One of the side effects of the events of 11 September has been a flight from equities to cash by European institutional investors. Cash still represents the safest haven for funds in times of market uncertainty and, if managed actively, can produce modest but useful returns.
Investors have moved assets into the quality currencies, notably the Swiss franc and the yen. In the final quarter of this year, for example, Credit Suisse has gone overweight in Swiss francs, a 3% increase on the preceding quarter.
To what extent have European pension funds followed suit? Pension funds are comparatively free to move assets into cash as they wish. There are few investment restrictions on cash and deposits holdings. Only three OECD countries – Germany, Italy, and Portugal – impose maximum limits. Germany has a 50% limit on bank deposits, Portugal has a 30% limit on short-term deposits and Italy sets a 20% limit on liquidity.
Spain restricts deposit and other money market assets to a range of 1% to 15%. In general, European pensions fund allocations are likely to be within this range. In Belgium, for example, a typical asset allocation to cash would be 6%.
The extent to which pension funds allocate assets to cash will depend largely on the maturity of their plans. In theory an immature scheme that does not need to pay out pensions for many years can afford to be fully invested – that is, out of cash altogether. In reality, most funds will need to have some exposure to cash.
The primary purpose is liquidity. Cash enables funds to meet their liabilities, and need have no tactical or strategic purpose. However, some funds also see cash is a key part of their portfolios, a discrete asset class that can be actively managed to provide modest but useful returns.
Cash and deposit allocations can be misleading, since cash is often bundled up with short-term investments. Stockholm-based Sparinstitutens Pensionskassa (SPK) has a cash and deposits allocation of 11%. However, Peter Hansson, chief financial officer of SPK, says that little of this is cash. “That figure includes all investments with duration less than one year. A minor part of the allocation is used to provide liquidity and security for the monthly payments of pensions. The major part is actively managed duration portfolios in combination with longer fixed-interest instruments.”
The bear market in equities that developed before 11 September had already increased the attractions of cash for some funds. In Switzerland, the SFr17.5bn Basel-based Novartis pension fund, with 18,500 pensioners on its books, began to increase its exposure to cash towards the end of last year. Gino Pfister, Novartis pension fund director, says: “As of the fourth quarter last year, we started to increase our cash position due to the growing uncertainty in the equity market. At the end of the third quarter this year liquidity had reached 11.6% of total assets.”
Other Swiss funds have switched assets from equities to cash for tactical reasons. The SFr4.6bn Bernische Lehrerversicherungskasse, a public authority pension fund for 14,500 teachers, has taken this route. Christian Leibundgut, the fund’s chief investment officer, says: “Tactically, we have reduced the equity portion in favour of cash and bonds due to the uncertain market conditions since the beginning of this year. As per the end of September, our liquidity exposure is 6%, and the existing strategic asset allocation for cash is set at 6%. Tactically we could reduce or increase this part between 2% and 12%.”
However, Leibundgut points out that the strategy is to reduce rather than increase the fund’s cash allocation: “Overall, we are not planning to increase the cash allocation strategically. We are planning to introduce a new strategic asset allocation with a target of 3%, with an allocation range of 0% to 5% within the next few months.”
Other funds have maintained a “wait and see” policy. The SFr20bn Zurich Canton pension fund BVK allocates over 8% of its assets to cash and deposits. BVK’s 2001 strategic allocation to cash was set at 8.3% of total assets. Daniel Gloor, head of asset management at BVK says, “Already at the beginning of the year, we were rather cautious about the development of equities markets and have therefore maintained the quota. Currently, cash – mainly in the form of a certificate of deposits denominated in Swiss francs, euros, US dollars and sterling – amounts to 8.4% of total assets”.
However, Gloor does not expect the allocation to be increased. “Cash allocation will probably not change considerably until the year end but may be partly reinvested into foreign equities,” he says.
Indeed, some investment officers question whether a move from equities and bonds into cash represents the most effective “safe haven” tactic. Hervé Noël, head of portfolio management at the Tractebel pension fund in Brussels says: “If you believe in tactical asset allocation, and – there is room for debate – I think you could better use an overlay structure with derivatives in order to offset or increase somewhat your exposure towards equities or bonds.
“Overlay structures and protection strategies – for example, trading gains in excess of X against stop-loss – are less expensive and disruptive than converting part of your long-term portfolio into cash,” he says “Anyway, from a momentum perspective I think it is a little bit late to become worried about the volatility on the equities markets.”
Tractebel’s cash allocation is unaffected by the current volatility of the markets and he adds: “We do not look at cash from a strategic or even tactical perspective. Today, cash is no more than a buffer between the premiums we get and the pensions we pay. It is managed in order to get the best return possible but being a buffer the duration and variety of investment strategies is, of course, limited.”
Most corporate pension funds use cash as a buffer to provide cash in hand for present needs. Fred De Brabandere, pension fund manager of the E76.9m BP-Amoco Pensioenfonds in Belgium says: “The only purpose of holding cash is to provide liquidity for ongoing payments. It has no strategic purpose.”
The E0.7m NV Belgian Shell pension fund uses cash in a similar way. Jan Vlietinck, a member of pensions investment policy and advice team, says that the main aim of holding cash is liquidity and that there are no plans to increase the cash allocation.
Cash is not treated as a separate asset class by most pension funds, but as a residual asset. Edwin Meysmans, managing director of the E700m KBC Pensioenfonds, says, “In our strategic asset allocation, cash has a 0% benchmark with a tactical allocation of between 0% and 5%. So, cash is not considered as an asset class.”
Since pension funds regard cash as a residual asset rather than an asset class of its own they are more likely to manage it in-house. SPK, for example, outsources all day-to-day operations of its investment management except for the liquidity assets and some strategic holdings. Other funds have split management between in-house and external managers. Ton Zimmerman, director of the E1.5bn Stichting Pensioenfonds van de Koninklijke Nedlloyd, the Rotterdam-based fund of the sea transport company, says: “Cash is mostly managed internally, but also the external managers may keep some cash for a short period of time.”
One effect of the current volatility in equity and bond markets may be that pension funds, like other investors, are holding on longer to their cash before deciding where to invest it. Meysmans points out that KBC Pensioenfonds now retains its cash “float” for longer than it did in the past. “In the current climate we find that new money coming into the fund from employer contributions is held longer before being actually invested or transferred to the money managers,” he says.
So, although European pension funds may not be moving wholesale out of equities into cash, they are holding on to what cash they have until the markets steady.