One of Belgium’s biggest pension funds, KBC, has recently increased its allocation to real assets and switched more of its equity allocation to alternative beta.
“Our defined benefit plan is closed for new entrants and quite mature, and a larger minimum variance allocation within equity will protect us better when, or if, equity markets fall off a cliff,” says CIO Luc Vanbriel from Brussels-based €2.5 billion KBC Pensioenfonds, founded in 1941 and the fund for employees of KBC, Belgium’s banking and insurance group.
The boosted allocation to minimum variance, which has increased from about a third of the equity allocation to half, is in line with its de-risking trajectory, while the push into infrastructure and real estate (increased to 15 per cent from 12 per cent) is driven by a desire to escape fixed income’s low yields and a need for inflation linkage.
Infrastructure and real estate will be built up over the next couple of years with a wary eye on high valuations, although Vanbriel notes this isn’t unique to real assets. “Everything is expensive at moment. Equity and bonds are expensive, and the present value of our liabilities is expensive. We are having to live with this kind of uncertainty.”
In real estate, he favours core brownfield projects without development risk where investment is equally split between Belgium – where the fund invests directly mostly alongside KBC Real Estate – and the wider Eurozone where the pension fund invests in funds.
“In Belgian real estate we prefer going direct if possible. We know the market in Belgium and it’s cheaper because we can avoid management fees.” In contrast, all infrastructure investment is via funds.
KBC’s portfolio, which was merged from three separate funds into one last year, is currently split between a €2.1 defined benefit fund and much smaller defined contribution scheme. Within the DB scheme, assets are divided between fixed income (18.5 per cent) real assets (15 per cent) private equity (2 per cent) and listed equity (34.5 per cent) plus a 30 per cent allocation to LDI introduced in 2007 to protect the fund against falling yields.
Back then yields on Belgium-government bonds was 4.5 per cent compared to today’s negative -0.13 per cent.
“Everybody thought at that time yields would increase not decrease,” recalls Vanbriel.
The fund has set a trigger that will increase LDI levels when rates hit 75 basis points, but at current levels those triggers remain far off. The LDI strategy also allows the fund to hedge inflation risk in a cost-effective way, on Vanbriel’s radar despite historically low inflation in the Eurozone, because of the potentially troublesome link between inflation and salaries.
“If inflation increases salaries increase which means our pension liabilities also increase. We have to protect ourselves against inflation and while everything is expensive, hedging inflation is actually quite cheap,” he says. And although inflation is low, the risk is never far away – take the US China trade war and its impact on rising prices, he flags. “Rising inflation is not in our base scenario, but we want to close the risk. Suppose something happens that triggers unexpected inflation.”
That cautionary eye has also led to a strategy to safeguard and insure assets in the DC allocation via introducing a floor to the portfolio. If the valuation of the portfolio falls below 90 per cent of its current value, Vanbriel will gradually sell risky assets, buy bonds and even switch to cash.
“Our potential to deviate from the strategic benchmark is much bigger and this really distinguishes us from other pension funds,” he says. “We can protect against worst case scenarios.”
Under his watch – Vanbriel became CIO in 2017 – the fund has also introduced ESG in all the passive equity and corporate bond allocations, tailored to push ESG themes without venturing too far from the benchmark. KBC limits its investment universe to the best performing ESG companies. For example, the fund used to invest across the entire MSCI North American index in its US equity allocation, but now only invests in the top 40 per cent of ESG rated corporates in each sector.
“We limit our universe to the best performing companies,” he says. An active small and mid-cap equity allocation remains out of this ESG scope.
Within this smaller universe, the fund remains sector and geographically neutral to limit tracking error and maintain close to benchmark returns.
“We considered only investing in the top 20 per cent of ESG rated companies. But we decided it would be too tough and that we would deviate too far from the index.” So far, the returns are good, he says.
“The portfolio is doing well and returns stay close to the MSCI. Last year it outperformed – this year it is a bit volatile but doing exactly what we thought it would be doing.”
Elsewhere, integrating ESG in corporate bonds is “relatively easy” because picking the best scoring corporates isn’t overly complex. However, it does bring risk, namely the potential of a high turnover as poorly scoring bonds are sold.
“We are cautious about the potential turnover in the portfolio. It’s not a huge problem but it could be a challenge if there is not enough liquidity in the corporate bond market.”
In contrast, integrating ESG into sovereign bonds is tricky and something he hasn’t begun yet.
“In the corporate bond market it is do-able but in government bond market it is more difficult, and we are reluctant to implement it,” he says.
