Which economic scenarios are you building in?

Jaime Martinez-Gómez
• The pension fund of Telefonica de España and other Spanish companies
• Invested assets: €4bn
• Members: 71,000
• DC
• Date established: 1992

Our asset allocation consists of 53% fixed income, 32% equities and 15% in alternatives, 5% of which is in commodities, 5.5% in private equity and 4.5% in real estate.

The fixed income portfolio has a euro bias. Two thirds of it is allocated to corporate bonds, with the rest in government bonds.

In the last 18 months, we have had a low exposure to peripheral government bonds. We underweighted these when we became worried about a potential European debt crisis and focused on the core instead. Our concentration on corporate bonds, which have much better balance sheets has also protected us from the sovereign debt crisis.

The equity portfolio is a global one but is at present heavily overweight euro equities. Around 90% of the portfolio is now invested in euro assets compared to only 50% last year. We decided to increase our exposure in October because euro equities were undervalued relative to other markets and we thought it was a sensible opportunity.

Whether it is a good time to take risk depends on your investment horizon. Due to their low valuation, European equities will now pay more over a 10-year horizon than core European government bonds. In the short-term however, because volatility increased over the last couple of months, to keep this under control investors should reduce their risky assets and increase them again once markets settle down. We, for example, just started to add risk in October.

The scenario we are building in is neither optimistic nor pessimistic, in other words it is neither preparing for a global recession nor for a fast recovery. We anticipate a gradual recovery, sub-par growth and a low interest rate environment for some time to come.

While we make active asset allocation decisions, both strategic and tactical, we are mainly a passive investor and just buy an index. We do not want to focus on securities selection or the supposed ability of fund managers to add alpha in their markets. We only have active managers in our portfolio where we cannot find a suitable passive investment vehicle, for example in areas such as high yield or emerging markets local currency bonds.

The average pension fund in Spain has a lower allocation to riskier assets and a higher allocation to fixed income assets than we have. We are more heavily invested in alternatives than other Spanish schemes, meaning we tend to suffer more in bad times but benefit more in good times.

Kári Arnór Kárason
Managing Director
Stapi Pension Fund
• Invested assets: ISK120bn (€758m)
• Members: 80,000
• Hybrid (conditional DB)
• Funding level: 94%
• Date established: 2007 following a merger, the oldest fund dates back to 1938

At the end of October, asset allocation consisted of 55.4% domestic government bonds, 10.4% domestic corporate bonds, 3.2% domestic mortgage securities, 3% domestic equity, 3.3% foreign bonds, 12.8% international equities, 5.8% alternatives and 6% cash.
The capital controls - which were introduced after the 2008 economic collapse and which are expected to remain in place for two or three more years - still make a reduction of the home bias impossible. Any moves in asset allocation now not only depend on the domestic situation but also on a solution to the European debt crisis.

Our domestic situation is improving and we anticipate slow growth going forward although a lot of uncertainty remains within the economy. We expect domestic interest rates to decline further but also new listings on the domestic stock exchange. We plan to gradually increase our exposure to domestic equities because it takes time to build up confidence and trust in Icelandic public companies after 2008. We would like to diversify away from government bonds but that depends on the quality of opportunities.

We have been looking for real estate investments but have yet to find anything attractively priced so we do not expect to expand our current exposure until next year, unless we see further market corrections. We also plan to moderately increase our domestic private equity investments.

From a fundamentals’ perspective, European equities are attractively priced. However, as the macro situation is so unstable we have been reluctant to invest because even sound companies can be negatively impacted by the macro situation. There are a lot of opportunities making us want to invest - but also a lot of risk and we are reluctant to be in risk assets within the euro-zone at the moment although we are not disinvesting. Our high cash position is down to our unwillingness to deploy money as long as we do not see where the economy is heading. Therefore our biggest equity allocation remains with the US. We also have an allocation to emerging markets.

The line between passive and active investment is blurred. We are investing actively but not so much in the traditional way of stock picking - we invest, for example, in an index player that does not invest in traditional indices. We have been avoiding purely capital weighted index products for some time. The separation of assets into a liability matching and a performance-seeking portfolio has helped us with our tactical asset allocation.

Walter Schmoiger
Head of asset Management
Valida Pension
• Invested assets: €4.1bn
• Participants: over 190,000
• Around 95% are DC plans, 5% DB plans
• All plans are fully funded
• Date established: 1990 as ÖPAG Pensionskassen, 2010 as Valida Pension

A typical pension plan managed by Valida Pension holds an allocation of around 56% in fixed income - 41% euro-zone government bonds, 7% investment-grade corporate bonds, 4% high yield bonds and 4% emerging market debt, the latter is mainly hard-currency denominated - 26% equities, 11% alternatives and 7% in cash. The allocation to alternatives includes hedge funds and real estate.

Only 7-8% of the assets are passively invested as we use passively managed funds mainly for short-term tactical allocation changes. For longer-term investments, we believe that actively managed funds can create alpha relative to their benchmark.
Due to the euro-zone crisis, the main risk to our investments is political because of our high allocation to euro-zone government bonds.

This risk is hardly predictable and can occur in either way: Failure to reach a sustainable solution to solve the ongoing debt crisis would lead to a sell-off in peripheral European bonds, whereas a success would result in losses in core European, mainly German bonds, as the flight-to-safety would reverse.

To reduce the risk, Valida Pension changed its benchmark for government bonds at the start of the year from the JPM Global Bond index EMU to the JPM Global Bond index EMU ex-PIIGS, a government bond benchmark excluding the periphery.

In line with this change, the allocation to PIIGS-countries was cut, although they can still be invested on a tactical basis. The decision to cut the PIIGS-exposure at the start of the year has proven to be the right move, German bonds in particular now look expensive, which could lead to profit-taking once hope for a more sustainable solution in the euro crisis emerges.

In early summer, the deteriorating economic situation in Europe, which most likely will lead to a recession, led us to reduce our exposure in corporate bonds, especially sub-investment grade issues and convertibles and increase allocations to safer investments, mainly German Bunds. Following better economic data in the US recently we have reallocated money to US high yield bonds though we remain overly cautious.
Due to the unpredictable nature of the political decisions in Europe, the allocation of Valida stays tactical and can change quickly in a matter of days.