Tectonic plates begin to shift
A gradual change is underway in the German pensions industry. Around 65% of employees are now being offered an occupational pension scheme by their employer, says Klaus Stiefermann, general manager of the Association of Company Schemes (aba). Most provision still comes via book reserves, which do not have to be fully externally funded, but Stiefermann detects a trend towards external pension vehicles, especially through direct insurance, Pensionskassen and Pensionsfonds.
Pensionsfonds struggled after their inception in 2002 but have since attracted increasing interest from companies that want to outsource their pension provisions and shorten their balance sheet, according to Stiefermann.
Some, however, opted to cover their pension promise through contractual trust arrangements (CTAs), a vehicle that enables them to invest in the market but avoid the regulation required of pension funds, which come under the stringent supervision.
Small and medium-sized companies cover their pension liabilities via liability insurance. And whether they are covered by such insurance, by CTAs or by Spezialfonds, they - unlike pure book reserves - remain on the capital market.
“That is why companies started to create CTAs,” Stiefermann says. “But the improvements in the fiscal framework in 2005 and 2006 have made other vehicles just as attractive, and I believe that the number and volume of Pensionsfonds will increase in the coming years.”
One such Pensionsfonds is Metallrente, which saw returns in 2006 of 11.1% for its main category, that for its members aged under 55. Its special categories, for those aged over 55 and those aged over 58 and which make up less than 10% of the total portfolio, returned 5.5% and 3.8% .
Metallrente’s CEO Heribert Karch attributes the good performance to its strong presence in rising European equity markets. “In our main portfolio 79% is invested in equities, 5% in bonds and 15% in a safeguarding product called Kapitalisierungsprodukt, which is a guarantee with a minimum return designed to match the liabilities,” he says. “The other two categories invest more in bonds and less in equities. The 55+ category is made up of 45% equities, 50% bonds and 15% Kapitalisierungsprodukt, while the 58+ group consists of 50% bonds and 50% Kapitalisierungsprodukt.”
Equities also contributed to the positive returns of Germany’s largest pension fund, Bayerische Versorgungskammer (BVK). It comprises 12 separate funds but its average net return for 2006 was 4.7%, with individual funds returning between 4.2% and 5.3%. The average 2006 asset allocation was 75% in bonds, 6% in German real estate and 20% in Spezialfonds, of which 15% is securities - including small, mid-cap, European and global equities, emerging market debt and high yield, commodities, absolute return and hedge funds - and 1% is real estate.
“Spezialfonds were our best overall portfolio with an annual performance of 14.5%,” says BVK’s CIO and deputy chairman Daniel Just. “The best master Spezialfonds, with returns of 23%, was European equity while the worst, with a 0.5% return, was corporate bonds, but we only have small quotas there.” Holger Schilling, finance director at the Versorgungswerk der Landestierärztekammer Hessen, the pension fund for self-employed vets in the state of Hesse, also believes that investments in securities Spezialfonds - less than a quarter of the Versorgungswerk’s total investments and consisting of 50% equities - helped positive returns of 5.1-5.2% in 2006.
In 2007 BVK will continue to increase hedge fund exposure in its Spezialfonds - from a current 2.5% to over 3% by the end of the year as part of a fund-of-fund multi strategy. It also wants to strengthen its hedge fund commodity exposure and integrate long-only commodity managers after bringing in a fund-of-fund long-short commodity asset manager last year. BVK will also look at fixed income portfolio optimisation through additional products.
Another new portfolio BVK created in 2007 aims at optimising its private equity allocation. “We have placed ourselves very broadly as the timing in private equity is very difficult,” says Just. “With our seven fund-of fund managers we are covering the vintage years 2005-2010. By the end of the year we will have committed €335m to private equity, almost 1% of our portfolio. Because we want to position ourselves anti-cyclically to the market - we already did this in the first half of 2007 by slightly reducing our exposure to rising equities - to counteract the exhaustion of the private equity market, we will overweight Europe and venture.”
However, BVK remains conservative about private equity, with minimum expectations below the average returns of the past few years and higher volatility assumptions.
For Metallrente the challenge is the rising volatility of equity and bond markets, which requires real-time dynamic risk management that the Pensionsfonds has been undertaking since its start in 2002.
“It is in a sense a constant proportion portfolio insurance (CPPI) transferred onto a Pensionsfonds,” says Karch. “It means you establish an equity quota, undertake a stress test and establish a buffer, which triggers sell signals for shares. Once a couple of buffers have been formed, the sell signals would only be triggered if the last buffer has been used up.”
He continues: “But this year we are a bit more conservative and introduced a lock-in strategy, which is a virtual 1% minimum interest on the contributions. It is created and calculated internally and can trigger sell signals before the last buffer has been used up.”
As part of its SRI investment strategy, this year Metallrente will also convert its previous classic benchmark based on its own selection and exclusions to a pure SRI benchmark, the Dow Jones Euro stoxx Sustainability Index, to further sustainable investments.
But due to asset-liability matching, its existing strategic lifecycle asset allocation will continue in the long term.
At the Landestierärztekammer Hessen, asset allocation has been conservative in the past and is not expected to undergo significant changes in the future.
Legal pension insurance institutes in Germany are generally subject to the German insurance law (VAG). But because such a law is missing in Hesse, the Landestierärztekammer sets its own limits to protect its members.
“Our goal is to approach the internal maximum equity quota of 15%, which means a possible increase in security Spezialfonds,” Schilling says.
“Apart from that we try to keep depreciation small and take the risk out of the depot.”
Pensionskassen have to meet more stringent regulations than Pensionsfonds. They have to be fully funded at all times and guarantee a fixed interest rate to its policy owners each year. Consequently, Allianz Pensionskasse portfolio concentrates on fixed-income with only a small percentage of equities and it posted a net return of 4.0% in 2006.
“Rising interest usually leads to depreciation in fixed income,” says Andreas Gruber, member of the board of directors at Allianz Pensionskasse. “But as a young company with large portfolio growth - our balance sheet increased from €1.4bn at the end of 2005 to €2.1bn at the end of 2006 - we have high volumes of new capital investments and welcome rising interest rates because they enable us to invest according to a higher interest rate. And so we expect at least another 4% net return this year.”
This autumn, it is expected that amendments to the VAG and a new German investment law aimed at preparing for the Solvency 2 insurance regime will be passed. According to Andreas Hilka, head of asset management at Hoechster Pensionskasse, it is closer to the Anglo-Saxon prudent person principle.
Just believes that the new law will help BVK’s strategic targets in the total returns and in particular in the hedge fund arena.
“We will take advantage of the opening of the hedge fund quotation of up to 10% from a current 5% limit,” he says. “We like the additional flexibility and liberty as well as the cost-efficiency of the Luxembourg vehicles. Our new private equity fund and our hedge funds are projected via a Luxembourg Fonds Commun de Placement (FCPs). It is important that Germany creates the same legal framework in order not to miss out because Luxembourg’s vehicles are very attractive to institutional investors.”
The future of the German pensions market and upkeep of occupational pension fund members also depends on whether deferred compensation contributions to external pension vehicles will remain exempt from taxes and social contributions.
As the current exemption will expire at the end of 2008, it is now up to the government to decide whether to continue this rule. And this, in turn, will heavily influence the course of German pension vehicles, says Hilka.