Agrica profile – risk managing SRI

Socially responsible investment is on the rise in France. Agrica, one of France’s largest pension schemes, talks to Blake Evans-Pritchard about transforming its portfolio

All over Europe, financial investors have been reviewing their investment strategies in the wake of the financial crisis that struck during the summer of 2007. One strategy that is growing in popularity across Europe is that of socially responsible investment (SRI). In France, the value of the SRI market rose an astonishing 70% between 2008 and 2009 to reach €50.9 billion (£43.2 billion) of assets under management (AUM), according to Novethic, a Paris-based research institute, and many analysts believe the trend will continue.

Agrica Groupe, the €5.8 billion Paris-based company that provides pensions and other financial services for those working in the agricultural sector, has been a socially responsible company since it was created in 1996, but it is only during the last few years that the group has looked towards basing its investments on SRI. At the end of last year, Agrica won a national ‘Responsible Investor Award', which was presented by investment consultancy Amadeis and financial services firm Natixis, in partnership with French newspaper Les Echos. Jean-Claude Guimiot, who manages the group's savings business, says the award was a recognition of the group's institution-wide approach to social responsibility.

According to Novethic, French pension funds are significant players in the SRI sector holding 24% of the SRI assets in the country. To give an indication of what has caused this growth, Novethic has published a breakdown of SRI assets under collective management, which account for 57% of the total SRI market and more than doubled between 2008 and 2009 (from €12.1 billion to €24.9 billion). Data for individual mandates is not publicly available.

The figures show that part of the sudden rise can be explained by a recovery of market performance, accounting for an additional €1.6 billion. But most of the growth came from new investments (€3.4 billion) and conversion from traditional investments to SRI (€7.8 billion).

Dominique Blanc, head of SRI research at Novethic, says this rise is linked to the crisis, as investors tried to find a way to protect themselves from future market volatility.

"We believe the crisis showed there were money-market funds reputed to be stable, which, when it came to the crisis, turned out not to be that secure," he says. "The SRI money-market was a way for investors to find their way back to confidence or to secured money market funds."

Blanc suggests that SRI can provide a natural screen from unwise investments, simply because those companies that prize social responsibility are least likely to violate the law or engage in questionable practices that could see them in court. Asset managers are also compelled to look carefully at the companies they invest in, to make sure they meet SRI criteria, which raises the visibility of the issuer. Blanc claims this helps to avoid toxic assets and, during periods of crisis, reduces the volatility of investments.

The rise in SRI is being played out across Europe. According to Eurosif, a pan-European think-tank, European SRI AUM accounted for €5 trillion at the end of 2009, up from €2.7 trillion in 2007. While Eurosif's market coverage has increased (the latest survey is the first time that Poland has been looked at, for example), the organisation says the latest study still represents "significant growth" on a like-for-like basis.

Becoming socially responsible

Agrica invests 80% of its portfolio in SRI and is hoping to eventually reach 100%. As Guimiot explains, such a high level of SRI has been achievable both because the firm's investment strategy is non-exclusionary (it will not prevent investments in a particular type of company just because its core business clashes with Agrica's values), and because Agrica's SRI values are completely integrated into the whole company.

There are two parts to Agrica's SRI strategy. The most important thing, notes Guimiot, is to be responsible to investors.

"The first thing we make sure of is that we do only what we understand," he says. "We do not have any securitisation and we don't have any subprime, because we do not understand these things. We also do not have any structured products. We want to know exactly what is in our portfolio."

Guimiot believes this simplistic portfolio allocation structure helped shield the group from the worst fallout when financial markets collapsed.

"Like everyone, the financial crisis was difficult for us, because we didn't know where the financial world was going," he says. "We are quite exposed in equities, so it was difficult when the equity market went down like that, but now the situation is much better because equities have bounced back."

Ultimately, Agrica decided to hold on to its equities, believing them as crucial to the firm's long-term investment strategy. Guimiot says this is an approach that has paid off.

The other plank of Agrica's SRI is to determine those companies that it can invest in, based on a set of social investment criteria. Top of the list is a respect for human rights, which accounts for 30% of the group's SRI. The rest of the investments are spread over a range of other criteria, such as the environment and social engagement.

Agrica uses Vigeo, an SRI rating agency, to determine which companies it can invest in. Every three months, Vigeo supplies a list of companies that perform well according to the criteria that Agrica has provided. Agrica then chooses which companies to invest in based on their rankings in the list. Guimiot says their financial performance is of only secondary importance.

"We want to find a balance between what we want to be, what we want to show we are and what we do," he says. He adds that, since pension fund members are well covered at the moment (110%, based on the discount rate for government bonds), it is not necessary to push for ever-greater returns.

Although Novethic's Blanc suggests that SRI performs better than traditional investments in the long run, Guimiot does not make such claims himself. "We do not expect short-term financial benefits from our SRI investment," he says. "Perhaps there is a benefit of investing in socially responsible enterprises in the long term, but I'm not sure. This remains to be seen."

Guimiot dismisses suggestions that SRI is a limiting factor for Agrica, and says that it is compatible with the fund's long-term financial goals. Unlike some other companies, Agrica follows a "best in the class" methodology, which does not exclude any group of firms simply because they are involved in a particular area. This means that, although the universe of funds that Agrica can invest in is smaller than it used to be, it is still large enough to offer the firm adequate flexibility in its portfolio management.

"Our approach is not based on exclusion," says Guimiot. "We don't say we don't want petrol or we don't want military. We try to have the best enterprise in every sector – this means managing our investments is not a problem."

