitoring by the FRR is truly outstanding. Jean-Louis Nakamura, the FRR chief investment officer, has publicly stated that the fund will be extremely vigilant when comparing the coherence of performance sources they observe with those announced by the asset managers, either during the selection process or when they hold the mandate.
To help ensure its low cost objective and high standard of monitoring before starting the effective portfolio building and financial management of the FRR, a special mandate was awarded in July 2004 to a transition manager to provide centralised securities brokerage services throughout the initial portfolio-building period of the fund, with the aim of minimising transaction costs and market impacts.
The transition manager was also hired to help develop a global reporting capability. A US house, Goldman Sachs, won that contest. The same month, the French subsidiary of another US firm - State Street Global Advisors - won an overlay mandate for a period of three years to ensure currency risk management and tactical management for the portfolios of the FRR and to provide macroeconomic and financial advice and implement the tactical decisions made by the Fund’s executive board. It will also be responsible for hedging the currency risk.
If working for the FRR is demanding and not so profitable, the reward is considered to be more the prestigious marketing window it gives to asset managers as a mean to advertise their skills and professionalism to other potential institutional clients.
“Frankly, being able to say we’ve been retained by the FRR is more important to us than really managing their money,” says the representative on an US asset management firm in France.
The label ‘FRR approved’ seems more useful to reap other mandates than the profit a firm gets from the FRR mandates themselves. “We lowered our fees down to 0.35% to get a mandate in active equities, says one of the managers selected by the FRR, and we know we’re not going to make any margin on that fees as we usually wouldn’t ask less than 0.4% to manage a passive equity portfolio and at least 0.65% to manage equities with active strategies.”
With these figures in mind, some professionals consider the ideal position is to have a stand-by mandate to use as a marketing tool rather than an active one to manage. “We’re not in a hurry to see money coming into the fund and to have our stand-by mandate activated,” admits a US firm awarded with a stand-by mandate. A position that fits well with the actual pace of investing being slowed by delays in government contributions. With the priority given to reducing the budget deficit, rather than feeding long-term projects, some fear the target of e150bn will never be reached by 2020 if the government does not show more commitment in feeding the FRR with money raised from scheduled privatisations.
Even the stand-by status does not seem comfortable enough to every firm. In the beginning of 2005, JP Morgan decided to resign and noticed the FRR that it would not extend the validity of the offers for which it had been awarded two stand-by mandates by the FRR in Euro-zone large cap equities and US mid cap equities. The FRR announced it will not seek to re-award the stand-by mandates for these lots. Put together, these arguments explain why foreign firms are well represented in the panel of asset managers retained by the FRR but finally not so eager to grab all possible mandates awarded by the fund. And they will probably influence the results of the pending tender offers for socially responsible investing mandates launched in June 2005 and for the last private equity mandates launched in December 2005.
In terms of performances, the fund earned a total return of 12.4% in 2005 including money market investments and of 19.2% on the long term part of the portfolio, essentially composed of equities. A very daring achievement compared with the legendary cautious French tradition of investing.

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