Still waiting for the future
By far the most important development in the Belgian pensions market has been the provisions for industry-wide pension schemes set out in the Vandenbroucke Law which came into effect at the beginning of last year.
The main aim of the law – to boost second-pillar pension provision by creating industry-wide ‘sector’ scheme – can only be good news for asset managers in a market where the E10bn under management at present has created a situation of too many players chasing too few opportunities.
But while the Law has created over a million second-pillar members in just over a year, asset managers will have to be patient: the initial contributions to the schemes set up following the passing of the law, which range from 0.5% to 2%, are too small to have any immediate impact on the market.
Thierry Verkest, consulting actuary at Hewitt’s Brussels office, goes further: “The salary increases that are being negotiated in the current round of collective wage negotiations will be low so there will not be much room to increase funding for second-pillar schemes.”
Patience is a virtue, so the saying goes, and asset managers will need to be virtuous indeed. It is partly due to the low level of contributions that insurance companies have been the first to benefit from the new business; around 80% of sector funds are with insurance companies. Insurers can guarantee the 3.25% return required for new contributions to all DC schemes more easily than asset managers, even in the short term; pension funds meanwhile have to use the mark to market principle.
Many funds are still too small to be able to devote adequate resources to the running of a pension fund. “Outsourcing to an insurance company may seem to be a temporary solution to certain sectors,” says Hugo Clemeur, secretary general of the Belgian Association of Pension Funds (BVPI). “For a number of sectors, pensions is a completely new subject and some insurance companies claim to offer ready made products.”
The learning curve is steep indeed. As Hewitt’s Verkest points out, “some sponsors hardly know the difference between quoted equities and private equity”.
But he stresses that some should know better. “It is crazy that employers, many of whom have financial knowledge, are not looking more at the long-term value of investments but are placing everything with insurance companies,” he says.
Jan Longeval, chairman of the executive committee at Degroof Instutional Asset Management (DIAM), takes a similar line. “Using an insurance company has been a comfort decision,” he argues. “Confused minds tend to say no to a pension fund; it takes more effort to grasp the benefits.”
He adds: “Most funds have signed five-year contracts with insurance companies; we are counting on them switching to the pension fund structure after that time. Today the total assets of the sector schemes are about E1bn so it is too early.”
One local consultant suggested that funds are now entering a second stage where they are starting to look at the guarantee and the cost of that guarantee. Clemeur agrees: “That’s what I hear. There is growing sophistication compared with three years ago, as funds are looking more closely at what they are getting back in return for what they pay to insurance companies. It is the natural course of things.”
There are number of theories regarding the critical mass that a sector fund should have to make the move to manage its own pension fund: a minimum of 500 employees is one of the guidelines used by ING, and a minimum level annual contributions of E1m is suggested by Verkest at Hewitt.
The 3.25% guarantee, while reassuring for scheme members, has attracted a great deal of criticism.
It is not the principle of the guarantee that is the issue but rather the
arbitrary way in which it has been set and the likely impact on asset management.
“We totally disagree with the 3.25%,” says Clemeur. “We are not happy at all with the blind way in which it has been applied, not taking the economic situation into account. It might limit the willingness of pension funds to take risks.”
Risk aversion will be compounded by the fact that the guarantee applies over the lifetime of an individual term of employment. Yves van Langenhove, head of institutional investment for western Europe at Invesco notes: “As a result portfolios will be managed defensively and in the long run this will have a negative impact on performance.”
He adds: “If the sponsor pursues a dynamic investment policy he is giving a free put option to his employees: if things go well they collect the investment return; if they go badly they still get the 3.25%. Which is why he tends to choose an insurance company.”
The guarantee, which was introduced last July, applies only
to new contributions. Sector funds which existed prior to the
Vandenbroucke law will have their work cut out. As van Langenhove explains: “A sponsor will need two sub-funds because the investment objectives of the fund taking guaranteed contributions will be different from the objective of the fund without the guarantee.”
As the guarantee applies only to new contributions, some sponsors are changing the rules whereby if members want a risky investment strategy it must apply to all contributions. Longeval says: “So employees will be less likely to take the risky option. I think the pension funds are right to rewrite the rules like this.”
Insurance companies are lobbying for the guarantee to be reduced. The consensus is that the rate should be 60% of the 10-year bond rate, or around 2.2%. “They could reduce it without any change in the law if they wanted to,” says Longeval. “They do not do this because of the psychological impact – it would imply that they were suggesting that the expected return will be lower than before.”
The pressure on insurance companies is such that some provide a 3.25% guarantee on part of the fund only. “This forms part of the negotiation with the client,” says Francis Heymans, director of sales and marketing for institutional asset management at Petercam. “Some insurance companies now ask asset managers to manage part of the reserves.”
