Five years after its first investments, France’s €28.9bn Fonds de Reserve pour les Retraites (FRR), has adopted a set of new investment policy guidelines, bringing to completion a review of its strategic asset allocation that began in January. Its investment policy reflects the exact role the FRR is expected to play in the quest to consolidate the retirement pension system as of 2020 when the full impact of the demographic shock will begin to be felt. Lacking a clear legislative view as to what their liabilities are, the FRR has adopted a set of guidelines incorporating two elements: the obligation to preserve the real value of its assets since inception and the need to implement more dynamic management of its reference portfolio to better address short-term risks and market volatility, which remain substantial. More specifically, the FRR will invest more heavily in inflation-linked bonds which will have a strategic asset allocation of 20% compared to the current 3-4%. In addition to inflation-linked bonds, the strategic allocation to bonds is set at 25%.

Following a 25% drop in the value of its performance in 2008 and an annualised performance of 1% through May 2009 since its inception in June 2004, the FRR has drawn a number of lessons from the crisis. “Taking into account extreme market scenarios implies more prudent asset allocation choices,” notes Raoul Briet, Chairman of the FRR Supervisory Board. The new allocation to equities is set at 45%, the level at which the market downturn has brought it to today. This compares to a 60% strategic asset allocation to equities set in May 2006.

Still, the FRR will continue to have a majority of its investments in riskier assets with an additional 5% allocation to real estate and 5% to commodities. Bond-type assets to cover liabilities will account for 45% of the portfolio. Based on a 6.3% annualised expected return and an average contribution of €1.5bn by the government, the fund is estimated to grow to €83bn by 2020. While the fund is up 3.4% for the year through end of May, the FRR expects the year to be particularly volatile. One assumption made is that higher volatility will also lead to higher returns on riskier assets. For example, the volatility assumption for real estate this year is 15% compared to 7% in 2006. The hypothetical return for real estate is also higher: 7% in 2009 compared to 5.5% in 2006. In order to facilitate the dynamic management of the portfolio, the Supervisory Board decided that the global weight of the most volatile performance assets (equities, real estate, commodities) could evolve within a broadly defined range of fluctuation that could be revised annually. The weight of the performance assets could therefore vary between 40% and 60% until the next review.

In other changes, a new investment strategy committee has been formed to ensure year-over-year monitoring of the portfolio and the range of fluctuation. The committee will draw on advice from recognised outside sources. An annual review by the Board of the portfolio and its range of fluctuation will factor in investment results, react to losses and consolidate gains.

The crisis has had a profound impact on the fund’s portfolio structure. The FRR had very little in money market instruments in 2007. Cash increased to almost 9.8% in 2008 and 18.3% through May 2009. Bond investments increased from 7% in 2007 to 39.6% in 2008 and stood at 33.3% through May 2009. One bright spot in 2008 was active management, providing a modest buffer against market depreciation. Active management mandates generated an out-performance of 1% on average. When the FRR made its initial investments in 2004, the split between active and passive was 75/25. The FRR plans a 50/50 split after the completion of its tenders. This realignment will result in a “reduction in fees and also reflects the difficulty of finding value in large cap equities relative to passive indexes,” says Antoine de Slains, head of asset manager selection at FRR.

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