Between 1997 and 2003 the DB funds followed a traditional strategic asset allocation model of 55 per cent in equity and 37.5 per cent in bonds, 5 per cent in real estate and 2.5 per cent in alternative investments, including private equity, hedge funds and emerging market debt.
This changed in 2003, when a new strategic asset allocation was proposed and implemented by the investment board.
According to Olivier Poswick, head of portfolio management Belgian Pension Institutions, in the employee benefits department of Suez-Tractebel in Brussels, it was decided, in the wake of the stockmarket downturn between 2000 and 2002, that the investment portfolio was overly exposed to traditional equity markets. It was deemed more prudent to diversify the portfolio in a greater number of risk-graded asset classes.
“We learned a lot from this difficult period. With the new diversified portfolio we now have, the expected return over the long term remains the same, but with a much lower volatility.”
Diversified risk profiles
The total portfolio for the three DB funds is divided into three different investment “zones”, each with a different risk profile (see pie chart below).
The first is a buffer zone comprising 37 per cent of thee total portfolio made up of investment grade bonds; the second zone contains 10 per cent real estate, 5 per cent convertible bonds and funds of hedge funds 5 per cent; the third zone is split into two categories, with 33 per cent in quoted equities and 5 per cent in private equity, high yield corporate bonds and emerging market debt. The portfolio is fully hedged against the dollar and pound sterling.
Eighty-five per cent of the corporate bonds in the buffer zone are eurozone issues while 15 per cent are in the US.
“Forty per cent of the eurozone corporate bonds are actively managed but we ask the managers to be neutral duration,” says Mr Poswick. “We cannot take any bets on the duration because we consider it difficult to manage duration. It can be one of the main reasons explaining the performance of the bond manager.”
The remaining 60 per cent is in passively managed government bonds. Mr Poswick says: “These bonds used to be actively managed but in May of last year, we opted for index funds because we consider there are four sources of excess return in the bonds market, duration – which is difficult to manage, yield curve – which is also difficult to manage, spread – which does not exist, and the converging effect, which also does not exist. So there is no sense in paying an active manager, if it is difficult for him to outperform the benchmark. The total expense ratio for passive funds is also much lower than for active management.”
The US bond portfolio is actively managed through an aggregate bond mandate, made up of government bonds, bank treasuries and investment grade corporate bonds.
The second investment zone comprises 85 per cent in quoted real estate and 15 per cent in unlisted property.
Mr Poswick says: “For the quoted real estate we launched a fund at the end of 2003 for investing in Belgian, French and Dutch property, because these opportunities offer low volatility and high yield. But we are not looking for optimal returns from our listed property portfolio. The objective is to have a good buffer.”
He adds that Suez-Tractebel has just appointed a manager to run the unquoted real estate portion of the property portfolio.
Convertible bonds are run by a single manager who has been directed not to take on too much risk. The object, explains Mr Poswick, is not to have an equity portfolio, but to keep a convertible bonds portfolio, with good management of the bond flow so the bond side risk is not too high for the convertible bond.
The 5 per cent hedge fund allocation is managed by two boutique hedge fund managers and one large hedge fund manager.
Mr Poswick says: “We don’t really like working with big managers because we think their only objective is to raise new assets and generate management fees. That creates a conflict of interest between the investor and the asset manager.
“The total expense ratio of the boutiques and large hedge fund managers is the same but the main difference is that the large players are intent only on raising money while promising their clients that they will never lose anything. In this context they are reluctant to take risk. Consequently, the return from the fund run by the large hedge fund manager is only 2-3 per cent.” Mr Poswick is looking for annual hedge fund returns of 6 per cent with low volatility.
On the other hand, he says boutiques know that if they want to survive they are obliged to deliver a good return. He adds that, unfortunately, it is difficult for him to propose boutique hedge funds to the investment committee. It is easier to promote big name asset managers.
High yield corporate bonds and emerging market debt each account for 50 per cent of the overall 5 per cent allocation in the third investment zone.
