New opportunities for pension funds in euro

On January 1st next the 11 economies which are now committed to entering the euro in phase one will adopt the new currency for all investment transactions. As such the euro will become a live issue for the investment markets, for fund management companies and, especially, for pension funds - in less than three months time.

The importance of this switch for pension fund investments is difficult to overestimate; we can certainly expect a period of significant restructuring of funds with the euro zone investment markets playing an increasingly important role and a diminished role for the old classification of Irish and European markets.

Lots of commentators will speculate about the impact of this change on different stock markets and the consequences for quoted Irish companies. But for pension funds and their trustees the switch offers real opportunities.

In the current, pre-euro investment environment, the assets of pension funds tend to be invested primarily in the markets in which the funds originate. So the bulk of Irish based pension funds tend to be invested in the Irish market and so forth. There are a number of reasons for this but the currency risk attached with investing overseas has been a significant factor. Because investing outside national boundaries involved adding currency risk, Irish pension funds have maintained a high exposure to local assets.

Currently around 60 per cent of the assets held by a typical Irish pension fund are denominated in Irish bonds, Irish equities, Irish property and Irish cash.

If we look at equity investments alone, the downside of this approach has been that Irish pension funds have been heavily exposed to a relatively constrained Irish equity market with a fairly limited range of industrial sectors and an unhealthy concentration of the market in the hands of the top 10 stocks.

Up until now there was little the trustees of pension funds could do about this situation bar worry about some catastrophe occurring to one of the major stocks in which they were effectively forced to be relatively overweight. But from next January, with the removal of the currency risk, they can start to demand that their assets are moved into a better balanced market where they can enjoy greater investment variety and less exposure to a handful of big players.

In the context of the role of the big players, table 1 is informative. The table shows how the top 10 stocks in the Irish equity market account for over 70 per cent of Irish equity weightings compared with just 22 per cent in the new expanded euro zone area.

An over-reliance on the leading companies is not the only issue for pension funds pre-euro. Because of the relatively small selection of sectors in the Irish stock market, Irish funds have also tended to be overconcentrated in a small number of sectors.

In Ireland the significance of the financial sector in the market is huge while other sectors which should have greater influence (such as retail, communications and technology) are under-represented. After January 1st next, they are likely to so something to reduce this risk gradually as value opportunities arise in the market.

This is even more self evident considering that companies like Royal Dutch Petroleum and Deutsche Telekom are bigger than the total market value of all the quoted Irish stocks combined.

Table 2 compares the sector spread available in the Irish equity market with the spread available in the new euro zone equity market. To a great extent the risk diversification will involve filling sector holes which exist in the Irish equity market because of poor representation in a number of sectors and the consequent over-representation in other sectors.

Whether a pension fund is seen to operate a specialist or balanced mandate the single currency eurozone has created a new range of opportunities. Irish Life Investment Managers has recently launched an indexed eurozone equity fund into the corporate pensions market designed to address these issues in an innovate and leading way and the response to date suggests that Irish pension funds are keenly aware of the opportunities which the eurozone will bring.

Gerry Keenan is director in charge of investment development at Irish Life Investment Development.