The very long goodbye
Irish pension fund managers are looking at a move to the euro in terms of a gradual drift rather than a precipitate transition. Fennell Betson reports from Dublin Any investment managers wanting to provide transition services to Irish pensions portfolios will have a hard time. The Irish are not approaching the euro like that. They are not forsaking the punt for the euro in one mad passionate embrace, as envisioned by transition managers, rather is it going to be a long goodbye. For some maybe a very long goodbye indeed.
Paddy Gallagher, who is responsible for the Ir£900m (E1.14bn) pension scheme of brewing group Guinness Ireland Group, says: There is a general consensus among funds that there is going to be a drift from Irish to Euro-zone equities, now that the Irish currency risk is gone." The current level of fund investment in Irish equities is put at around 30% and this is generally seen as likely to reduce to at least 20%, maybe even further, he says. "But this shift will take place slowly, rather than very fast."
Guinness is in the midst of a review, which will look at various issues including the euro. "This is a normal review procedure and the euro is factored into this as one of the issues." The scheme trustees have been in discussion with Bank of Ireland Asset Management (BIAM), the sole in-vestment manager of the scheme, about the implications of the euro for the fund. But Gallagher puts his finger on a key element in the discussions current in many schemes, when he notes that the trustees are very much in the hands of their professional advisers and investment managers. "Trustees won't be the key drivers in the change, they will have to rely on the advice of the experts."
Much the same debate is in progress at Irish Cement, a smaller scheme with assets of around Ir£155m and around 370 active members and 780 pensioners. Personnel manager Nora Finn, who looks after the scheme, says "we are reviewing our parameters currently to see what effects the changes in the currency environment will have on us".
She recently made a full presentation to the trustees of the ramifications of the euro. "I talked about the question of diversifying and the opportunities the euro presented to do this. I pointed out that we have a problem in the small range of Irish stocks we are invested in. The Euro-zone will present us with an opportunity, as there will be a new large dom-estic market. This will enable us to di-versify outside Ireland and increase our portfolio's liquidity without currency risk."
She adds: "That is the pro-side of the argument, but the other side is that Irish market has outperformed other markets, so that we are not in a big rush to get out of something that has done so well."
This is a quandry that Irish Cement is not alone in having - that of the need to broaden out the "domestic equities" portfolio into an Irish and rest of the Euro-zone, but having to decide on the extent and timing. The Irish Cement scheme has a 26% Irish equity content, but what should that be reduced to? At Guinness, Gallagher talks of the need to reduce exposure from the "small, tightly-held Irish market, which has been delivering terrific returns for the past few years".
But no one is talking about reducing the proportion to 1 to 2% of portfolios, equal to the Irish market's weighting in European capitalisation.
Brid Horan, who heads one of the country's largest schemes, that of the Electricity Supply Board, says the Ir£1.8bn fund has carried out an asset liability study as part of the preparation for the euro. It is in ongoing discussion with its fund managers, including ESB Fund Managers, which is owned by ESB, the fund sponsor. "We commissioned the study to dovetail into our ongoing discussion with trustees." She has also been active in the Irish Association of Pension Funds programme for trustee information on the euro: "We still see a distinction between Irish and euro assets and do not envisage a situation where we could immediately move to a European market weighting in Ireland. Generally, we think it is an opportunity for trustees to reduce their stock-specific risk within the Irish market." With just three shares accounting for over 50% of the Irish stock exchange capitalisation, these risks are considerable.
The vast majority of Irish pension assets are run as balanced accounts with a range of domestic managers who have discretion over the asset allocation within benchmarks that favoured high Irish equity exposures. Normally they would have discretion over the transition process. Horan comments: "It is hard to know what has been happening within individual portfolios but the overall trend is towards a reduced presence in Irish equities."
The debate in Ireland has been concentrated on whether people will move out or into Irish equities on balance, she says. "The issue is to what extent will overseas buyers compensate for the outward moves by Irish managers." There are differing views on that, she points out, though in 1998 there were strong inward flows. "Irish investment managers will seek to time their exit from the market and balance this with the strength of inward flows."
But are managers up to this? Horan says: "Our hope is that they will play that game rather than watching each other and not doing anything different to their competitors." That could be the real risk for their pension fund clients, she considers.
