Scarcity value

Nina Röhrbein spoke with Vincent Ribuot, chief investment officer of UMR Corem, one of France’s few pension funds about working within a life insurance dominated market and the limitations it can cause

In France, where life insurance companies still hold the reins, pension funds are few and far between. One of those rarities is UMR Corem, a third pillar voluntary scheme. It was initially created for, and by, French teachers but taken over by UMR, the union of French mutual pensions companies, in late 2002. After the 2003 Fillon law, UMR Corem was able to open its doors to the entire French population regardless of occupation, as long as they become mutual insurance company members.

But because of the fund’s historic association with the teaching sector, as of today, 70-80% of its members are public sector employees.

The fund is a hybrid of defined benefit (DB) and defined contribution (DC).

Upon joining the fund, members purchase a defined number of points via a technical rate, which buys them a lifetime guaranteed rate of return. This forms the DB portion of the scheme. Members can alter the amount of points at any time and decide for themselves how much they want to put into the fund, which is the DC part of the scheme.

UMR Corem runs a stochastic model approach based on its long-term liabilities.
For the purpose of its liability-driven investment strategy, it undertakes an asset liability study every year and a quarterly tactical review.

“Our job is to make a promise that we can fulfil,” says Vincent Ribuot, chief investment officer at UMR Corem. “We try to find the most efficient strategic long-term asset allocation with the target of achieving a 100% funding ratio.”

The French regulator has placed the fund on a strict plan in 2002 to lead the scheme to a 100% funding ratio over 25 years. However, its funding level has sharply increased over the eight years since UMR took over the original pension fund, which is why five years ago it agreed with the regulator to achieve fully funded status within 15 years. But Ribuot now expects the fund to hit the 100% mark as early as 2012. At the end of 2002, UMR Corem’s funding level stood at 81.5%. By the end of 2010, it had risen to 99.1%, with a fixed discount rate of 2%. “My objective is to deliver 5% net return every year,” says Ribuot.

Another important number for the pension fund is the long-term minimum rate of return it has to generate to achieve 100% funding. Today this annually calculated rate stands at 3.35%.

If UMR Corem fails to meet this annual target, it does not pay any extra return to its members. It also restricts its investment room for manoeuvre for the following year. However, due to its strict asset and liability management the fund does not have an option to manage its risk. According to Ribuot, the only time UMR Corem is likely to change its risk profile was at a funding level of 140% and above.

“In such an event, apart from paying some of the wealth back to our members we would also be likely to take on more risk and be more aggressive on certain asset classes.”
In recent years, UMR Corem’s investment strategy and asset allocation has not changed much, as the fund’s liabilities have remained stable.

“What did change during the course of the financial crisis was that previously a good part of our fixed income and equity was invested to fund the financial sectors,” says Ribuot. “Today we are more likely to finance corporates directly through bonds and equities rather than through banks or governments. There is a lack of trust in the banks and governments when it comes to supporting the economy, and as the ultimate long-term investor we need to invest our members’ money more directly in the corporate sector.”

The pension fund was already invested in corporate fixed income and investment grade bonds but has started to invest more and more in emerging market debt and high yield bonds through external, specialised investment managers.

Apart from the high yield and emerging part, UMR Corem manages its bond portfolio internally - however, the management of other asset classes is outsourced.

At present, the pension fund’s asset allocation is two thirds invested in bonds. This, together with a 10% exposure to cash-yielding real estate, makes up the hedging or matching portfolio. The stable income generated in this portfolio is designed to cover liabilities.

The other quarter of the overall investment portfolio is made up of the performance or added-value portfolio, which consists of 15% listed equity, 5% hedge funds and a 5% mix of private equity and infrastructure vehicles. This portfolio aims to generate capital gains on a long-term basis by positioning itself countercyclically and opportunistically.

The fixed income portfolio is 100% invested in the euro-zone although, Ribuot says, very diversified in terms of names and sectors. Around 38% of its bond issuers are from the financial sector, of which 17% are insurers. Over 10% is allocated to bonds issued by utilities and infrastructure-type issuers, while 16% is invested in corporate bonds of the transport industry. The remaining corporate bonds are invested across issuers and countries.

At the moment, only 5% of the fixed income portfolio is invested in government bonds, none of which can be classed as core euro government bonds, such as German Bunds and French government bonds. Instead, UMR Corem is invested in high-yielding government bonds including Portuguese, Spanish, Italian and Greek bonds.

