Pensionskassen are investing more in equities following disappointing bond markets and a widespread feeling that the time of high real estate returns is over. And their belief has not been weakened by the equity market correction in July.
“The correction was expected,” says Karl Timmel chairman of the board at Austria’s largest Pensionskasse, VBV, “But what is important is that fundamentally nothing changes on the European equity market.” Backed by a strong economy, equities will continue to perform well, Timmel says, and other Pensionskassen agree.
“We will go overweight in equities,” says Rudolf Böhm, director at ÖPAG. Last year his Pensionskasse performed slightly under the market average of 5.5%.
“With a larger equity portfolio we could have done better than the average,” he adds. “We found our active managers had outperformed the benchmark, but could not fill the gap left by the lower exposure.” For 2007 he expects a similar return to last year’s 5% but above the market average.
However, Christian Böhm, chief executive at the APK, says his fund did better than the market average without taking a higher risk in equities. “Not being part of any banking group allows us to choose our managers more freely,” he says. Its selection of 10 to 20 managers enabled APK to outperform the benchmark of its equity portfolio by three percentage points.
Over the last three years the share of equities has increased to 41.6% of the €12bn total Pensionskassen assets from 33.9%. Correspondingly, bonds now make up only 56.3% of the portfolios, down from 64.82% in 2004.
Even those Pensionskassen that went heavily into bonds after the 2000/01 market crisis “have recovered from the shock at the beginning of the 21st century and are returning to a normal asset allocation, ” says APK’s Böhm, who also co-heads the Austrian Pensionskassen association (FVPK). “The members of the Pensionskassen are also more willing to increase the equity exposure in their portfolios.”
The growing equity portfolios are diversified worldwide but Pensionskassen appetite for emerging markets has reduced.
“Unlike a year ago, you cannot be sure that emerging market securities give you a winning edge,” says ÖPAG’s Böhm. “They are performing more and more like developed market equities, which shrinks their diversifying effect in the portfolio.”“A lot of the things labelled ‘emerging markets’ can no longer be seen as such as many of the countries are now OECD members,” notes APK’s Böhm.
As for their domestic equity market, the three highlighted the performance of the ATX index over recent years but conceded it might not continue.
“Only recently the ATX passed the 5,000 mark but we do not see it continuing to go up like that,” says ÖPAG’s Böhm. “We will continue to make use of the Austrian market but we will not go overweight.”
“Because of its size, the Austrian market is more volatile than others,” says Timmel. “But fundamentally it is in a very good position.”
“For a long time the local equity market was one of the best performing in Europe,” says APK’s Böhm.
“It will be difficult to continue that. However, Austrian companies will continue to profit from their ties with eastern Europe.”
But the continuing shift from bonds to equities is driven by poor bond yields as well as strong equity returns.
“Bond portfolios are a big problem because of the increase in interest rates,” explains ÖPAG’s Böhm. “We will include money market funds in the bond portfolio as well as increasing our use of duration overlay strategies,”
Debt spread products will not be used in the bond portfolio as the ÖPAG fears negative event risks because of increasing activity of private equity funds, he adds.
“There will be one or two more hikes in the interest rates this year,” Timmel forecasts. “For next year we don’t expect the rates to rise any further because the economic growth in Europe will slow again. We have decreased the duration in the bond portfolio.”
“Government bonds are worst at the moment, with high risk and low return,” says APK’s Böhm. “Therefore LDI strategies are not seen as very useful at the moment.” The switch from bonds has also benefited real estate and alternatives, although to a limited degree. Alternative investments still make up less than 1% of the combined assets of the 19 Pensionskassen while real estate accounts for 2% of the total.
“There is a bit more movement concerning diversification and use of alternatives but there are no big moves,” says APK’s Böhm based on his experience as FVPK head. “The Pensionskassen are mostly making their first ‘attempts at walking’ in these alternative asset classes.” For APK he wants to “look at everything that might make sense and maybe implement something carefully but not participate just because it is fashionable at the moment”.
A relatively new investment strategy for Austrian Pensionskassen is currency overlay management. VBV introduced it at the end of last year and awarded the mandate to two managers. “We are profiting very much from it,” says Timmel. “Not in every single period but overall it has paid off.”
He is also content with VBV’s hedge fund investment, which is at the low-risk end. “We are invested in multi-manager fund of hedge funds and we do not expect a double-digit return,” he says. “We want a nice absolute return of 5% or 6%, therefore the risk is also very low. However, at the high-return end of the hedge fund spectrum another bubble may be about to burst.”
Meanwhile, real estate portfolios are no longer seen as opportunities for high return. “The really profitable years of real estate are over,” says ÖPAG’s Böhm. “We are using the diversified portfolio to stabilise our returns.” He adds his fund will not participate in the real estate boom in eastern Europe as this might soon collapse.
The introduction of the prudent person principle with the implementation of the European pension fund directive in July means that caps on certain types of investment have been almost completely abolished for Pensionskassen.
Under the so-called risk management decree (RIMA) all Pensionskassen had to compile a handbook laying out the risk management processes they have in place and, if by the end of June the supervisor, the Finanzmarktaufsicht (FMA), had not asked for changes, the Pensionskassen was seen as being RIMA compliant. All larger Pensionskassen achieved this status but some smaller entities might have chosen not to go through the process. “They might not necessarily need it,” notes Böhm wearing his FVPK hat. “For larger Pensionskassen it is a question of image.”
Risk management was in place at all major Pensionskassen long before RIMA so they only needed to adapt the reporting and the process to achieve compliance.
“To fulfil the FMA’s requirements we restructured our existing risk management and put a formalised process on top,” says ÖPAG’s risk manager Wolfgang Lehner. “It took us about one year to compile the handbook, implement the changes and the formalised process.”
“We have concentrated the flood of reporting requirements pragmatically,” says Timmel. “There is no use burdening the board of directors with inch-thick books on risk management. We inform them with a few significant figures.”
Pensionskassen that did not file a risk management handbook are not allowed to put more than 5% of their investments in either alternatives or derivatives. The cap for real estate is 10% and they can only invest in UCITS-compliant funds in non-regulated markets.
Caps on investments also continue to apply for other Pensionskassen according to the law on these entities. However, with equities capped at 70%, or 50% for guaranteed return products, foreign currency at 30% and securities on non-regulated markets 30%, they are far above any current exposure.