Last year's buoyant markets are making up for grim start to decade, writes Caroline Madden.

Individuals with occupational pension schemes will have been pleasantly surprised by the strong performance of managed funds in 2005. The average fund delivered an impressive return of almost 22 per cent, a level of growth that hasn't been seen since the dotcom bubble burst.

Although annual growth rates have been creeping back up into double digits since 2002, the average return per annum over the past five years lies at just 2.8 per cent, dragged down by negative returns experienced in the early years of the millennium.

However, over the 10-year period to the end of January 2006, the average return lies at a healthier 9.9 per cent per annum.

Equities

The key driver behind the impressive performance of Irish pension funds last year was the buoyancy of global equity markets.

The Iseq rose 21.7 per cent, the euro-zone market produced a robust 25.9 per cent return, and after 16 years in the doldrums, the Japanese market experienced a spectacular 44 per cent growth spurt.

One of the few equity markets not to flourish in 2005 was the United States, which grew by just 7.3 per cent. However the strengthening of the dollar meant that this rate of return was magnified to 23.8 per cent when converted to euro.

Although balanced managed funds are based on multi-asset portfolios by definition, in times of bull markets, managers invariably place most of the fund's eggs in equity baskets, which is exactly what occurred last year. According to Noel Collins of investment consultants Mercer, the average equity allocation in such funds at the close of 2005 was 77 per cent.

Having been richly rewarded for taking this relatively high-risk position last year, fund managers are maintaining their preference for equities.

Richard Temperley of Eagle Star believes that equities are the preferable asset to be in at the moment, and Roy Asher, chief investment officer at Hibernian, says that it also continues to favour equities, in particular European markets. "We see equities as the best asset class in 2006."

Asher adds that Hibernian has recently taken a position on oil by investing in oil and energy service companies.

Noel Collins also points out the high level exposure that funds have to the relatively compressed Irish equity market, which ran at an average of 18 per cent last year. However, there has been a gradual downward trend in the allocation of Irish pension funds to the domestic market.

For example, in 1998 the average managed funds invested 30 per cent in the Irish stock market. While the introduction of the euro sparked this trend by encouraging fund managers to enter European markets, the strong performance of the Irish market has remained enticing.

Property

Property constituted approximately 5 per cent of the average managed fund portfolio in 2005, although some funds avoided this asset class completely.

Many fund managers who invested in the Irish property market cited a lack of value for money as a major drawback in this area.

Noel Collins says there has been a noticeable trend to "try and broaden exposure outside the Irish market".

In order to find better investment opportunities, many funds are diversifying into continental European countries such as France, Germany, Spain and the UK.

Bonds

Euro-zone bonds produced a healthy 7.9 per cent return last year, as bond yields continued to fall. Fiona Daly of Rubicon Investment consultants explains that this phenomenon has been driven by excess market demand. According to Mercer, the average bond allocation in managed pension funds was approximately 13 per cent last year, although there was a high degree of variation underlying this figure, with bond exposure ranging from 10 per cent and 20 per cent in different funds.

While 2005 saw exceptional returns on the assets side of the pension equation, decreasing bond yields also caused the value of pension scheme liabilities to rise substantially.

Philip Shier of pension specialist Hewitts estimates that average pension liabilities increased by 15 per cent in 2005 due to the significant fall in long bond yields.

He considers it likely that the overall result for the year was therefore somewhat positive, but not as strong as the 21.6 per cent return on assets initially suggests.

Montgomery Oppenheim and AIB Investment Managers were invited to provide a summary of their activity this year but declined the opportunity.