COVID-19 has put paid to the FRR pension reserve fund’s planned transition to a new status and investment model
- The FRR pension reserve fund pays €2.1bn a year to the CADES debt fund
- Payments are now planned to continue indefinitely
- A new investment policy has been postponed
Less than a year ago, the future of the Fonds de réserve pour les retraites (FRR) had been well mapped out.
Based in rue de Lille, Paris, FRR was set up in 1999 to buttress the pay-as-you-go state pension system, and now pays €2.1bn a year to the Caisse d’amortissement de la dette social (CADES), a fund established in 1996 to assume and redeem past social security debt.
FRR started investing in 2004. Since the beginning of 2011 – when it stopped receiving contributions and started making the payments to CADES – it has achieved an annualised average return of 4.9% net of all expenses, much higher than the cost of public debt borne by CADES (1.05%).
The annual payments were set to end in 2024, when CADES’ debt was due to be fully repaid. In parallel, FRR was due to be transformed into a reserve fund for the universal pension system that president Emmanuel Macron is planning to introduce. The change was to be effective from January 2022 and FRR was to be renamed Fonds de Réserves Universel (FRU).
As a buffer fund for the pay-as-you-go pension system, the new FRU would have no foreseeable end date, and therefore a much longer investment horizon than FRR. Furthermore, its liability profile – incorporating regular payments to CADES – was set to become much less onerous in terms of investment constraints.
Both these factors meant FRR would have been able to embark on a new investment approach – for instance by transitioning its asset allocation to more illiquid, long-term classes.
However, as with many other projects, the arrival of COVID-19 has led to these plans being delayed.
On 16 March 2020, Macron declared his intention of suspending his overhaul of the pensions system because of the pandemic.
This was followed in May by the publication of a new government plan to deal with deficits in the social security system resulting from the virus. Social security debt of €136bn was to be transferred to CADES, to be paid off by 2033, with CADES’s lifetime extended accordingly.
The legislation proposes that FRR be required to continue annual payments to CADES, although at the rate of €1.45bn rather than €2.1bn per year.
The extension of FRR’s contribution to CADES is foreseen “to the extent that a significant portion of the current or future debt relates to the pension regimes”.
The government says the proposal would see FRR making the revised annual payment until 2033 – meaning €13.05bn in total extra payments – “or until reserves are exhausted”.
A second proposed measure was to bring forward a scheduled payment to CNAV, the national old-age insurance fund, to 31 July 2020, amounting to €4.9bn as at the end of the previous April.
Changes in direction
Any public investment fund runs the occupational hazard of changes in government policy. Now this risk has been supplemented by the rapid about-turn caused by the government’s response to COVID-19. This means that FRR’s planned new investment model will not be adopted as early as planned, and indeed will suffer an indefinite delay.
However, FRR has had to deal with similar contingencies before. France’s pension reform of 2010 was also a major watershed for FRR: inflows into the fund were stopped and a fixed-liability schedule for payments to CADES between 2011 and 2014 was set. FRR switched from an ‘assets only’ strategy to a fully-fledged liability-driven investment (LDI) approach.
Executive director Olivier Rousseau joined FRR towards the end of 2011 when the fall-out was still being felt. The fund carried out what Rousseau called a “brutal” de-risking process in a 2017 interview with IPE.
He said: “The fund had to sell equities at the wrong time. We abandoned real estate investments just when we were about to award two mandates worth €1bn and had reduced our commitments to private equity from €1.5bn to €1bn.”
Ten years on, with France’s financial landscape dominated by COVID-19, it is now, however, a case of adjusting investment policies and asset allocation to a continuation of regular outflows over an indefinite period, instead of the planned segueing into a portfolio with a much longer investment horizon.
Fonds de réserve pour les retraites (FRR) at a glance
● Sovereign reserve and buffer fund
● Founded in 1999
● Started investing in 2004
● AUM: ˇ33.6bn
● Returns: 9.66% (2019)
● Annualised return since 1 January 2011: 4.9%
● Portfolio: performance-seeking 50%; liability hedging 50%
Source: FRR, 31 December 2019
FRR declined to comment about any possible changes. It only states that the discussion of the changes has been postponed until next year.
The fund’s assets are split roughly equally between a performance-seeking portfolio (PSP) and liability-hedging portfolio (LHP).
The PSP is invested in developed and emerging market equities, emerging market and high-yield corporate bonds, and unlisted assets, mainly in France.
The LHP invests in French government bonds and investment grade corporate bonds in euros or US dollars.
FRR has told IPE that at the end of 2019, it had a 36% strategic allocation to equities, and slightly over 5% to unlisted assets, primarily private debt but with growing private equity, infrastructure and real estate components.
Meanwhile, half of its LHP was in OAT Treasury bonds and investment-grade credit with a very low duration.
Any strategic investment policy to make the transition to an FRU would have advantages for active management, suggests Estelle Castres, executive managing director and co-head of Western Europe at Natixis Investment Managers.
Castres says: “As an active asset manager, we do favour a longer-term investment horizon that best suits high-conviction portfolio managers creating value-add on long-term equity themes.
“There is a potentially higher allocation to riskier assets, be it listed equities or real assets. Furthermore, infrastructure, private equity and private debt, for instance, tend to have long-term maturities, sometimes above 20 years, and are a better match for those asset classes financing the ‘real economy’.”
FRR also has a strong commitment to financing the French economy and pursued this during 2019 by accelerating its long-term and responsible investments.
Castres notes that a long-term investment horizon also helps with the latter.
She observes: “French institutional investors and retirement regimes like FRR, ERAFP and Ircantec have largely adopted environmental, social and governance policies, including climate change impact and renewable energy investments. Nevertheless, a longer maturity would also help enhance these policies in new territories that match longer maturities, like impact funds, natural capital, biodiversity and recovery investments.”
FRR’s obligation to make payments to CADES for the foreseeable future looks like it will mean a continuation of the current strategic asset allocation and its short-term constraints. These could even be intensified should CADES’ huge debt burden mean that contributions are raised.
But it is not just the inability to forge ahead with longer-term and less restricted, higher risk/return focused investment policy that is a potential headache.
Much work has been carried out over the past two years to adapt FRR’s strategic asset allocation to a five-year shrinking liability horizon under highly uncertain market conditions. How much of this work can be salvaged is not clear, but a fresh modification will now presumably be at the top of FRR’s to-do list.
But one thing seems certain: FRR will deal with its changed circumstances with the speed and efficiency required.
In his 2017 interview with IPE, Rousseau paid tribute to his colleagues’ ability to accomplish the change in direction required when the CADES payments were imposed, recalling that in spite of the “big trauma for the institution” of introducing a fully-fledged liability-driven investment approach, “The team reacted very gallantly, putting together a new model very quickly.”