The Irish Airlines fund is one of the few Irish schemes run on a specialist manager basis, so the asset allocation is very much more under the control of the trustees than with a balanced fund. The Irish equity portfolio is run in-house, says scheme manager Bob O'Reilly. He adds: "We run it very successfully, if I may say so, by not churning the portfolio.
"In theory, we should say that Euro-land is now one equity market and that there is no currency reason for any predominance of Irish equities. But I think we are going to move slowly on that one."
The Ir£1bn fund has an Irish equity exposure of 20%, well below the average for Irish schemes, he points out. "We are not adding to our Irish equity investments.
We are likely to grow the European element by diverting new cash into Europe. But how far we go in reducing the Irish content will be decided in due course." He says: "The advent of the Euro-zone presents an opportunity to reduce stock specific risk by reducing the percentage of the portfolio represented by any one stock."
Within consultancy circles, there has been discussion of Irish equity proportions shrinking to below 15% on average for pension funds. But the pace at which this will happen, looks like being dictated by the asset managers. Kevin Goss of consultants Aon Beech Hill says: "Different managers have different ways of going about this and there is a lot of discussions at meetings with trustees. Generally, trustees are letting the managers do their own thing."
At consultants Coyle Hamilton, Joe Byrne acknowledges that for a "greenfields balanced fund client", should such a rarity occur, the Irish equity content could be in the 10 to 15% bracket. "But if you are currently at 25 or 30%, and you want to shed 10 to 15%, you are only going to do this on a phased basis."
He says that discussions are in progress with a number of clients about their risk profile, asset allocation and benchmarks. "Where people want to reduce the Irish equity element, you have to structure the benchmark so that they are changing over time, with so much of a change occurring over six months, so much over 12 months, 18 months and so on." He adds: "We work with the asset managers on this. Since most managers have full discretion on this, we give them a broad outline as to how they might do it, going forwards."
There is no sign of Irish pension funds making complete once and for all portfolio shifts, as they might under a professionally managed transition programme, says Deborah Reidy of Mercer's investment practice in Dublin. "It is my personal view that investment managers believe that it is to their competitive advantage to keep the price of Irish equities artificially high. Once they lose that advantage they would be fair game for external managers from abroad."
She does acknowledge that the outperformance of the Irish market, with some of the stocks still looking like good value compared to the European counterparts. "But I still do not think they should be 20 to 25% or more of portfolios going forward."
Mercers has been actively promoting an alternative view that Irish equities should make up 20% of portfolios this year and 15% next year. "In our end-state, which may be 10 years away, it will be 1.5%, lining up with Ireland's position in the European markets," she says. "We hope the asset managers will do the right thing by their clients."
But problems arise in trying to dispose of stock in a relatively illiquid market, which accounts for the 'go slow' approach. "Also people had a wait-and-see approach to the euro, to see if it would in fact work. And there was some nationalistic approach about clients not wanting to see managers drop a lot of Irish stock that quickly."
During the course of last year, the figures show that Irish equity holdings had fallen, but that, it seems, went to Euro-zone bonds and not the equity markets. "This may have been due to the volatility of the markets." She agrees that clients are letting managers manage the transition. "Since the benchmark in Ireland has been the peer group of Irish managers, clients are able to see what sort of job their manager has done in terms of timing in selling out of the local market and moving into Euroland, by looking at the peer group - the manager averages."
Some ideas as to where managers are in terms of portfolio allocation can be obtained from the pooled fund figures, which give a good indication of what is happening in their discretionary balanced accounts as at the end of 1998.
Ireland's largest asset manager, with Ir£25bn under management, Bank of Ireland Asset Management (BIAM) has been caught up in the dilemma of the market, by having had a lower domestic equity exposure in its portfolios for a number of years. BIAM's Tom Finlay says: "As value managers, on purely fundamental grounds, we reduced our overall equity weightings, particularly in Ireland, where we had stock-specific concerns.
As a result, we have been almost 10 percentage points below the market average of 30%." This underweighting has had its costs, he admits. "On a two-year view we are underperforming due to this weighting, despite having more on average in the US market, which did well." One of the best performing managers has been the much smaller Friends First, the Irish subsidiary of a UK insurer. Here head of investments Pramit Ghose reckons that its Irish equity exposures will go to 15% or so in the next three years, having brought the proportion down from 34 to 28% over the past year. "Euroland is now our favourite market, and we have increased our allocation from 10 to 15%."
