This year’s drop in the equity markets has not significantly affected the, mostly conservatively managed, French pension funds. However, the jump in interest rates has sparked alarm.
Most are still very risk averse in their investment approach with, on average, 40% held in equities and 60% in bonds, according to consultants Watson Wyatt.
“I think (our allocation to equities) is typical for a French pension fund manager,” explains Pierre-Antoine Perennes, a pension manager at UMR Corem. “In France, 20% is considered a very high allocation to equities for pension funds and life insurance companies. So, given our culture we are pretty close to the maximum at 15%. It is directly connected to our need for revenue, which has pushed our investments more into bonds than equities. We don’t want to increase that exposure, so even if the market goes up we will sell some shares to keep within our 15% asset allocation.”
The Corem pension fund might have low equities exposure but is considered one of France’s most progressive. It used to have a buy-and-hold approach but was overhauled with the advice of Mercer Investment Consultants in 2003. The new model is intended to help it meets its future liabilities and since then its return on investment has improved to 6.38% at the end of 2005 from 3.42% in 2002. Last year was slightly down from 2004’s return of 7.34%.
Like many French pension funds, Corem has a large allocation to the bond market. In 2005 this was reduced slightly to 48% from 53%, as it considered bonds were getting too expensive. Instead, it moved more into real estate and other alternative asset classes. In fact the fund’s major change last year was an increase in its real estate allocation to 7.1% from 5%. Its long-term aim is 10%.
Simon Desrochers, managing consultant at Watson Wyatt in Paris, says the increase in interest rates and its detrimental effect on the bond market has alarmed many French pension fund managers.
“The problem is the bond managers,” Desrochers says. “If you are invested in bonds you would expect your manager to position himself well in the curve to protect the investment from a huge increase in interest rates. But this isn’t happening. Often the performance of bond managers has been disappointing.”
The poor performance of these two key asset classes might prompt more French pension funds to explore other options.
Unlike many of its contemporaries, Corem is fairly adventurous when it comes to alternative investments. At the end of 2005 the €4.1bn fund held 4.6% of its assets in hedge funds and is now moving into private equity, although at 0.7% the allocation is still tiny.
Corem uses Paris-based hedge fund of fund manager Ofivalmo Palmares for this portion of its portfolio.
Hedge funds, mostly used to reduce rather than increase risk, have become increasingly popular in France since they became regulated in 2004/5. Regulation is considered to have brought more transparency to the hedge fund market and made it more attractive for institutional investors.
Like Corem, most institutions are choosing the fund of funds approach. More than 80% of the hedge fund money is held in funds of funds rather than direct investments in regulated hedge funds.
However, there is still a long way to go. “Hedge funds are still viewed by most funds as speculative and even unethical because they are seen to be playing the markets at the expense of long-term employment.” Desrochers says. “It’s a shame because there are a lot of good instruments that are not speculative at all and could be used as a good defensive strategy.”
The country’s largest pension-related fund, the Fonds de Reserve pour les Retraites (FRR), which was established to top up the state pension system, has ruled out investment in hedge funds. The FRR, which had €27.7bn in assets at June 2006, considers hedge funds too expensive and risky even though it has a quite aggressive asset allocation plan compared with most French pension funds.
Earlier this year it revealed that it was targeting an asset allocation of 60% in equities, 30% in bonds and 10% in alternative assets such as real estate, public infrastructure, commodity index and private equity investments. At end-June 30 it was well on its way, with 56.2% already invested in equities, 23.5% in fixed income investments and 20.3% still in cash and money market funds.
The FRR can get away with this strategy because it has such a long-term investment horizon - 2050 - and needs to focus on good returns to cope with France’s ageing population problems.
According to the French Pensions Advisory Council (COR), government spending on pensions will swell to 13.7% of GDP by 2020 and 16% by 2050 from 12.8% in 2003.
Although the FRR’s first management mandates were only invested in June 2004, performance has been quite good, with an annualised return of 8.52%. Much of this was due to last year’s very good 12.4% total return net of fees.
The directors of the fund said they were pleased with how well the equities mandates had fared despite the “strong and sudden downward correction” in the equities market in May. They noted that “mandates invested in equities progressed overall, outperforming their benchmark indices”.
Within equities, the FRR’s annual report for 2005 shows it had a relatively modest exposure to the oil and gas sector. Petrol and gas made up 9.5% of the stock portfolio, finance companies share was at 29.9%, followed by industrial stocks at 11.2% and consumer goods at 9.9%.
The directors noted that in 2005 they had voluntarily adopted a cautious attitude towards the markets as they considered prices too high.
However, like the Corem fund the FRR has been less impressed with the bond market, criticising recent “unacceptably low yields” in a
“deteriorating global bond market climate”.
Desrochers says the FRR is not only much larger than the average French pension fund but also more sophisticated. It is already showing a certain amount of creativity with its investments. Earlier this year it awarded five asset managers a total of €600m in socially responsible investing mandates.
The French pensions arena has undergone changes since pension reform legislation in 2003. It introduced a defined contribution pensions option known as the plan d’epargne retraite complementaire (PERCO) that could be offered by companies to their employees. By the second half of 2005 the number of companies with a PERCO rose 93% on the first half. They have also proved more popular than a similar option, the plan d’epargne retraite populaire (PERP) which are sold through banks and insurance companies.
According to AFG, 2,000 PERCOs had been put in place by end-2005, including 90 multi-employer schemes. This meant 23,000 companies were covered, amounting to 600,000 employees and €330m in assets under management.