European plans stepping into more active allocations

Active money managers might find more opportunity in European defined contribution plans than in the U.S., as plan executives on the Continent increasingly look to them for help in broadening their portfolios' exposures.

The growing DC business in Europe has arrived on the radar of active money managers at a time when many U.S. plans have increased their allocations to passive funds in an effort to reduce fees.

While cost constraints for European plans remain a barrier to non-traditional asset classes, sources said low-cost diversification also has become much harder to achieve because formerly uncorrelated asset classes now move in tandem. And European DC plan executives are realizing passive-only strategies overall are not providing the kinds of returns they need for the growing and changing needs of DC participants.

"There is a limit to how passive a plan can be," said Lode J. Devlaminck, managing director, global equities at DuPont Capital Management, Wilmington, Del., which runs $29 billion in assets.

In Rome, the €700 million ($812 million) defined contribution plan for employees of Italian small- and medium-size businesses last month launched a search for an active equity manager to run €95 million.

"In the past, when unions had a stronger position, it was important not to pay a lot in fees ... but this has changed. Now, we are looking for higher returns," said Mauro Bichelli, director at Fondo Nazionale Pensione complementare per i lavoratori delle piccole e medie imprese, known as Fondapi.

Still, he said: "Money managers believe that our sector will grow so we won't spend as much on fees compared to (plans) worldwide. We are going to pay no more than 25 basis points (for the equity allocation)."

In addition, some sources believe the dispersion among returns of different sectors has increased in the past couple of years. Although volatility remains low, this improves the market ​ conditions for active equity managers to outperform passive ones, Mr. Devlaminck said. He would not give specifics about the DuPont investments.

But for Mark Fawcett, chief investment officer of the £1.8 billion ($2.4 billion) National Employment Savings Trust, London, active management in equities is not justified.

"Where available, indexed management is often more efficient than active management. In certain asset classes, such as developed equities, active managers are going to struggle to outperform an index after fees," Mr. Fawcett said.

Instead, NEST is considering an active approach for other asset classes. "We're currently exploring options for commodities, global investment-grade credit and private markets, including infrastructure," Mr. Fawcett said.

Sources said one reason active strategies are increasingly featured in DC portfolios is executives' belief that some asset classes tend to be more efficient than others. A passive approach might work very well for large-cap equities, but less so for small-cap equities or bonds, Mr. Devlaminck said.

Mr. Fawcett agreed: "For global developed equities, it makes sense for us to be passive investors. But for credit, the largest companies in a market-cap index may also be the most indebted — therefore the most risky — which is why we go for active credit managers to manage those risks."

Mr. Devlaminck also agreed. "Going active in bonds is more commonly found."

Some European DC plans recognized the need for active management in fixed-income allocations and have had these strategies in place for a few years. Fondapi's Mr. Bichelli said: "Both of our active fixed-income managers were up (compared with the index) in the last year." Pacific Investment Management Co. LLC and BNP Paribas Asset Management together manage 20% of Fondapi's portfolio in corporate bonds.

Consultants and money managers running multiasset funds continue to see a stream of inflows from plans of all sizes as they look to access active managers through a variety of styles. Tapping into the alpha might seem affordable to some small plans only through multiasset solutions, which offer access to a mixture of passive and active strategies, but sources said small plans are not the only ones that tend to go for these options.

"We have found business with some 200 DC plans in the U.K. in the last five years. Corporate plans choose these active off-the-shelf solutions if they don't want the cost (of a tailor-made solution)," said Brian Henderson, partner, DC and financial wellness leader at Mercer in Edinburgh.

"Mercer's £10 billion multiasset fund has been one of our most successful products, offering an annualized return of 11.5% net fees over the last five years," he added.

Erik Goris, chairman at Volo Pensioen, Zeist, the Netherlands, that accounts for €4 billion in defined contribution assets, said active management, in certain pockets of investments, is a good way to recoup some of the return that plans end up losing as a result of being in a passive strategy. Mr. Goris added: "We see a trend toward portfolios with less investments but more focused investments, which utilize active strategies."

However, many more esoteric asset classes still remain off limits because active strategies tend to cost more than the prescribed expense ratio, making investing in, for example, hedge funds particularly challenging, sources said.

Mr. Fawcett said: "For us, what's most important is identifying the asset classes we need to offer the right risk and return characteristics for our members' portfolios. We then need to ensure we can deliver that within our 0.3% total expense ratio. That means driving hard bargains with all our fund managers to deliver high quality to our members."