Another factor likely to boost the fortunes of asset managers in Belgium is the gradual move from balanced to specialised management.
But while the move might be sure, it is slow. “There is still a lot of balanced management,” notes Peter De Proft, general manager of Fortis Investments in Belgium and chairman of the Belgian Association of Asset Managers. “Smaller funds take the view that if you add asset classes you add risk. The concept of reducing risk through diversification is still very new.”
In this regard size is a major constraining factor: there are in Belgium only 22 pension funds with assets of more than E100m, according to figures from the BVPI. “So only a limited number of funds have the size which could possibly justify a move to fully specialised management.” says Clemeur.
The movement to specialised management – albeit modest – should be a time of increased opportunity for foreign managers. But the supply-demand ratio means that business is not as brisk as it might be. Furthermore some suggest foul play.
“Fees are very low in the Belgian market,” says De Proft. “Low fees will make most mandates unattractive for foreign managers. It has been a successful policy of some colleagues to keep out foreign competition.” Luc Vanbriel, head of product development at KBC asset management denies the claim, however.
And as in other markets, specialised management also opens up opportunities for boutique managers. But Vanbriel believes that boutiques might not have very much to gain from the move of assets to specialised management. “If we look at RFPs, pension funds are paying more attention to risk management,” he says. “To achieve a sufficient level of risk management takes a lot of money and time, which some boutiques might not have. These days you have to deal with the issue of risk management.
But De Proft disagrees: “Boutiques are very efficient,” he says. “Some are making market share gains but it is a mixed picture.”
Where the smaller managers are concerned presence in the specialised market varies by size, and cost is an issue. Pol Pierret, country manager
at Axa IM Benelux notes that Degroof and Petercam are taking market
share through the trend to more specialised managemement. Specialisation among the local boutique managers focuses largely on European equities and fixed income.
One of the smaller boutique operations, local boutique manager Capital & Finance Asset Management, manages eight portfolios which are shared by its clients, and mandates vary between E2m and E70m. “This keeps our costs down – a light cost structure is an enormous advantage in this market,” says Antoine de Séjournet, one of the company’s managing partners.
Perhaps more of a necessity than an advantage, given the low fees prevalent in the market.
He adds: “We may not be specialised enough for the large funds, except where European equities management is concerned. We don’t have a team dedicated to responding to RFPs because our simple business model does not require this, and institutionals could simply buy our funds as those fit part of their strategy.”
The company moved into the institutional market four years ago. Its institutional business now accounts for 15% of its E1.25bn assets under management, the rest being private wealth management; total assets under management have increased fourfold in the past four years. “Most of the growth in our institutional business comes from direct investment by institutional clients,”
de Séjournet notes. “Growing the institutional business is our main challenge for this year.” The company has also been selected for the Fortis multi-manager product.
A consultant based in Brussels believes that the move to specialised management has exposed Belgian banks as having expertise that is largely limited to eurobonds and European equities. He also believes that they are guilty of charging active fees for what is closer to index performance.
Heymans believes that a lot of local investment managers produce results that are more linked to enhanced indexing than truly active. “So now the clients are pushing the banks to take more risk,” he says.
But Clemeur is quick to counter the claim. “According to our partial survey in January, the best performing Belgian pension fund in 2004 was run by a Belgian bank,” he says. “I have no reason to believe that their expertise is limited to these areas or that they deliver indexed management but charge active fees. I have no knowledge of any material proof that supports these allegations; it is very cheap to make that sort of remark unless it can be proven.”
The suggestion has been made that as the market has started to move toward specialised management the big local banks – KBC, Fortis and Dexia – have tended to want to do everything themselves, rather than outsource as is common in some other countries. In short, open architecture has not taken off in
Belgium. Van Langenhove agrees but doubts that the local banks are to blame for this: “If there should be outsourcing to specialists then the clients should ask for it,” he says. “If a Belgian bank offers open architecture it will weigh on the profitability, so they won’t offer it unless asked, especially if the competitive threat is not there.”
Jean Sonneville, general manager at ING investment management in Brussels sets out the structure. “Most smaller pension funds tend to have one supplier for investment and custody services, with their biggest manager as the custodian; for these funds it is rather exceptional to have a custodian that is not also one of the managers. But that is changing – custody has been opening up over the last two to three years.”
Is open architecture perhaps more likely to be offered by the foreign banks? Citigroup and Deutsche are the only banks offering open architecture in the Belgian market at present, and Axa is also looking at the possibility of doing so.
The approach of the local banks is varied but seems to offer little by way of open architecture. Vanbriel at KBC explains that “if the client wants a mandate we can’t deliver the client can go elsewhere. We don’t go in for partnerships.” Meanwhile De Proft at Fortis says: “If the potential is there and we don’t have an area of expertise we acquire it.”