“Even before the financial crisis we did not invest in French or German government bonds because we thought it was not a good risk reward on a long-term inflation basis,” says Ribuot. “For us the best way to lose money is to invest in so-called non-risky government bonds from the euro-zone or the US and get a 3% yield for 10 years.”

The pension fund also invests in real estate for stable, inflation-linked returns on a long-term basis. In 2010, its real estate portfolio returned 5.23%. Geographical and sector diversification are important to UMR Corem, which is why it - together with other French institutional investors and the help of a real estate asset manager - started to invest directly through dedicated vehicles in large commercial centres and office buildings in France, Italy, Germany and other European countries but does not invest in listed real estate.

UMR Corem has two dedicated equity fund of funds, one for European and one for global equity. Each holds approximately 40 to 50 funds. The pension fund decides about the strategic asset allocation for this equity portfolio with regard to the countries or size of companies to invest in. Once these sub asset classes have been defined, it selects the individual funds or asset managers with the objective of beating the markets benchmark.

“The funds of funds have proven to be a real success,” says Ribuot. “In 2010, the European portfolio returned 18.37%, well above the 8.60% of the Stoxx Europe 600 index. Because we position ourselves tactically and contra-cyclically we pump cash into our fund of funds when markets go down. Last year we were over-invested in small and mid-caps. We ask the asset managers of our funds of funds to invest in very liquid futures or exchange-traded funds (ETFs) to capture the beta of the market before selecting the best alpha-creating manager. We have tried to outperform the MSCI World at the same time as having lower, long-term volatility, which we managed to do. Since their inception in April 2004, our equity fund of funds have returned 32.28%, with the MSCI World in euro returning only 15.99% over the same period.”

Since late 2002, UMR Corem has had a strategic 5% allocation to hedge funds. Similar to its equity portfolio, it invests via a dedicated fund of hedge funds called UMR Select Alternative. Again, the pension fund decides on a specific investment strategy internally before selecting individual hedge funds with the help of fund managers.

“We aim to reduce the overall volatility of the fund of hedge funds to try to improve the risk return ratio of the overall asset portfolio,” says Ribuot.

It seems to have paid off because the hedge funds portfolio has generated a stable return of around 5% every year since inception.

For its private equity and infrastructure portfolio, where it has invested since 2003, the pension fund selects the investee companies internally.

But because of French legislation, the pension fund cannot invest as much in alternatives as it would like. Ribuot says this reduces the fund’s ability to invest in non-liquid, profitable long-term asset classes, such as infrastructure and small companies, which would help create jobs and boost the economy.

“Today we have a 15% allocation to listed and a 3% allocation to private equity,” he says. “However, on a very long-term basis we would rather invest 20% in equity, of which 10% would be listed and 10% non-listed. Due to our well matched assets and liabilities we do not need liquidity, which is why we are very happy to be rewarded for non-liquid products. The bond portfolio alone generates enough revenue to pay our liabilities until 2027 without us having to sell risky or non-liquid assets to pay the pensions.”

Since the financial crisis, UMR Corem has deviated from its previous performance approach and become more focused on risk instead although its overall strategy particularly with regard to diversification has not changed. The pension fund today is much more constrained by risk than it was before.

But the biggest challenge for UMR Corem is the introduction of Solvency II, as France did not incorporate the European IORP directive into national law and thus, pensions are viewed as an insurance matter.

“Solvency II - which is a very pro-cyclical regulation - could be the death of UMR Corem if applied as it is today,” says Ribuot. “The regulation is good for companies that insure risk and have to be able to pay out the cash. Solvency II is the 0.5% probability of going bankrupt within a year. However, we are a pension fund. If I take, for example, UMR Corem’s current fixed income portfolio, assume 10% of coupon revenues will not be paid and the fund will not receive any more contributions the pension fund will still have enough revenue to pay pensions until 2024, which is why Solvency II does not apply to us. We cannot be bankrupt within a year. At the same time we can neither suddenly increase our current €310m capital solvency margin to the legislation’s required €1.5-2bn.”

“We have four options,” says Ribuot. “First, we can succeed in transferring the law in France, meaning Solvency II will not apply to us and we can continue operating under suitable European pensions legislation. Another option is to find someone lending us the required money so we can continue to exist under Solvency II, which is unlikely. The third option is to move UMR Corem to another European country, which is viable. The fourth - and the ultimate death-knell - is to stop operating and return all the capital to the members.

“The French have never had the culture of pension funds and instead opted for life insurance where they are able to take the capital back at any time. This is why Solvency II has this impact on us, one of the country’s few pension funds.”

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