BRUSSELS, Belgium -- The Vlaamse Radio en Televisie pension fund has adopted the euro as its domestic currency in its benchmark, making it one of the first pension funds to base its asset allocation on the single European currency.
Officials at many continental European pension funds are wrestling with whether to switch their benchmarks and portfolios in light of the euro's introduction next Jan. 1, but few have arrived at any decisions.
Adoption of the euro has critical implications for asset allocation and portfolio construction -- particularly for continental European pension funds, but also for funds in noneuro European countries as well as for other international investors.
The Brussels-based VRT fund has an advantage over existing pension funds: it only recently has been established as a funded pension plan, taking over 14 billion Belgian francs ($373 million) in pension obligations from the state last year.
The 8 billion Belgian franc ($213 million) fund is seeking to hire one global bond, two euro-zone and one noneuro-zone equity managers, said Hugo de Vreese, the VRT fund's chief executive.
Similarly, Deutsche Shell AG's 2 billion deutsche mark ($1.1 billion) pension fund -- recently converted from a book-reserve scheme -- was able to leapfrog use of the deutsche mark as the domestic currency. Instead, the Frankfurt-based fund split its mandates 60/40 between European and non-European portfolios (Pensions & Investments, Nov. 24).
Pension experts say it will take much longer for existing pension funds to switch to a euro or pan-European basis for domestic asset classes because of the time and costs involved.
Plus, the risk of mismatching liabilities, as well as cultural factors -- such as comparison to a fund's peer group -- mitigate against sudden changes, according to officials at Watson Wyatt Worldwide, Reigate, England.
"We think pension funds would be taking too large a risk to move to that structure today," said Roger Urwin, head of the firm's global investment practice. "Changes in the benchmark should be implemented on a gradual basis."
That advice, however, is not universal, Mr. Urwin said. Pension funds based in countries, such as Belgium, that have small equity markets have greater reason to obtain more diversification now, he said.
FINNISH DEBATE
While few have adopted changes in their benchmarks, many European pension officials are holding lengthy internal debates over whether to switch the domestic asset class to the euro.
"We're working on the issue but haven't made any final decisions," said Petri Kuusisto, head of securities for Finland's Local Government Pensions Institution, Helsinki.
But there are signs officials at the 45 billion Finnish markka ($8.14 billion) fund will adopt the euro as the domestic currency.
The fund, which covers 450,000 Finnish municipal workers, roughly one-fifth of the country's work force, divides its asset mix between Finland and the rest of the world. That leaves the fund heavily exposed to forestry-related and telecommunications stocks, which dominate the Finnish stock market.
What's more, the partially funded plan is in the process of boosting its equity allocation to 40% by the end of 2000, up from just 3.5% at the end of 1992. Currently, 23% of assets are invested in stocks, split evenly between domestic and international stocks.
Mr. Kuusisto said the fund already holds 1.4% of the Finnish market capitalization, and there are no plans to raise that level.
In fixed-income, Mr. Kuusisto said: "In the future, we would see that we would have a euro zone," dividing bonds between euro and noneuro segments.
BOND MARKET EFFECT
The most immediate effect of the euro will be on bonds. Euro bloc government bonds in the 11 countries expected to enter into economic and monetary union were valued at $2.055 trillion Feb. 1 -- rivaling the $2.154 trillion U.S. government bond market, according to Salomon Smith Barney, London. Existing debt will be redenominated in euros, forming a much deeper and broader market.
In the new euro bloc bond market, credit quality is expected to become far more important in pricing bonds.
And the low-interest-rate environment brought on by European states' efforts to meet Maastricht Treaty criteria will drive changes in pension fund strategy, said Roland van den Brink, manager, policy and information, for Stichting Bedrifjspensioenfonds voor de Metaalnijverheid.
As a result, the 27 billion guilder ($13 billion) pension fund might seek higher yields in different strategies. Officials of the Rijswijk, Netherlands-based fund are contemplating hiring three or more external managers later this year to cover euro bonds, U.S. bonds and emerging-market debt, as well as developing its internal expertise, particularly in the euro bond market. Size of the allocations is undetermined.
Now, 56% of plan assets are invested in fixed income; the strategic asset mix has four-fifths invested in Dutch and German bonds. No major changes in the overall asset mix are envisioned.
However, the strategic bond benchmark could be rejiggered to be based on credit quality and geographic allocations, Mr. van den Brink said.