Laurent Ollinger, head of institutional investment at local boutique manager Capital at Work, believes that the local banks are changing “slowly but surely”. Pierret believes that change will come from client pressure. “There has been a lot of cross-selling among the big local banks and transparency on returns and costs has been lacking,” he says. “But this will change because clients want to pay exactly for the value that is added. The big local banks had plenty of means to recapture fees that don’t show as asset management fees.”
He adds: “So the implementation of UCITS 3 will help the profession in Belgium.” Implementation took place last month, later than in many other European countries.
The small scale of many pension funds mean that mutual funds are popular. Mutual funds account for the majority of pension assets – estimates vary between 70% and 80%. Funds under management in SICAVs, the chosen vehicle which provides the only way in which funds can avoid witholding tax, rose by 62.4% last year following a rise of 62.5% in 2003. They are an effective means for small funds to diversify, although the transparency issue is an obvious area for improvement.
But while foreign banks may be ahead of their local counterparts when it comes to open architecture, Belgian pension funds’ culture of working with local banks still exists. “The trend to foreign banks has been pushed by the consultants,” says Verkest. But consultants have to realise that in a selection process it is important to take into account that many employers appreciate having local banks.”
But he also stresses that some
multinationals work only with
preferred providers. “I can see most local players losing to the big
foreign houses because of this.”
Liability matching is becoming more important because of IFRS. Most defined benefit (DB) plans in Belgium use a discount rate of 6% for minimum funding requirements, the maximum that is allowed by law. “The Belgian authorities just look at the yields in the bond market but the rates are not in line any more,” says Vanbriel. “It is very dangerous to look at the funding level based on a discount rate of 6%. Pension funds can use a lower rate – the 6% is a maximum – but I have the impression that most pension funds use the maximum rate.”
He adds: “Under IFRS funds of quoted companies will have to use the discount rate for corporate bonds. But it will be difficult to compare the funding level of a DB plan using a discount rate of 4% and one with a discount rate of 6%.”
Liability matching is only one element of the solution, as Clemeur explains: “We want to guarantee the return and protect against inflation at an acceptable level of risk and asset liability doesn’t take that aspect into account,” he says.
Sonneville at ING sees less demand for liability matching in the Belgian market. “What we can see in clients’ bond portfolios is more diversification from government to corporate bonds and emerging market debt rather than a duration increase. With a flattening yield curve there is not much extra yield to be picked up at the long end. The appetite for equity investments is also increasing.”
While there has been clear movement in bond portfolios, overall asset allocation has remained largely stable. Vanbriel notes: “It is partly because the Belgian authorites are only interested in the discount rate of 6% that most funds have not decreased their holdings in equities.”
According to figures from the BVPI the assets of the mainly balanced pensions market in Belgium are around 45% invested in equities and 45% in bonds.
Historically funds have not invested a large proportion of their portfolios in equities. “A psychological hurdle is reached at 50%,” says Jean-Pierre Ysebaert, senior product manager for institutional clients at ING. “Funds are very socially minded. Even during the boom, equities were at 50% with the remainder in bonds. They knew that the overperformance would be followed by underperformance; when the downturn came the industry and the regulator did not panic.”
But he notes that change is afoot. “Although pension funds are generally risk averse they are becoming more open to discuss riskier investment strategies.”
Typically equity allocations have a high weight in Belgian equities. “The Belgian market is asymmetric in that it has fewer cyclical equities so it is not correlated with other markets,” says Pierret at Axa. “It has value stocks, small caps which have both done well in the last three years. So the market did better in the collapse and was also up 35% in 2004.”
Meanwhile, real estate represents
5 to 7% of portfolios on average, of which real estate funds make up a small proportion. Van Langenhove believes this will not be the case for much longer. “There will be a move to closed international real estate funds which will offer a higher return and a well diversified portfolio,” he says.
Hedge funds are not popular. Some of the smaller managers cite the ‘black box’ factor, ie a lack of transparency, as a major drawback. Ollinger notes that there is little by way of legal incentive: “it is still very difficult to register a hedge fund in Belgium,” he says.
In the environment of low interest rates structured products have
gained ground. “If you are using a
5% discount rate for your liabilities, interest rates are low and the stock market outlook is bright, they can be a good substitute for bonds,” says Longeval.
One of the main advantage of structured products for asset managers is that they have a captive market. “This is the easiest product to sell to the semi-public authorities,” says Heymans. “They cannot afford to have one or two years of negative returns due to negative press and the consequent need ministers to explain themselves in parliament. We advise clients not to work with this kind of fund. They are not transparent and they are very expensive. Their main advantage is the nice profit they make for the banks.”
Whatever strategy is chosen it is likely that consultants will play a significant role. De Proft at Fortis notes: “Because funds are managed equally by employers and employees and they don’t want to have to take decisions on the funds for which they are responsible so they have to rely on an objective body.”