Expectation has given way to the reality of the euro. When we last surveyed investment managers on their benchmark preferences the euro and EMU did not yet exist. This meant that much of our analysis, published in the January issue of IPE, had to be based on expectations about the way in which the new environment would impact on benchmarking. We have now lived with the euro for six months, which seems an appropriate point to examine how the race to provide the dominant Emu and European equity and bond benchmarks is progressing.
IPE and Aon have again surveyed leading investment management organisations from across Europe about their preferred European indices and about the trends they expect to see developing over the rest of this year. The 50 plus organisations that responded to the survey were mostly based in Europe (both inside and outside the Euro zone).
Whilst investment management companies are responsible for investing the bulk of European pension fund assets and are well placed to comment on the trends that are developing, in most cases pension funds decide which indices are used to benchmark their assets. Therefore the views of pension funds themselves have been added to our follow-up survey to give us a first-hand picture of developments. A number of asset managers who participated in our earlier survey indicated that they would not do so this time as they now left it to their clients to stipulate the indices used.
Pension funds were asked to comment on the way in which their European investments are structured, as well as their choice of indices for each European asset class. Whilst the preferences of individual pension funds must remain confidential, some interesting observations can be made about the general trends.
The sample consists of almost 30 pension funds from across Europe, 16 of which are based inside the Emu bloc.
On average, European pension funds still invest the majority of their bond and equity assets in their national markets. However, when the preferences of pension funds domiciled inside and outside Emu are analysed separately, two very different pictures emerge. Most pension funds from non-Emu countries have kept their focus on domestic markets, although a surprisingly high proportion of equity assets (an average of 19%) are already invested using a pan-European approach. Some Scandinavian pension funds that are domiciled outside Emu have decided to invest a proportion of their assets in euro portfolios.
Turning to pension funds within Emu, an average of only 27% of equities are currently invested in national markets and this figure is expected to drop further to 13% by the end of the year (see figure 1). It is interesting that the majority of assets that have moved outside national markets are invested right across Europe, ignoring the currency boundary of the Emu bloc. Few commentators predicted that funds would be ready to take this step at such an early stage.
Bond investments are following a similar trend (see figure 2). Again, many EMU funds have moved away from national bond portfolios. An average of only 38% of bonds are invested in funds’ national markets. This figure is expected to fall to 22% of assets by the end of the year. It is interesting to note that most funds are observing the euro currency zone for bond portfolios and moving their assets into Emu rather than European portfolios, probably due to the greater importance of currency factors in bond investment and regulatory factors.
Now that the Emu area exists as a separate currency area, investors need to decide how to structure their European investments. Following on from the results of the last survey, tables 1 and 2 show the structure of European investments that investment managers are observing and the position that is expected at the end of the year. The options are:
q Invest in Emu bloc assets as a separate portfolio and Europe (ex Emu) assets as a part of a foreign portfolio
q Run investments on a pan-European basis
q Invest in Emu bloc assets and Europe (ex Emu) assets as two separate portfolios
It is clear that the growing importance of pan-European equity investment is having a strong influence on the structure of equity mandates. The proportion of European equities that is expected to be run by Emu investment managers on a pan-European basis by the end of the year has risen from 51% to 66% since January. However, a significant proportion of assets are expected to be run as stand-alone equity portfolios with other European investments being included as a part of foreign equity portfolios. There has been little change in the prefences of investors from outside the Emu bloc who have retained a strong preference for pan-European investment.
The preferred structure for managing European bonds still crucially depends on whether the question is viewed from inside or outside Emu. For non Emu investors the preference is for a pan-European approach although there is considerable support for the other two structures. Some Emu investment managers also forecast that the pan-European approach will be important, but the majority see funds running an Emu bond portfolio and including other European bond holdings with US and Japanese bonds to form a foreign portfolio.
Investment managers’ preferences for benchmarks for EMU and European equity portfolios follow a similar pattern to the results in the January survey. There is a strong preference for the MSCI indices, which have increased their lead since the January survey with over 60% of funds preferring MSCI indices for European portfolios and almost 50% for Emu portfolios, compared with 48% and 42% respectively at the start of the year (see figures 3 and 4). There is also a loyal following for the FT/S&P indices, still largely from UK and Irish funds.
The indices that have picked up most support since January are the Dow Jones Stoxx indices, now preferred by 23% of funds for Emu mandates, although their broad Europe counterparts are less widely used. Support for the FTSE Eurotop indices has reduced slightly, possibly due to the success of the Dow Jones indices.
Pension funds’ benchmark preferences for European and Emu equities are very similar and follow the same pattern as investment managers’ responses (see figures 5 and 6). The clear winner is again the MSCI family of indices: 32% of funds prefer this index as their benchmark for Emu portfolios and 39% for European portfolios. The FT/ S&P-A indices still have a loyal following from the UK and Ireland. The two Dow Jones Stoxx indices are preferred by over 20% of funds for Emu benchmarks but only 14% for European portfolios. Many funds choose indices that are not mainstream Emu equity benchmarks. These include several national market indices, Eur-ope ex UK indices and the MSCI world index.
Fund managers’ preferences for bond benchmarks have only changed marginally since the start of the year with the majority (48% for Emu and 45% for Europe) preferring the JP Morgan indices (see figure 7). Support for the Salomon Smith Barney indices has increased slightly since the start of the year. The votes in the other category were for customised indices, local indices and the EFFAS family of indices.
Pension funds’ preferences are also clear, with the JP Morgan indices leading the field (see figure 8). They are preferred by over 40% of funds for both European and EMU mandates. The only other indices to get significant support were the Salomon Smith Barney indices and for Emu bonds the MSCI Emu sovereign bond index. In the “other” category, there were votes for a diverse range of indices including local indices and considerable interest in the EFFAS family of indices. This is a similar pattern to responses from investment managers.
Investment managers’ clear preference for an investment grade index is the Salomon Smith Barney Broad Investment Grade Index (see figure 9). There is still some support for the Lehman Brothers index, although the MSCI Investment Grade Index did not pick up any votes. Pension funds’ preferences are more mixed (see figure 10). Support is split between the Salomon Smith Barney Index and the MSCI Investment Grade Euro Credit Index. There is also widespread use of government bond indices as benchmarks for broader portfolios.
Most organisations, both pension funds and investment managers, still plan to use the same family of indices as a benchmark for Europe ex Emu assets as they do for other bond or equity portfolios. This is in keeping with the trend we saw in the last survey.
The responses to the Aon / IPE survey clearly demonstrate the growing importance of pan-European investing. However there has been little change in investment managers’ benchmark preferences over the six months since the last survey and their views are fairly close to their clients’, the pension funds, views. It is interesting to note that of our sample of 30 funds, only five had made changes away from the family of indices that they used prior to the introduction of the euro.
As the survey shows that Emu funds have progressed a long way down the route towards pan European or Euro-wide investment, time is running out for the new index suppliers to gain support for their indices.
Claire Lumsdaine is head of investment consulting at Aon Consulting in London