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Dutch fiduciaries maintain their guard

Fiduciary managers foresee greater demand for inflation-linked strategies and give a cautious welcome to some aspects of a still vague pension deal, writes Mariska van der Westen

In the Netherlands, an estimated two-thirds of pension assets are managed in ‘fiduciary' mandates. Despite a vested interest, however, fiduciary managers have so far been reticent on the new pension deal - the planned wholesale overhaul of the Dutch pension system.

The reason for the silence is a cocktail of modesty, realism and pragmatism. As for the modesty part: the debate so far has focused on the liability side rather than the asset side, and fiduciary managers aren't keen to weigh in on issues outside their realm. For the second part, managers are being realistic. Leen Meijaard, managing director and head of BlackRock's EMEA institutional business sums it up: "Details of the pension deal at this point are still so sketchy that's it is really impossible to say anything sensible about it."

Add a splash of pragmatism, stir, don't shake: "Regulatory changes, though important, are but one dimension of what we do as fiduciary managers. Our job is to ensure financial stability so the pension scheme can at all times meet its liabilities. Regulations factor into that but are by no means the most important aspect," says Hanneke Veringa, Netherlands head of AXA Investment Managers.

Fiduciary managers are nothing if not pragmatic. So it should come as no surprise that their most bitter complaint about the deal pertains to the laborious and drawn-out political process surrounding the deal and the ensuing lack of clarity: "We would hope for a little more direction from the authorities," remarks Meijaard. "It just isn't a good thing to leave an entire industry hanging like this."

Although they are loath to get involved in the debate, fiduciary managers do have opinions and strong ones, at that.

BlackRock, for instance, is opposed to using expected returns instead of the swap curve as the discount rate for pension liabilities. "Discounting by market rate allows pension funds to hedge their risks. Discounting by academic long term return expectations will make it that much harder to implement sound risk management, because you cannot hedge the risk that real returns deviate from your original return assumptions," says Meijaard.

"There's always the risk that you sell the hide before you shoot the bear," Veringa concurs.

But despite misgivings, fiduciary managers find plenty to rave about. "No matter what you think of the discount rate debate, one thing seems clear: there is a determination to move away from short-termism and towards the long term horizon of pension funds. That is definitely a good thing," says Mark den Hollander, managing director and head of investment solutions at ING Investment Management.

"Although the new regime doesn't allow pension funds to differentiate between age groups, in comparison to the old regime it will become easier to tailor the investment strategy to suit the participant population and employ lifecycle investment insights," he adds.

In addition, both Meijaard and Ernst Hagen, head of fiduciary investments at F&C, specifically mention the shift from nominal guarantees to real pension benefits as a substantial improvement to the ‘old' system. "Under the old system pension funds were striving to realise ‘real', inflation-proof pension ambitions while delivering nominal guarantees in the short term. Under the new system they get to choose. That allows for more clarity," Hagen says.

The two Dutch supervisory agencies - the Financial Markets Authority (AFM) and the Dutch Central Bank (DNB) - on 28 September called on pension funds not to wait till the expected launch date of the new system in January 2014, but to begin preparations immediately.

Fiduciary managers, however, advise their clients not to change lanes just yet. Particularly as details of the deal - and of the accompanying new supervisory framework, FTK2 - are still up in the air.

But once details of the new system and regulatory framework are hashed out, fiduciary managers do expect the deal to impact on investment strategies. "There wouldd have to be a significant impact, considering the fact that pension funds' objectives will be fundamentally different," says Marjon Brandenbarg, head of Dutch institutional clients at ING Investment Management. "Under the current system, pension funds work to realise guaranteed nominal pensions, with optional indexation. Under the new regime they will work towards real pensions, with optional guarantees."

Strategically, managers expect to see a greater demand for inflation-linked strategies and instruments, including commodities, property and infrastrucure. In addition, fiduciary managers expect to see strategic shifts within the equity space: "think of a shift to healthcare stocks, or gold mining, or high dividend. We might see some of that," said Den Hollander.

However, fiduciary managers do not expect the changes in pension fund investment behaviour that have dominated the debate over the past few months. In particular, they take pains to debunk the myth that interest rate risk management will take a back seat under the new deal, and question the belief that pension schemes will irresponsibly increase the allocation to risky assets.

"Lately, every single self-respecting broker has produced a report to convince pension funds to sell the long end of their interest rate hedge, arguing that pretty soon everybody will be selling at the same moment because the new pension system will reduce the need to hedge interest rate risk. Customers are calling us about this and we tell them: If you believe the interest hedge is a good investment, by all means, don't sell it," said Meijaard.

Managers agree that the new regime will no longer ‘punish' pension funds for their exposure to interest rate risk and so hedging will become optional. "Currently, we strongly advise clients to strategically hedge a significant part of their interest rate risk, but under the new system hedging will be more likely to hinge on a pension scheme's interest rate expectations. The decision to hedge becomes an investment decision," says Den Hollander.

But managers unanimously reject the view that interest rate risk management is set to become less important as "overly simplistic." "Return expectations include an interest rate component. So when pension funds under the new regime begin discounting their liabilities against expected returns, they will be exposed to interest rate risks, albeit indirectly, and they may want to hedge against that," says Hagen. "It's a discussion we are having now with our clients."

In the same vein, fiduciary managers reject the concern that pension funds will rush to up their allocation to equities, simply to artificially buff their funding ratios. "The new supervisory framework doesn't deal with equity any differently from the old one, so there is no real reason to allocate more to equities," says Meijaard.

Hanneke Veringa does believe some pension funds will allocate more to equities, but rejects the notion that schemes will go overboard. "The new deal does indeed allow for the possibility that pension funds increase the funding ratio by allocating more to equities. But funding ratios in and of themselves aren't of crucial importance. We take coverage ratios into account, but alongside other measures - such as ROI, VAR and volatility - that can be objectively measured independent of regulatory changes," she says.

Hagen of F&C agrees that pension funds will, under the new system, be keen to invest in categories with a clear link to the real economy. But he points out that the corresponding risk profile involves more stringent risk management requirements and, under the new regime, must be communicated clearly to plan participants.

Consequently, he and others expect more of a shift in risk management than a shift in strategic asset allocation. Absolute return and downside risks will become a priority, "ranging from simple put options to more complicated low volatility strategies," Hagen says.
 

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