LONDON - The average stock allocations of European defined benefit plans will converge toward the U.S. norm of 60% stocks, predicted Jean Frijns, head of the investment division of the Algemeen Burgerlijk Pensioenfonds.
Currently, asset allocations across Europe vary tremendously. While U.K. pension funds have an average allocation to equities of 77%, Swiss funds have 29% in stocks, Dutch funds have 23%, and German funds, 18%. Including the book-reserve system, however, boosts German pension funds' equity exposure up to the level of British funds, Mr. Frijns said.
The main factor pushing convergence will be more common attitudes toward risk, Mr. Frijns told the National Association of Pension Funds' European investment conference in London.
While British pension funds' appetite for equities will be diminished because of the expected adoption of minimum funding rules, continental European pension funds will be influenced by professional money managers and the introduction of performance measurement techniques, according to Mr. Frijns.
But the growth of defined contribution plans, at the expense of defined benefit plans, will weigh in favor of more conservative bond-oriented asset mixes. The overall allocation of pension assets will not change that much, Mr. Frijns said.
Many observers have attempted to explain the reasons for the current divergence in asset allocation among countries.
Mr. Frijns believes the most important factor is pension funds' view of short-term market risk.
U.K. and German pension funds both have greater risk tolerance. Both use long-term funding standards, compared with the Netherlands and Switzerland. And in both British and German pension funds, the corporation bears the risk for providing pension benefits.
In Holland, by contrast, risk is shared with employees, and in Switzerland, which Mr. Frijns characterizes as a defined contribution market, the employee bears the entire risk.
In addition, in the United Kingdom, short-term market risk effectively is smoothed away through actuarial calculations. In Germany, there is a relatively small risk premium on equities - stocks have provided an average real return of 6% a year from 1967 to 1990, while bonds have provided a 4% average annual real return.
In the United Kingdom, there is a much greater risk of inflation, which encourages use of equities: average annual inflation was 9% during the 23-year period, which lowered the real rate of return on bonds to 1% a year.
In contrast, stocks provided an average real return of 8%, according to ABP.
The second most important factor in asset allocation decisions, Mr. Frijns believes, is peer group behavior. Pension officials in different countries are at different stages of the learning curve, he said.
British pension executives are accustomed to using specialized money managers and consultants, while executives in other countries still rely predominantly on in-house investment, banks and insurance companies. The Dutch market is in the throes of the greatest changes: pension funds there are adopting performance measurement and are strongly influenced by their U.S. counterparts.
Lastly, Mr. Frijns said liquidity and size of capital markets is an important factor in determining equity exposure. Anglo-Saxon markets are more liquid and larger in size relative to gross domestic product, and more transparent than continental markets, which encourage an equity culture.
But the factors of peer group behavior and liquidity and size of capital markets will become less important as capital markets become more international and integrated, he said.
Asset allocation will be more determined by differences in pension fund risk profiles, Mr. Frijns asserted.
How much risk - in the form of equity - will be acceptable will depend on solvency requirements, valuation standards and the maturity of the fund, he said. With a long-term outlook and a well-funded plan, a pension fund is better able to maintain a high equity weighting.
But the aging population and tougher funding standards also could lead pension officials to switch to defined contribution plans, he said.
Still, Mr. Frijns foresees a convergence in risk attitudes because of expected adoption of tougher funding rules in the United Kingdom and a gradual move up the learning curve on the Continent, inspired by professional money managers and introduction of performance measurement.
Tim Gardener, head of asset planning at William M. Mercer Ltd., London, agreed that convergence is possible.
Mr. Gardener projected that British pension funds will sell off about 40 billion in domestic equities.
In three years' time, Mr. Gardener forecast that the average weighted U.K. pension fund allocation to British stocks will drop to 75% from 85%.
In addition, the internationalization of capital markets creates larger and more liquid markets with similar return patterns, enhancing equity investments, he said.
Among the factors that could weigh against a higher equity exposure are increased regulation, the aging of the population and potential switch to a defined contribution system and changes in tax systems that would treat private savings the same as defined benefit plans.