He adds: "We are changing our investment process so that we can run Ireland and Europe on a sectoral basis. We will be treating Irish and euro equities as one class." But when does he expect that there will no difference between an Irish and a euro stock? In his view this would not be for a year or two. "This is because the country position of Ireland is so different from the rest of Europe, that it would be silly to do this. The characteristics of Irish companies and their valuations are far different. What is happening domestically in Ireland still has a year or two to run."
The second largest asset manager is AIB Investment Managers (AIBIM) with Ir£8bn assets under management, of which over Ir£5bn are pensions assets, has reduced significantly its Irish exposure to around 22%, according to observers. Tim Walsh, strategist with AIBIM in Dublin, talks of the development over time of a "euro-class, which is a composite of Irish and other euro stocks". "While there may be one euro-class, it has the bulky Irish component in it, so the issue is how the various elements will develop over time. This is going to be a gradual process. But we do see Ireland as being a large part of the greater euro market."
Other managers have been able to take a different approach.
Edinburgh-based Baillie Gifford stands out by having a Euroland ex Ireland weighting of two to three times that of the average Irish manager, according to Gareth Howlett. "We have positioned ourselves so that we are now where the other managers know they are going to move towards in the next few years. We are ahead of the game with our distinctive asset strategy." It also reckons it is ahead of its own expectations by already attracting outside funds to its recently launched pooled pension fund for Irish investors. "We take this as an expression of confidence in our approach."
Last year, Hibernian Investment Managers saw the euro as an opportunity, where it could take advantage of the good performance it had achieved in European equities. "We felt we could get ahead of the posse, by launching a range of 'euro' funds in January of last year," says Dara Fitzgerald. Hibernian did this without knowing which countries would be the definite participants. "We did overweight Ireland at 10% on the grounds of cultural prejudice. It would have been too much to go for market weighting of 1.5%." By having the funds up and running for a year, it now has a year's track record. "For pension fund clients, we suggest that they do not realise equity to invest, but divert cash flow instead into one of the funds."
The consultants report an increasing number of contacts and sightings of managers, from the UK, US and continental Europe, who are interested in the Irish market. But Alan Broxson of Irish Pensions Trust, which has re-cently merged with Mercer in Dublin, is extremely optimistic about the ability of Irish managers to take their cli-ents successfully into the Euro-zone. "Irish managers have always had to manage significant volumes of money overseas. I would be more confident of an Irish investment manager's to cope with the new Euroland than their counterparts in most other countries." Broxson also sees the Irish market being pretty protected from the attentions of outsiders, because of its size. "Pension fund assets are only around Ir£30bn, and even new local managers have found it hard to gain business." With the bulk of pensions assets being held in balanced portfolios, it is hard for managers offering specialist services to make inroads.
At Aon Beech Hill, Goss agrees about Irish managers' skills: "In terms of track records, that of Irish managers is very good when investing overseas." But he thinks the requirements of the new euro markets will make new demands on managers generally. "This will demand a new style requiring skills in a number of markets, so the jury is out as to how they will perform. But Irish funds need not worry unduly as they have managed very well internationally."
But one market observer expresses some reservations as to the depth of expertise on the international side in the Irish market. "The good people in Dublin are as good as the best anywhere in the world, but once you move outside that pool of good managers, the quality levels drop away drop away quite sharply. There are not enough high quality people in the market to choose from," he says. But, as Byrne at Coyle Hamilton points out, it is very important to be open minded on the role of outside managers. "We have brought overseas managers into beauty parades as we are keen to see what they have to offer. Our advice to clients is: 'Weigh up all your options!'" At the same time, he reckons that if Irish and UK managers' overseas performance is compared, that of the Irish managers would generally be better.
And at the investment groups themselves, there are no doubts about their capabilities and credentials.
Walsh at AIBIM puts it as follows: "We have always had to manage overseas assets and we will be able to deliver all that our clients need in Europe.
We feel that we have been exposed to the glo-bal scene more than many of the European banking and investment groups."
BAIM has been tremendously successful in winning pensions assets outside Ireland, with some Ir£10bn of assets being managed for overseas clients. Finlay says: "We see Irish funds now moving in the direction of our overseas portfolios. We have more money invested in these new euro markets than any other Irish manager." But of BIAM's Irish competitors, he says generously: "The other home players do stack up well on an international comparison basis." There is no place for complacency as their home market is going to become much more competitive, he says. "Outsiders have always shown interest and this will only increase."