Most pensions are provided by national pay-as-you-go (PAYG) schemes, which hold about a year’s contribution income in the form of reserves; these are invested in short-term deposits and bonds.

Apart from a handful of schemes operated by large companies such as IBM, most supplementary provision is in the form of group insurance contracts.

The scourge of these is guaranteed annual investment returns of at least zero, and sometimes more, which severely restricts the ‘investment managers’ (ie insurance company’s) asset allocation strategy.

This is very much demand-led rather than supply-driven: unit linked pension products which can ‘go down as well as up’ are offered, but most customers are not interested. As a result, the average pension scheme is backed by a portfolio dominated by bonds.

An additional constraint is insurance company legislation which requires, among other things, assets matching 80% of a scheme’s liabilities to be invested in a matching currency.

The euro will have an impact on bond investments, as the currency matching requirement will be satisfied by all Euroland bonds as well as French bonds. This is likely to lead to a diversification of the portfolio as managers seek out higher yields where available - certainly they are likely to pursue the greater availability of non-sovereign bonds.

As far as equities are concerned, these represent a relatively minor part of current pension scheme assets and so the need to diverse is less. The amount in equities will only change significantly when the demand for annual investment guarantee diminishes and a greater tolerance for volatile asset classes emerges.

However, the need for greater investment in equities is increasingly understood, and recent sharp declines in bond yields may act as a further incentive to look more towards the long term in seeking out investment returns.

Tim Reay is with Bacon & Woodrow France

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