With solvency ratios averaging just 92%, continental European pension funds are developing strategies to meet their obligations after a period of disappointing market returns, according to the results of a study by Greenwich Associates.
“Given that their equity allocations are roughly 20% of their assets, and that fixed-income rates are at or near historic lows,” observes Greenwich consultant Berndt Perl, “it is difficult for a lot of plan sponsors to see how they will be able to cover their obligations to beneficiaries – except by obtaining large contributions from employers.”
The 282 fund professionals interviewed by Greenwich for its 2003 study of continental European investment management reported that they plan to respond to the solvency issue by beginning to increase equity allocations, stepping up their participation in alternative and international investments and reviewing their use of absolute return strategies for their portfolios.
While pension funds in other major markets have suffered large losses over the past three years, solvency ratios on the Continent are substantially lower than those in North America and the United Kingdom, with almost 60% of the large continental pension funds that disclosed their ratios reporting they are technically insolvent, according to the Greenwich report.
Berndt Perl explains: “The effects of the global equity market collapse have been more acute in Europe for three reasons: First, declines in continental stocks were more dramatic than anywhere else in the world except Japan; second, continental institutions shifted out of fixed income and into equities in the late ’90s and were harder hit by the bursting of the ‘bubble;’ and, third, regulatory requirements in various continental markets forced funds to sell stocks at unfavorable times.”
Greenwich Associates research reveals that the recent reduction in equity holdings as a proportion of total institutional assets is a virtually Continent-wide phenomenon. For the coming year however, almost 50% more institutions expect to increase their allocations to European equities than expect to decrease them. Most funds expect to reduce their use of European government bonds, but many anticipate using more corporate and non-European bonds.
“The wrong lesson of the disastrous equity market returns of the past three years is that ultra-conservative is good,” cautions Chris McNickle. “A long-term asset allocation balanced between equities, fixed income, and possibly alternative investments, based on your time horizon and risk tolerance, continues to make sense.”
In order to bolster risk-controlled returns, many European institutions are planning to increase their participation in alternative investments. During the next three years, nearly 10 times as many European institutions expect to increase their use of hedge funds as decrease, and six times as many expect to use more private equity than expect to use less.
The report also shows that salaries for European investment professionals remained steady last year while bonuses fell slightly. Average total cash compensation for the 282 institutional investment professionals in Continental Europe was Ђ121,000 in 2002. Average salaries remained stable, while bonuses of most professionals fell slightly. Not surprisingly, median cash compensation levels differed by location. Compensation of investment professionals in the Nordic countries (Ђ121,000) and Switzerland (Ђ128,000) was higher than the continental Europe median of Ђ114,000, while compensation levels fell below the median in Germany (Ђ93,000), Italy (Ђ108,000), and Spain (Ђ78,000).