Two very different Europes
The arrival of the euro last year was expected to revolutionise investors’ approaches to European investment. The January 1999 IPE/Aon survey had revealed that fund managers and institutional funds were moving away from national mandates and towards pan-European mandates, and that the responses indicated that this trend would continue.
Since these predictions were made, significant currency pressure has weakened confidence in the euro. There has also been a wider supply of indices available to investors, including the well-publicised addition of the local Europe ex-multinational series produced by FTSE and Bacon & Woodrow. So have these factors reduced or reinforced the move to pan-European benchmarks? To answer these questions we invited pension funds and managers to comment on their current European investment structure, and to outline their expectations for 2001.
Of the 67 organisations that responded to the survey, there was a fairly even split between Emu and non-Emu institutions. In more detail, the sample broke down into 26 pension funds and 41 investment managers.
Within our sample, national equity mandates have dropped to an average of 18% of pension funds’ total assets under management (see Figure 1). This was less than the 27% that was expected, and indicates that the take-up of new Emu investment structures has been faster than expected among the Emu countries. The non-Emu European pension funds were also expected to reduce their national equity mandates; however, surprisingly they actually rose marginally to 80% of total assets against last year’s expectation of 70%.
When it comes to euro equity mandates there appears to be no middle ground. Only Euro-land pension funds tend to operate these Emu briefs. Non Euro-land countries remain reluctant to run Emu mandates, preferring instead to allocate money to national and pan-European mandates.
The movements in bond mandates have been similar to the pattern seen in equities (see Figure 2). Euro-land countries have generally reduced their exposure to national bond mandates, and increased the percentage of total assets allocated to Emu mandates. In fact, the movements during the past six months have been exactly in line with expectations set in January. Because of regulatory requirements, liability profiles and other factors, exposure to national bond mandates by non-Emu pension funds remains at almost 100%, with no expectations for change over the coming year.
The importance of pan-European equity structures for investment managers continues to grow. We asked whether money was being managed on an Emu basis, pan-European basis or a combination of separate Emu and Europe ex-Emu briefs. Our manager responses revealed that, on average, only 10% of assets were managed on a national equity mandate. European managers now run between 60% and 70% of their assets on a pan-European basis, with the remaining 20% managed as an Emu bloc brief (see Figure 3). As might be expected, the non-Emu managers ran slightly less funds on an Emu structure.
The influence of the new currency and regulatory environment on the national bond mandates is very evident from Figure 4. For the first time, the preferred benchmark for managing European bonds has shifted from national to pan-European and Emu bond mandates. Furthermore, our respondents said that they expected the trend toward pan-European bond mandates to continue. The most common structure for managing bonds by Euro-land managers is the pan-European mandate.
The preference for a benchmark to run an Emu brief is similar to the pattern of results we presented in the January survey. As at June 2000 managers’ most popular index was the MSCI Emu index. However, looking at the indices by provider, there is roughly an equal split between users of the Dow Jones, FTSE and MSCI families of indices (see Figures 5 and 6). The lowest index take-up in our sample was with the S&P and Salomon Smith Barney families, which were used by only a very small proportion of the sample.
The MSCI index was the most popular pan-European index in use as at June 2000. However, our sample showed that the MSCI index has experienced a 20% reduction in its use since last year. The changing preferences for a European benchmark are favouring the FTSE and Dow Jones indices, which have seen a 10% increase in usage within the sample.
Pension fund benchmark preferences are very similar to the investment manager response patterns (see Figures 7 and 8). The clear winner is again the MSCI European index, with around half of the sample preferring this as their pan-European and Emu equity benchmark. There was a low uptake of alternative indices for benchmarking Emu and European equities, with the FTSE, S&P and the Dow Jones index families all lacking a presence in the EMU mandates.
Fund managers' preferences for bond benchmarks have only changed marginally since the start of the year (Figure 9). The favourite remains the JP Morgan indices. However this could change soon, as close behind JP Morgan we can see that support for the Salomon Smith Barney Indices is increasing. The other votes in the category were for customised liability indices, such as local indices and the Effas index family.
Pension funds’ preferences for government bond indices is essentially a “two-horse” race (see Figure 10). The JP Morgan index is only narrowly ahead of the increasingly popular Salomon Smith Barney index. Furthermore, there was a wide dispersion of the remaining government bond indices in our sample, with a number of respondents using the Effas family of indices. Other well-known providers of indices such as MSCI, Merrill Lynch and Lehman Brothers were poorly represented in the sample.
The MSCI Investment Grade Credit Index was the most popular investment grade index with pension funds; there was also wide support for the Lehman Brothers and Salomon Smith Barney indices (see Figure 11).
There was considerable support for the Salomon Smith Barney investment grade index in our manager sample, with over half of the managers using this index (see Figure 12). There was a notable increase in the use of the Merrill Lynch Euro Aggregate index, which increased usage at Lehman Brothers’ expense. Surprisingly, there was little support for the MSCI indices. This contrasts sharply with pension funds who take a favourable stance toward the MSCI index.
The responses to the survey clearly demonstrate the growing importance of pan-European investing. However, changes in pension fund benchmarks and investment structure do not follow the speed and agility of the shift that investment managers have taken. Perhaps European pension funds outside Euro-land lag behind investment managers in attitude, or perhaps from a liability perspective. This is evidence that there are two very different Europes on the continental shelf.
Martyn Dorey and Ben Fox are with the investment consultancy practice of Aon in London