Taking a slice of the national pie

Ireland's reserve fund has proved to be a great success, in part because of its secure funding, says Rachel Fixsen

In the years since it was established, Ireland's National Pensions Reserve Fund (NPRF) has grown into a giant. In these its early years its growth has been mainly due to the statutory slice of GNP it receives each year - a regular inflow envied by other European reserve funds - rather than to its investment returns.

Established in April 2001 the aim was for the NPRF to meet as much of the costs of social welfare and public service pensions in Ireland as possible from 2025, moving public pensions from a pay-as-you-go system to a part pre-funded arrangement.

"When it was established, it was a fantastic piece of public policy," says Frank O'Dwyer, chief executive of the Irish Association of Investment Managers (IAIM). Particularly laudable was the idea that the state should be locked into contributing an amount equivalent to 1% of GNP to the fund every year, he notes. Last year, the government contributed €1.7bn.

The legislation behind the fund was pushed through by Ireland's former finance minister Charlie McCreevy, now European Commissioner for the internal market and services.

The fund's value is projected to peak at 50% of GNP around 2040, according to the National Pensions Review, published by the Pensions Board in 2006; and by mid-century the review shows that payments from the fund will cut the impact of pension payments on the exchequer by 3.5% of GNP.

"There are differing views in Ireland as in other countries about the pros and cons of reserve funds such as the NPRF," says Brendan Kennedy, chief executive of the Pensions Board. "Nonetheless, I think that the NPRF is generally seen to be a success."

In the projections that the Pensions Board has commissioned of future Irish pension costs, the NPRF has a noticeable effect in smoothing out the future growth of exchequer pension costs.

If any large-scale government initiative is to work in practice over time, it is important that people support it, and this has been the case with Ireland's reserve fund, according to Kennedy. "In setting up the NPRF, the most noticeable success was in achieving a considerable amount of consensus for the fund," he says.

"The fund also benefited from the strong performance of the Irish economy since it was set up, which made the contributions to the fund easier to manage."

In fact, the fund has managed to achieve an annualised return of 6.2% since its inception. Even if 2007 was a bad year for markets, the reserve fund still managed a 4.1% return that year. At the end of last year it had a market value of €21.3bn, or 13.3% of GNP.

As investment director of the NPRF, John Corrigan certainly appreciates the guaranteed inflows. "The statutory annual 1% of GNP contribution has been of tremendous assistance in the management of the fund, particularly in the design and implementation of our investment strategy which is predicated on the premise that real assets, such as equities and property, will continue to outperform financial assets such as bonds. Technically, the contribution acts as a volatility dampener smoothing the prices at which assets are purchased due to the long time period over which purchases are made."

On top of this advantage, Corrigan points out that it gives the fund regular cash flow, putting it is a good position to invest in property and private equity funds without having to liquidate existing investments in other asset classes. The NPRF only has two investment no-go areas: Irish government bonds and taking a controlling interest in a company.

 

f Irish investment managers are going to compete for the mandates from the reserve fund, they have to be able to offer the suite of products that are available from asset managers in London or other major financial centres, O'Dwyer stresses. In the Dublin market the level of sophistication in asset management has certainly been rising since the reserve fund first came on the scene, though this development cannot be ascribed to the fund itself, he says.

"The Irish market has been moving dramatically anyway," he adds, noting that much has happened as a result of the introduction of the single European currency. "Mandates became much more sophisticated in terms of the euro rather than the Irish punt. The large fund managers are competing internationally now to win mandates from Irish pension funds and international business.

"There's been a whole period of change. As whole suites of new products have arrived such as LDI, funds of funds, Irish managers have had to offer those services not just to keep pace with the huge mandates from the likes of the NPRF, but also to win mandates from the Irish pension funds themselves."

In any case, from an investment perspective, the reserve fund is very different from mainstream pension funds in Ireland, says director of policy at the Irish Association of Pension Funds Jerry Moriarty. "The NPRF is different from most funds in that it has a truly long-term horizon in that there will be no drawdowns from the fund until at least 2025," he says.

"Therefore, it will only have an inward cash flow unlike occupational pension schemes that would expect to be paying out benefits."

As a result, its approach is necessarily different, because the risks attached to it are different, he adds. "It also does not have the same type of liabilities as occupational schemes as it has not been specified how its payments will eventually be made. So it doesn't have the same issue with asset/liability matching."

Moriarty adds: "I do think it provides a useful benchmark and reference for pension funds, particularly larger funds."

Corrigan says some of the asset classes the NPRF invests in, such as private equity, would be inaccessible or unsuitable for smaller or more mature funds. "One area where we do differ from the average Irish group pension managed fund is that we have no specific allocation to Irish equities," he explains. "Being established in 2001, we took the view that the euro-zone should constitute our domestic market."

The Green Paper on Pensions released by the Irish government late last year set out various options for reforming the nation's pension system. But while the system is under pressure to reform to ensure it can provide for people retiring in the next few decades, it seems to have avoided the crisis that faces many other European countries that are struggling to find ways of meeting the huge need for pensions that will emerge as baby boomers retire.

O'Dwyer sees this as one of two factors that Ireland has in its favour. "There is a big plus for us in our demographic profile - probably we will have a little bit longer than other countries before we have a big pensions gap and, second, we have the reserve fund established already," he says.

Despite the foresight shown by the government that brought the reserve fund into being, it is impossible for any policymakers to know exactly how finances will pan out in 30 or 50 years' time. So there are bound to be changes ahead for the NPRF.

"One issue that will need to be examined is how the funds will be distributed," says Moriarty. "And it would seem clear that the original intentions, however vague they were, will not be met due to the rising costs of public sector and state pensions."

There will be new challenges for investment managers too. As with any large investment fund, the NPRF's growth can cause logistics problems. The fund's rapidly increasing size and regular cash flow can make it difficult to reach investment targets in areas such as alternative assets where there is no market index in which to invest and there is a significant difference between first quartile and median performers," Corrigan says. "We manage this issue by setting investment targets subject to suitable market opportunities - if we're not satisfied with the opportunities available, we simply stay out of the particular market and slow the pace of our alternative investment programme."

There is scope for the reserve fund to develop as public sensibilities change. O'Dwyer notes that the fund is a part of the evolving issues around ethical investment just as much as any pension fund in Ireland. "They are observing the ethical side of things, just as the profile of ethical, and ecological investment is rising; there are areas of discussion between the fund and the industry," he says.

As a signatory to the UN Principles for Responsible Investment, the reserve fund hired Hermes Equity Ownership Services last July to carry out proxy voting and engage with companies on its behalf.