Independent consultant Koen De Ryck of Pragma Consulting, Mechelen, Belgium, believes the biggest challenge facing European pension plans in 2005 will be to continue to squeeze good risk-adjusted returns from their existing assets.
Mr. De Ryck does not expect to see particularly strong returns from fixed income in 2005 as the possibility of higher interest rates might reduce investment returns.
But plan sponsors hoping to increase their allocations to equities in 2005 might be hobbled by new accounting standards and increased "meddling" by regulators, which was creating distortions in the market, he said.
Sponsors with less well-funded pension plans may find themselves forced by regulatory penalties to put more money into liability-matching assets such as fixed income. The greatest pressure from regulators for liability matching is happening in the Netherlands, Denmark and to some extent in the United Kingdom, and is leading to lower equity allocations in these markets, according to consultants.
If investment markets stay stable over the next 12 months, U.K. pension plan equity allocations could fall by five percentage points because of the push for liability matching, said Gareth Derbyshire, executive director of the European pensions group at Morgan Stanley, London.
Nonetheless, pension plans will continue to put more money into specialist asset classes such as emerging markets and small-cap and midcap stocks, said Mr. De Ryck. But he warned that alternatives such as real estate and commodities are increasingly expensive strategies in which to invest despite generally good returns.
"We think there will be more pressure to move to more specialist mandates, so the opportunities for money managers will be there," he said.
Mercer's Mr. Muysken believes pension plans will continue to invest in hedge funds of funds, currency overlay and currency funds, global tactical asset allocation strategies, private equity and global real estate, which is a relatively new strategy for European pension plans.
European plan sponsors are also for the first time considering new asset classes such as infrastructure-linked investments and timber funds. Some of the new allocations may be funded from shaving allocations to core passive strategies. Plan sponsors will only reallocate assets to active strategies if they are sure the money manager will outperform the market, said Morgan Stanley's Mr. Derbyshire.
"Pension funds are moving from a situation where in the past they relied on the market return and to only a small extent on the return from active management. Now they are relying more on active management returns," said Mercer's Mr. Muysken.
"But the balance is shifting. Traditionally they have relied only on equity market returns but now they are looking for better returns from other asset classes such as fixed income, real estate, private equity," he added.
A number of European plan sponsors have already lengthened the duration of their fixed-income benchmarks, and many are considering interest rate swap programs as a means to implement this change, said Morgan Stanley's Mr. Derbyshire.
Some plan sponsors are increasingly willing to give their fixed-income managers greater discretion in investment mandates and allow them to hold a broader range of asset classes, even permitting them to short the market. "We are just starting to see that but only a handful of European pension plans have expressed an interest in it," said Mercer's Mr. Muysken.
These changes to fixed-income mandates and plan sponsors' focus on liability-led investing have been driven by new accounting standards and pension regulations among European Union member states.
