France’s pension system is not the easiest to understand, nor is it especially inviting to asset managers. At least, not yet. Little by little, its market is opening up. Third pillar pensions are increasing in importance and nearing e100bn in assets under management. President Nicolas Sarkozy appears determined to reform the debilitating pay-as-you-go system via structural changes and buffer funds.

It is largely unknown when the system will change, or if significant adjustments can even be made. Pensions are such a sensitive topic that Mr Sarkozy has been careful to avoid tackling them too early in his presidency. It was no mistake that, prior to this month’s municipal elections, not a single politician brought up the issue. However, now the elections are over, and Mr Sarkozy’s party has maintained its majority, the reformers and unions could be ready to rumble.

France’s attempts at pension reform have always been difficult, but, bit by bit, reforms have taken place. While the majority of French workers have generous pay-as-you-go schemes, and a small group belong to the outrageously generous ‘special regimes’, a few buffer funds and optional third pillar schemes have emerged.

The first serious changes to the system began in 2003 with the Loi Fillon, which required individuals to work longer for their pensions. But, more critically for asset managers, the law gave birth to the Fonds de Reserve pour les Retraites (FRR) and Etablissement de Retraite Additionnelle de la Fonction Publique (ERAFP), and encouraged the growth and creation of supplementary and optional third pillar schemes. The law has been criticised for not going far enough. The cripplingly expensive special regimes are still firmly in place, however, the law has opened up the market and this liberalisation appears set to continue.

ERAFP is growing at a rapid rate, primarily because it is receiving e1.5bn in contributions from its 4.4 million members. Its assets currently sit at e4.7bn, making it the second largest scheme in the country, next to the e34.5bn FRR. It hopes to reach e9bn in assets by 2010.

However, its asset allocation is profoundly regulated. Currently, it is not allowed to invest in emerging markets, alternatives or real estate. Its equity exposure sits at 25 per cent with bonds making up the remainder. This allocation only recently changed from an 85 per cent exposure to fixed income and 15 per cent to equity. At the larger FRR, the restrictions are nowhere near as tough, but it still does not invest in hedge funds.

Pierre Perreaux, chief investment officer at ERAFP, says there is a great desire to diversify, but any significant changes will take a long time as they must be approved by the government first.

He says: “We’d like to diversify more in the coming years. We’re interested in private equity, commodities, real estate and emerging markets, but right now our investment universe is relatively limited.”

If these restrictions are removed for the fund, it will be interesting territory for asset managers with the scheme growing rapidly over the coming years. However, changes could be years away, and for now the most fertile ground could be in the evolving third pillar.

COREM, a third pillar fund for the insurance industry, which is open to everyone, is one such example. At e4.6bn it is adding members at a clip of 5,200 each year and hopes to add 10,000 in 2008. It is an optional defined contribution scheme, but has proven remarkably popular with many losing confidence in the state’s ability to sustain the pay-as-you-go system.

With close to two-thirds of its assets in bonds, it is certainly overweight in the asset class, but remarkably diverse in that it holds 10 per cent in European property, 15 per cent in equity, 5 per cent in hedge funds and 2 per cent in private equity. There are some cash reserves on hand as well.

Vincent Ribuot, its investment director, is excited about the fund’s prospects and looks forward to making investments in private equity, infrastructure, commodities and emerging markets.

He says: “If the legislation allows it, I would like to diversify further, but currently I can only invest 10 per cent in alternatives. We have a surplus and I’d really like to put that to better use. However, I’m optimistic that the regulations will change. If they don’t, I might move the fund to Dublin, but in any case there is a real future for the third pillar.”

Sylvain Favre-Gilly, Barclay’s Global Investors’ senior equity sales manager for France, agrees. While he notes the impressive rise of buffer funds in France, he is keeping a close eye on the emerging optional third pillar funds. In his opinion, the third pillar will help the situation in France, but it is not a problem solver.

He says: “There is a growing trend for employee saving schemes, but at the moment they are too concentrated in larger companies. The smaller ones just don’t have the resources to create them.”

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