Nonetheless, Agrica is still some way from achieving its overall goal of 100% SRI, and Guimiot admits it will take some time to find a socially responsible match for the remaining 20%. Other pension funds in France - such as the French Public Service Additional Pension Scheme (ERAFP) - have been able to manage their portfolio on a fully SRI basis, but Guimiot says that this is because they started from scratch. "Managing an SRI portfolio is not complicated if you start from zero," he says. "The challenge is to transform an existing portfolio into an SRI portfolio. Our management arrangements have allowed us to adjust 80% of our assets. The remaining 20% is more complicated - mutual funds, unlisted shares, real estate, cash - and it will take time."

Enter Solvency II

It is not only conversion to full SRI that is challenging Agrica's management. Just around the corner lurks Solvency II, which Guimiot says is going to present something of a problem for the firm's investment strategy.

European occupational pension funds have fought a long and hard battle in order to escape being caught up in Europe's new Solvency II regime, which is due to enter into force within the next couple of years. By and large, these funds have managed to persuade regulators that their business is different enough from life insurance - which is a profit-oriented industry - to fall outside the scope of Solvency II.
While life insurers need to generate decent returns for their shareholders, pension funds tend to be backed by a sponsor and argue that, if they were subjected to more stringent solvency requirements, their sponsor would have to inject more money - or they would have to sell off equities - for which there will be a higher capital charge.

But, in France, pension funds tend to look more like life insurance and therefore do fall within the remit of Solvency II (see box, page 30). This has caused investment managers to worry about what the new regulation might mean for them. "Solvency II is going to force us to take fewer equities, which is a problem because we need equities to meet our long-term goals," says Guimiot. "Bonds, which at the moment deliver performance of around just 3% a year, are not very interesting for us."

About a quarter of Agrica's investments are in equities. But once Solvency II comes in, the company may either have to sell off some of its equities or be prepared to take a hit on its solvency ratio. The decision on this is still pending - it will be up to the board to choose the best course of action - but Guimiot does not think they will be able to get rid of too many shares and still match their liabilities.

Guimiot boasts that Agrica's solvency ratio is currently four or five times the ratio of some leading life insurers on the market, largely because of its prudent investment strategy. Nevertheless, Solvency II threatens to put a significant dent in this position.

When Agrica recently participated in the fifth Quantitative Impact Study (QIS 5), which was run by insurance companies across Europe in order to assess how they would be affected by Solvency II, available capital was slashed in half. Guimiot adds, however, that "the ratio still remained satisfying".

Agrica has two pension funds. The oldest, CPCEA, dates from 1996, when Agrica was first created. It has €616 million AUM and invests 35% in equities. The rest of the portfolio is mostly made up of euro bonds (53.8%) and international bonds (9%). Guimiot says this fund used to hold 50% equity but, with Solvency II on the horizon, it was forced to reduce this exposure. The other fund, CCPMA Prevoyance, worth €1.16 billion, invests 18% in equities, with 74.4% invested in euro bonds and 5.9% in international bonds. Both funds have a residual amount in cash.

"Some aspects of Solvency II are good," says Guimiot. "Pillar II [supervisory review] and Pillar III [disclosure requirements], for example. But the financial aspects of Pillar I [quantitative requirements] could really affect us. It's a problem because we have competition from pension funds in other countries. In [the European market], it is now possible for multinational corporations to use pension funds that do not come under Solvency II."

In particular, in its current form, Solvency II requires investors who take on a lot of equities to hold more capital, to reflect the slightly riskier nature of the asset class. An ‘equity dampener' has been introduced into Solvency II to assuage some of the concerns that capital requirements could prove too onerous at times of crises for those firms that have significant equity exposure.

The idea behind the dampener is that, as equity values fall, capital requirements ease and firms are required to hold less capital to retain their solvency position.
Even with the dampener though, investors such as Agrica, which rely on equities to generate decent coverage levels for their customers, may have to rethink their investment strategy in light of the new framework.

The shape of things to come

Guimiot says because Agrica currently has a good solvency position, it could hold on to equities, if it was prepared to use up some of its solvency ratio in order to take on additional risk. "I think this may be the best thing to do, but it is up to the administrator or director to decide," he says. "It may be that we need this extra capital for commercial development or to create new projects."

Guimiot says Solvency II will make it difficult for many occupational pension funds to stay as they are, although he hesitates to speculate about what that might mean.
As far as Agrica goes, there is no suggestion that the investment group will relinquish its SRI strategy to meet more rigid requirements. On the contrary, Guimiot says that managers at the fund are still focused on the 100% SRI target, even if that means solvency ratios take a tumble.

One thing in Agrica's favour, which might help its future investment strategy, is the reform of the pension system, currently going through the French parliament. The key change, which has seen millions of demonstrators turn out on to French streets, is an attempt to raise the retirement age from 60 to 62. Most occupational pension schemes, including Agrica, will mirror this change.

"We can profit from this evolution," says Guimiot. "Not only will our liabilities be less, but we can also invest for longer in order to meet them."

The French way

Many European pension funds have managed to escape the reach of Solvency II - at least for the time being. But not in France, where pension liabilities appear mostly on the balance sheets of insurance companies rather than corporate balance sheets.
Occupational pensions are mandatory for all French workers, and complement the state's statutory pay-as-you-go insurance scheme, which is funded by national insurance contributions. The third pillar of the pension system, voluntary private-funded accounts, is not so popular in the country, given the strength of the other two pillars.

Occupational pension provision, which is run on a pay-as-you-go system, is typically taken care of by a private pension institution that underwrites the primary risks linked to death, disability and longevity. Such institutions do not have recourse to a sponsoring employer. In other words, they look much more like a standard insurance undertaking than a classical pension fund, which explains why they fall under the remit of Solvency II.

Most private pension funds are affiliated to either Agirc, for executives, or Arrco, for all employees. These organisations supervise, regulate and control the operations of pension institutions in France.