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Domestic bonds are no longer enough. Rachel Fixsen reports

Pension funds in Spain invest so heavily in domestic bonds that other classes of investment are all but squeezed out. But fund managers are now prising themselves away from this haven of security in search of better returns.

Asset allocation is Spain is essentially just in fixed-income securities ... this is so overwhelming that the rest of the investment instruments - shares, property - are hardly there," says Christian Lux, senior consultant at Watson Wyatt in Madrid. "That's been the traditional investment since 1987."

Long-term and short-term domestic bonds make up 76.9% of average assets of individual and company pension funds, according to data from the end of 1995 compiled by Watson Wyatt. Combined with cash, this portion has a weighting of 89.9%. Foreign bonds account for a mere 1.6% and foreign equities for just 0.6%. Even domestic equities are scarce in the average portfolio, at only 3.6%.

Funded pensions are a relative novelty for Spain. Until 1987, many company pension schemes relied on their own book reserves to pay retirement benefits. Some still do, though this practice, disastrous for employees if the firm goes bust, will be outlawed when the latest pension legislation takes effect.

Though still in their infancy, Spain's pension funds are growing up rapidly. Last year, total assets were Pta2.9 trillion ($20.1bn), up 36% from the previous year, according to data from InterSec Research Corp. This is still small fry compared to the UK where nearly $1,000bn is currently invested in pension funds. Some 2 million people participate in the Spanish schemes.

A Spanish newspaper recently forecast pension fund assets would surge by 330% between 1995 and 2000, bringing them to around Pta7 trillion ($49bn).

Companies have until 1999 to switch from the book reserve system to the new funded method, and can make substantial past service single contributions tax-efficiently, which will give a giant boost to pension fund assets in the next few years.

Generous state pensions, which can pay around 80% of final salary to those earning a maximum of Pta4.6m ($32,000), mean there is virtually no call for private pension plans for many Spaniards. This, coupled with employers' unwillingness to abide by guidelines for "qualified" pension schemes, keep Spain's pensions market stunted. Pensions assets are only around 3% of GDP, compared with over 70% in the UK, Switzerland, the Netherlands and Denmark.

In Spain, under the 1987 law on pension plans and funds, a plan was only "qualified", and therefore tax-efficient, if it complied with certain conditions. It could not be funded by book reserves, and at least 51% of the control panel, which makes investment decisions, had to be employee representatives.

This had deterred employers from starting funded schemes. However, the 1995 pensions law allowed the company to have power of veto over any major investment decision.

Investment managers of Spain's pension funds like to play safe, touching little else but fixed-income. And these fixed-income securities are almost exclusively Spanish.

Ian Hinton, senior consultant at pensions consultancy Aserplan in Madrid, puts the heavy fixed-income average weightings down to the natural conservatism of the funds' control committees. "They haven't got the equity culture," he says.

Pension funds for individual schemes appear to have a marginally more aggressive strategy than the company pension funds, with the overall equities weighting in individual pension scheme funds a couple of percentage points higher than in company funds, the Watson Wyatt survey noted.

However, these averages mask the fact that some large companies have much heavier stock weightings. This applies in particular to multinationals, accustomed as they are to the pension funds of subsidiaries in the US and the UK harvesting strong yields from equities. "I'm aware of one or two of the larger companies having benchmark figures of close to 40 or 45% in equities," says Hinton.

But this is not typical, and the majority of Spanish companies are invested very conservatively, he says. "But this is starting to change, especially with the bigger employers who are looking to get higher returns. It will take some time, but gradually this will feed through to smaller company plans," Hinton says.

Historically, Spanish stocks have given very strong returns. In the 10-year period to 1993, domestic equities yielded an annual average of over 23%, compared to domestic bonds which produced 13.8%, according to data from PDFM fund managers.

"Yields in long-term government bonds are decreasing, so that might prompt managers to question their traditional asset mix," Lux says.

But some see Spanish bond prices declining heavily this year on market worries surrounding the prospect of European Monetary Union. BZW sees a negative return of 3.1% for bonds in the 12-month period - in line with the prediction for many other European countries.

A shift towards equities is already happening. Last year, according to InterSec, domestic equities made up 7% of total pension fund assets in Spain, up from 3.75% in 1995, and foreign securities occupied 4% of the mix, after 2.5% the previous year.

Spanish stocks are looking forward to a buoyant year, with total returns higher than most other European countries, according to BZW Securities. It forecasts an average 8.1% total return for Spanish stocks over the next 12 months.

Spanish pensions funds face only the following legal requirements restricting investment:

q A pension fund is not allowed to hold more than 10% of its assets in the shares of any one company.

q A pension fund may not hold more than 5% of the issued capital of a single company.

q At least 90% of assets must be invested in quoted securities, bank deposits, property or mortgages.

q 1% of the scheme or more must be held in current accounts or money market contracts with maturity dates of less than three months.

"There are a number of restrictions in the 1997 pensions law, but they are still flexible," says Lux. "That is going to be defined, but in practice ... companies could accommodate virtually any asset mix."

Though there is no legal restriction on foreign investment, Spanish pension funds hardly invest abroad at all. "The first overseas area they look at is Latin America. This is an area you wouldn't expect UK pension funds to invest in," says Hinton.

Rachel Fixsen is a freelance journalist"

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