Officials at Pensioenfonds PGGM, the 83 billion guilder ($40.5 billion) pension fund for Dutch health-care workers, also are contemplating a major shift in their bond benchmark.
PGGM officials are toying with creating a global bond benchmark, with euro-zone bonds making up 60% of assets; and U.S., Canadian, U.K. and Japanese bonds making up the balance, said Marinus Keijzer, chief economist and strategist.
The proposals, which will be considered by PGGM's board in late April, also would move the fund into emerging-market debt.
EURO OR PAN-EUROPE?
Some experts believe many pension funds will move directly to a Europewide index, eschewing a euro bloc index.
If fund officials adopt a euro-zone approach, they would exclude a hodgepodge of European states, including Great Britain, Switzerland and most of Scandinavia, said Sandy Rattray, head of Goldman Sachs International's equity derivatives research team in London.
Plus, investors would omit pharmaceutical stocks, which are based in Britain and Switzerland, and would include only half of Europe's oil stocks, he noted.
Even with the added currency risk from including those countries in the benchmark, it might be easier to go straight to a pan-European approach rather than adopt a euro benchmark that might well be revised within three years' time, said Chris Sutton, head strategist for index strategies at Barclays Global Investors, London.
However, Mr. Urwin and others believe currency risk is the most important issue.
Otherwise, there could be a mismatch with a plan's liabilities, they noted.
BELGIAN DILEMMA
The issue also affects how European equity portfolios are being constructed. Managers report increasing demand for pan-European equity portfolios.
In addition, many funds already have pan-European approaches or face having to integrate their domestic stock mandates with European approaches. Karel Stroobants, deputy general manager of the 14.5 billion Belgian franc ($387 million) Voorzorgskas voor Geneesheren, Tandartsen & Apothekers VZW, Brussels, said his fund is evaluating how to redefine equity mandates for three external managers: Gartmore Investment Management PLC, London, which manages a 1.5 billion franc large-cap European (ex-Belgium) growth mandate; Singer & Friedlander International Asset Management, London, which runs a 600 million franc small- to medium-cap European (ex-Belgium) mandate; and Puilaetco, a Brussels-based manager that handles a 2.8 billion franc equity portfolio.
The issue can be tricky. "To move from Europe ex-Belgium to Belgium is easy," Mr. Stroobants said. But switching from Belgian stocks to pan-European, "that's another question," he said.
Terminating Puilaetco -- which consistently has outperformed its benchmark by more than five percentage points a year -- would be "a difficult thing to do," he said.
VRT'S ADVANTAGE
Brussels-based VRT has the good fortune of not having to revamp an existing structure.
Created last year when the state radio and television unit was reorganized into a 100% state-owned company, VRT assumed 14 billion Belgian francs in existing pension obligations -- but 50% above that level in projected benefit obligations.
The 8 billion franc ($213 million) fund will have access to 6 billion francs in insurance reserves held by Onderlinge Matschappij Der Openbare Besturen, Liege, plus 1.8 billion francs from a lump-sum state contribution made last year to invest in four external mandates by July 1.
Also, in January, the state started making monthly contributions of 60 million francs to help erase the deficit. Plus, employer and employee contributions total 27% of gross pay, Mr. de Vreese said.
The fund is expected to grow to 20 billion to 30 billion francs within the next 10 to 15 years, said Johan Heymans, an actuary with Watson Wyatt's Brussels office, who consulted to the plan. After that point, the fund is expected to shrink in size as the plan matures.
The fund, which covers first-pillar pensions, or social security-type benefits, for 2,900 VRT employees and retirees, is closed to new employees. A pension plan for new employees has not yet been created.
A study by Watson Wyatt in Brussels resulted in a strategic asset mix of 49% bonds, 41% stocks and 10% realty securities.
But target allocations are based on the euro, not on the Belgian franc. VRT is "one of the first big funds who will have that approach," Mr. Heymans said.
VRT fund officials are seeking one active manager to run the bond portfolio, whose target asset mix will be 86% euro-zone bonds and 14% outside of the EMU.
One-quarter of plan assets will be split evenly between two active euro-zone equity mandates. Up to 40% of each portfolio (5% of total assets) will be invested in real estate securities.
Lastly, a noneuro zone equity mandate, equaling 16% of assets, will require active country allocation and passive stock selection.
