LONDON - Regulatory changes will help drive investment policy in major European pension markets in 1997.
While pension experts are not anticipating major changes, they do expect regulatory changes will start to shape investment policy in the pension markets of the United Kingdom, Switzerland and the Netherlands.
U.K. pension funds, with some 600 million pounds ($1 trillion) in assets, are still digesting the effects of the 1995 Pensions Act. But it already is clear the law's requirement that pension funds adopted well-defined investment policies is partially responsible for growing use of customized benchmarks.
Use of fund-specific benchmarks by U.K. balanced funds jumped to 40% in 1996 from 29% in 1995, while use of median manager data has dropped to 73% from 80%, according to Greenwich Associates, Greenwich, Conn. Equity and property investments are slipping, while bond allocations are on the rise.
Swiss pension funds, meanwhile, face a new requirement to formally define investment policy, forcing pension executives to come to terms with their policies and accelerating the trend toward asset-liability studies.
And, draft funding rules in Holland are running head-on into other regulatory policies. Some Dutch pension experts worry the draft rules - which would require pension funds to maintain a 30% reserve for equity investments - might inhibit equity investment for less well-funded plans.
At the same time, Dutch authorities are trying to encourage pension funds to increase stock allocations.
"You could say there is a tension" between the two policies, said one Dutch pension expert.
Following is a summary of major developments in these leading European markets:
United Kingdom
In 1996, U.K. pension trustees spent much of the year complying with requirements imposed by the 1995 Pensions Act - including minimum requirements for member-nominated trustees and new contracting-out rules, as well as evaluating the effect of a new minimum funding standard.
But one of the least-heralded of the changes required trustees to develop a formal "statement of investment principles" - essentially a document outlining how each fund addresses its investments in relation to risk and return.
"I think the statement of investment principles will be more important than the (minimum funding requirement) for most funds," said Robert Ross, director of consulting for Frank Russell Co., London. While the funding requirement will affect only less well-funded plans, the SIP will affect all plans.
The investment principles must include: a policy for meeting the new minimum funding requirements; a policy to assess the suitability of individual investments; the kinds of investments that will be held; the fund's asset mix; risk levels; and the expected rate of return.
Consultants said the requirement has caused trustees to focus much more on the liability side of the pension fund. That, in turn, has pushed more funds into adopting customized benchmarks.
"There is a trend toward liability-driven benchmarks that will accelerate," explained Andrew Dyson, head of U.K. pension funds at William M. Mercer Investing Consulting, London.
Half of the largest U.K. pension funds responding to a Russell survey reported that have adopted strategic benchmarks, rather than the traditional WM Co. or Combined Actuarial Performance Service peer universe, Mr. Ross said.
That's significant because U.K. pension funds are moving away from the peer-driven benchmark, in which pension funds are compared with each other regardless of their liability profile.
But change rarely happens swiftly in the U.K. market. As Bill Goodsall, managing director of First Quadrant Ltd., London, said: "I don't think we are going to see people swept off to the Tower because they haven't done that by May 1997," he said.
Still, some changes are starting to surface. A combination of the law's minimum funding rules and growing pension fund maturity are resulting in a higher fixed-income allocation and shrinking equity and real estate allocations.
Greenwich consultants found bond allocations rose to 14.3% in 1996 from 11.8% in 1993. What's more, U.K. pension managers expect to raise bonds to nearly 16% by 1998.
Meanwhile, stocks have dropped to 75.9% last year from 78.5% in 1993, but plan sponsors expect that level to hold steady. The real loser, continuing a long-term trend, is property, which has fallen to 5.4% in 1996 from 6.2% in 1993, and is expected to decline further to 4.7% in 1998, according to Greenwich.
The long-term impact of the Pensions Act might be to spark a shift toward defined contribution plans, which are less costly to operate (and often less generous to plan participants).
Greenwich found that use of money purchase plans climbed to 17% in 1996, up from 11% in 1994. Moreover, the proportion of U.K. companies planning to adopt defined contribution plans has more than doubled to 12% from 5%, the consultant found.
Swiss pension funds
A new requirement that Swiss pension funds have clearly defined investment strategies and controls is starting to be felt, said Dominique Ammann, partner at Pension Portfolio Consulting AG, Zurich.
Many Swiss funds - with some $280 billion in assets - had never articulated their investment strategies, consultants said.
In addition, new guidelines requiring Swiss pension funds to disclose their derivatives exposure also have taken effect. They are expected to have relatively little impact, because most Swiss funds are conservatively invested.
For 1997, many Swiss funds are looking to lock up gains of recent years, which will make them even more conservative, Mr. Ammann added. That might stall growth in international equities for the next few months, but funds will boost stock investments in the long term, he said.
Also, Swiss pension funds are abandoning country-by-country asset allocations, instead favoring a move toward building a portfolio of multinational companies, Mr. Ammann added. They also are rethinking how they approach international bond investments because of uncertainties created by European Monetary Union.
Swiss defined contribution plans, meanwhile, are wrestling with the implications of meeting a minimum 4% annual investment return in a bear market, said Divyesh Hindocha, a senior consultant with William M. Mercer Ltd., London.
One thing Swiss funds can do is not book a part of their gains in an up year, setting aside a portion of the gains in a reserve, he explained.
Dutch pension funds
Conflicting policies by the Verzekeringskamer, the Dutch Insurance Chamber, might affect the ability of some Dutch pension funds to increase their equity allocations.
Dutch pension funds have total assets of about $327 billion, according to InterSec Research Corp., London. By the end of 1996, the Dutch funds had about one-third of assets invested in equities, of which two-thirds were invested abroad, according to The WM Co., Amsterdam. In comparison, Dutch funds had only 20% of assets invested in stocks six years ago.
While the Dutch regulator has pulled back an earlier draft that would have required pension funds to have reserves that would have sustained the fund should it suffer a 40% stock market drop, some experts believe the rules need to be eased further.
Experts say a draft rule that has circulated among the pension industry would require a 30% reserve for equity investments. Thus, a pension fund with a 40% equity exposure would be required to maintain at least a 112% funding level.
Those levels of reserves would force a "very short-term orientation to an industry which has a very long-term orientation," said one pension consultant, who asked not to be identified.
Most Dutch pension funds are well funded, and the rule - if adopted in its current form - would not pose a big problem, experts said.
Dick Snijders, managing director of the Philips Pensioenfonds, Eindhoven, said the move toward an approach that matches assets with liabilities will "not hamper the necessity for Dutch pension funds to increase their equity holdings further."
Still, some experts worry the rule could limit flexibility in the future and runs head-on with other Insurance Chamber policies encouraging greater equity investments.
Further discussions will occur between the regulator and industry officials on the subject. "I'm confident we can convince the Insurance Chamber that it is not such a good idea to go for 30%," said Kees van Rees, managing director of Shell Pensioenfonds Beheer B.V., Rijswijk, and chairman of the Dutch Association of Private Pension Funds, Stichting voor Ondernemingspensioenfondsen, The Hague.
Meanwhile, the Insurance Chamber also has been collecting data on use of derivatives by Dutch pension funds. Mr. van Rees said the chamber is looking for the extent of derivatives usage and what controls are in place for pension investments.
