European growth, regulatory changes drive asset moves

The recovery of the European economy — combined with moves by regulators to free up potential sources of return — is leading to a paradigm shift in asset allocation.

But conflicting regulatory regimes could curtail some of the opportunity, sources said.

European pension funds' investing patterns are beginning to change, thanks to a lifting of asset allocation restrictions across the Continent that is coinciding with the long-awaited recovery in the European economy and a changing global interest rate environment.

The global financial crisis left asset owners in Europe with no appetite for more volatile asset classes. And European pension funds historically were heavily invested in fixed-income instruments.

Some European asset owners already have taken of permissions given to enter or increase allocations in equities, emerging markets or alternatives.

Verona-based Cometa, at €9.6 billion ($10.3 billion) the largest Italian pension fund, last year restructured its portfolio to include emerging markets and alternatives after the Italian regulator, Covip, removed limits on investment in these asset classes. The multiemployer fund for metalworkers now has a combined total of €5.4 billion, more than half its assets, in those asset classes, according to consulting firm Spence Johnson. Cometa officials declined to comment because they are still finalizing the allocations.

Italian occupational pension funds are now able to invest in stocks and debt of non-OECD countries without restriction. Previously the maximum-allowed allocation was 5%. In addition, before the law changed they were not allowed to invest in alternatives. The regulator lifted the restriction for alternative funds, permitting up to 20% allocation.

Jonathan Libre, analyst at Spence Johnson in London, said the changes to restrictions on alternatives and emerging market investments signify the beginning of growth in multiasset strategies in Italy.

And in France, regulators gave pension funds permission to invest up to 3% in open-end strategies, a change made in 2015. Since then, the Etablissement de Retraite Additionnelle de la Fonction Publique, Paris, took advantage. “Using (our) right to invest in open funds we have started to invest in private equity and infrastructure funds,” said Philippe Desfosses, CEO at the €26 billion pension fund.

The French regulator also relaxed its maximum investment rules on equities. According to Mr. Desfosses, the maximum ERAFP can now invest in variable revenue assets — mainly stocks — was raised in 2015 to 40%, from 25%. ERAFP had 29% of its assets allocated to equities as of Jan. 31, according to fund information.

But despite the relaxing of equity restrictions by the French regulator, institutional investors in the country are not necessarily able to take advantage of it because of other regulatory requirements. “We have not really changed our (equity) asset allocation because unfortunately, although ERAFP is a real long-term investor, our regulators still require that we maintain a buffer to absorb a stress test ... as if we were submitted to Solvency II, which is not the case,” Mr. Desfosses added.

One of the problems in the application of Solvency II capital requirements to pension funds might be a misunderstanding by regulators, said sources. While executives at some pension funds believe they have demonstrated they are fully funded, and have been eager to maintain high allocations to equities, they said regulators seem to equate volatile asset classes with risk.

“With a duration of close to 30 years and a net positive cash flow of €2 billion per year for the next 10 years, ERAFP can invest in stocks and hold them for a very long time and in that case volatility is not an issue. It is sad that regulators cannot get it,” Mr. Desfosses said.

Some institutions in Norway are facing a similar situation. This spring, Norway's regulator, Finanstilsynet, is expected to announce a new piece of regulation imposing Solvency II capital requirements on occupational pension funds. By adopting rules similar to Solvency II, pension funds will have the same safety for future pension payments as beneficiaries of pension products offered by life insurance, a spokesman for the regulator said in an email. “The current Solvency I requirement is not risk sensitive, and does not adequately reflect the actual solvency of the pension funds.” The email continued: “The pension funds products are the same products that are offered in life insurance. Similar activity with similar risks should be subject to similar regulation.”

The move is expected to see pension funds forced to collectively reduce their equity exposure to 15%, from 30%. Espen Klow, Oslo-based secretary general at Pensjonskasseforeningen, the Norwegian pension fund association, said collectively occupational pension funds in Norway had 90 billion Norwegian krone ($10.51 billion) in global and domestic equity as at Dec. 31, 2015. In 2016 the average equity return was 5.3%, said Mr. Klow.

A chief executive at a Norwegian pension fund in Oslo, said the regulation will make executives at the fund cut its exposure to domestic and global equities, which now constitute about 40% of the allocation.

Still, some pension funds are keen on equity, and able to invest.

In the Netherlands, €18.8 billion Philips Pensioenfonds, Eindhoven, last month increased its equity allocation to 30% from 29% at the expense of fixed income to be prepared for an increase in interest rates. They cut fixed income to 50% from 60% and allocated some of the assets to cash and real estate, a spokeswoman said.

In the U.K., local government plans collectively increased exposure to equity in the past three years by 8.6% to a total £120.7 billion ($150 billion), according to research by State Street. In 2016, equities constituted 47.9% of total investments.

Sources said the result of Solvency II requirements is that asset owners might be missing out on allocations that would otherwise add value to their portfolios. In 2016, MSCI World Index was up 7.5%.

Lukas Daalder, chief investment officer for Robeco Investment Solutions, said: “Equities have had quite a strong performance over the last 12 months, on the back of optimism about the "Trump-linked' reflation trade, as well as the economic rebound that has been taken place worldwide.”

Despite the MSCI Europe index being down 0.4% last year, pension funds remain optimistic and have maintained high allocations, such as the Brussels-based €1.6 billion KBC Pension Fund, which approved its three-year strategy earlier this year, keeping equity at 35%.

The relaxation of regulatory restrictions for more volatile asset classes should boost the business of European money managers as well as those outside of the Continent.

Alberto D'Avenia, country head in Italy for Allianz GI, based in Milan, said: “Based on what we've already secured, I expect to grow the business in Italy by some 60% in 2017. This includes one new mandate from Cometa adding exposure to emerging markets. Multiasset setup is what clients are responding to following the changes in domestic pension regulation.”