Mr Poswick says: “We have 15 per cent allocated to Chapter 11 Bankruptcy and 15 per cent for high yield corporate bonds. We are not investing in distressed debt because we think there is too much money in that market at present. But we might make a 15 per cent allocation to that market by the end of this year. We make a link with the private equity market where a lot of money has been raised in the last three to five years. For instance, there is too much money in the leveraged buy-out market so we predict a problem in the future.”
Emerging interest
Mr Poswick says he is considering an increase in the allocation to emerging market debt at the expense of traditional high yield corporate bonds. He cites two reasons for this, the first being the strong narrowing of the spread of high yield bonds.
“We saw the same strong decrease of the spread of emerging market debt, but we are convinced that there are some structural improvements in the emerging market debt sector while the same cannot be said for high yield corporate bonds.
“Second, by investing only in traditional high yield corporate bonds, we are strongly correlated to and affected by the spread in the market. On the other hand, by being invested in distressed debt or Chapter 11s, you are less affected by the evolution of the spread. So I can foresee a move to a 70 per cent allocation in emerging market debt, 15 per cent in distressed debt and 15 per cent in chapter 11.”
Suez-Tractebel invests in private equity through three private equity fund of funds and two single private equity funds.
The commitment to these private equity vehicles is €65m of which 40 per cent has been invested.
Mr Poswick says: “We have 85 per cent in private equity funds of funds and 15 per cent in single private equity funds.This gives us good diversification in terms of sector and investment stage. We also have a high level of transparency in that we know what the underlying funds are.”
Fifty-two per cent of the public equity portfolio is invested in Europe, of which 10 per cent is actively managed in Belgian stocks, 7.5 per cent is in European small and mid-caps, 7.5 per cent is invested in eastern Europe and 7.5 per cent is in European large caps.
Thirty-five per cent of the public equity portfolio is invested in the US, of which 7.5 per cent is managed in US small and mid caps.
Mr Poswick says: “For the US small and mid-cap and European small and mid-cap portfolios, we use a quantitative approach because there are so many stocks in this universe. For instance, the European small and mid-cap arena contains more than 2000 stocks so it is difficult to find a stock-picker capable of outperforming this market. We combine quantitative with a fundamental approach in an effort to outperform the benchmark.
The 13 per cent of the quoted equity portfolio devoted to the rest of the world (ROW), has a 35 per cent investment in Japan of which 75 per cent is indexed and 25 per cent is opportunistic. The remaining 65 per cent of the ROW portfolio is actively managed in emerging markets equities.
Last year, it was decided to place 87.5 per cent of the public equity portfolio in index funds. This was because Suez-Tractebel believes it is very difficult for the traditional active manager to outperform the mature markets such as US and Japan over the long term.
Mr Poswick contends: “It is possible to find good stock pickers. But active managers often feel obliged to have a lot of bets in their portfolios. We are convinced that it is better for them to have some bets and maybe three months or six months later if there are no opportunities on the market, they can decide to be fully invested.
One of the key points for us is that an active manager must agree to have a passive portfolio if they cannot find a new opportunity in the market. But often active manager feel that to justify the fee they are obliged to have some bets in their portfolio.
The remaining 12.5 per cent of the equity portfolio is managed on an opportunistic basis, where a boutique manager is given a tracking error of 10-12 per cent and licence to make off-benchmark bets. Tractebel is still looking for an opportunistic manager.
Last November, Suez-Tractebel consolidated all its various investments in one newly-launched Luxembourg Sicav containing three sub-funds – high risk, medium risk and low risk. Before 2004, the pension fund portfolio comprised 35 separate funds. It has transferred the assets from all the pension funds and in exchange receives shares in Esperides, the new Luxembourg Sicav.
Almost the entire €1.3bn of DB assets is now being managed in the Sicav, in addition to the assets of the DC schemes.
Mr Poswick says: “The Lux Sicav is a big advantage for the DC schemes because it enables them to achieve a broad diversification of assets.”
In the future, he adds, it might be possible for the other pension funds in the Suez-Tractebel group in France, Switzerland and UK to invest in the Luxembourg Sicav fund.
PORTFOLIO FOR SUEZ-TRACTEBELl’S THREE DB FUNDS:
Source: Suez-Tractebel
