Union Investments assesses impact of regulation

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Alexander Schindler, Union Investments’ institutional business head, says helping pensions and insurers is not just about investment products and advice.

Advisers to institutional investors in Europe have a great opportunity to assist clients. However, the opportunity is arguably only there because of the size of challenges confronting pensions and insurers.

Before describing how best to solve the challenges of institutional investors, Alexander Schindler, member of the executive board responsible for business with institutional clients at Germany’s third-largest asset manager Union Investment, first describes them.

Three primary challenges exist, and they are intricately linked.
Investors face an immense volume of regulation, an increasingly sharp divergence between their investment returns and liabilities – “set to become a major headache for German insurance companies and pension funds in future” – and they are heavy in fixed income in a low interest rate climate.

Three more years

Schindler expects low rates will possibly last for three more years – matching the ECB’s LTRO lifespan and, more recently, president Mario Draghi’s outright monetary transactions (OMT) programme. Similar purchase programmes by America’s Federal Reserve, and the Bank of England, mean long-dated G7 debt now rarely yields above 3%.

“There is so much liquidity in the system, as long as it only focuses on buying higher quality bonds it will keep rates low,” Schindler says. Many pensions in Germany have 90% or more of their assets in fixed income, which understandably concerns Schindler.

“Most portfolios are overweight in sovereign debt. You have to move them out of the public sector, and introduce tactical asset allocation, too. Some German pension funds, for example, ran their most recent liability studies back in 2006, and you can guess how viable they still are today,” he says.

Schindler says institutions understand they must expand beyond the sovereign paper’s “return-free risk”, and his team witnesses “most institutions looking this year for ‘yield pick-up’ investments. First of all, they are moving away from sovereign debt into private sector corporate bonds, and EMD and covered bonds”.
Convertible bonds is another higher-yielding candidate but  under Solvency II provisions it could potentially be treated as an equity-like instrument, carrying a higher risk weighting for capital reserving purposes.
Since 2006-07, German pensions’ equities allocations have roughly halved from between 7.5% and 10%.

Schindler admits he would like to be able more often to advise clients allocate to risk-controlled equities, “but regulation is forcing institutions out of this, not into it, and institutions cannot stand the volatility [of shares], because their risk budgets are so low”.

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