A Selective Focus
ABN AMRO’s Dutch pension fund believes its focus on all stakeholder interests has helped prevent it from dropping below its statutory funding level. Liam Kennedy spoke to Rob Meuter, chairman of the trustee board, and Geraldine Leegwater, head of investments for the fund’s in-house pension bureau
Investment policy is particularly crucial when the shareholder of your sponsor is the Dutch state and the taxpayer must, in effect, foot the bill for underfunding. But in law, Dutch pension fund boards must take a well balanced account of the interests of the parties involved - the sponsor, the active particpants, the deferreds and the pensioners.
Navigating 2008 and early 2009 without falling into a recovery position - a situation ABN AMRO’s Dutch pension fund managed to avoid - was clearly an important achievement. This is especially the case when around 340-350 pension funds - including that of ING - had to submit a recovery plan to the supervisor, the DNB, because of their statutory coverage ratio was below the minimum.
The fund maintained its focus on the outcomes for the stakeholder groups, delivering a net positive funding position throughout the recent financial and economic turmoil.
The chairman of the fund’s trustee board, Rob Meuter, and the head of investments, Geraldine Leegwater, are convinced that their structure of decision making avoids time-consuming and potentially unnecessary board discussions on economic and market factors, for example, by focusing on outcomes for the stakeholder groups.
“The sponsor is interested in a contribution as low as possible over time, the pensioners are interested in indexation in the short term, deferreds and participants are interested in indexation over the longer term,” as Meuter puts it. “These are different and conflicting and if you only took one interest into account you would have one very specific strategy.”
So as part of the fund’s move to restructure its investments at the end of 2007, the pension bureau prepared 10 scenarios, which it expressed in terms of coverage ratio, possibility of shortfall, chance of indexation and chance of additional sponsor contributions. The board had agreed to make a blind choice between these scenarios, and to commit itself to an investment policy that the pension bureau had determined for that scenario, by using board-approved return and risk assumptions for each of the asset classes that made up the ten possible investment portfolios.
In the end, the board chose the scenario out of the 10 which, in expectation, had a 100% chance of indexation in the long run, assuming inflation of 2% at the lowest risk. This was with risk measured as downside risk of the coverage ratio and the lowest chance of additional contributions for the sponsor.
“We took the optimal balance from our perspective for a potential outcome, weighing the different interests,” continues Meuter. “There was a big debate as each strategy weighed the interests of the three parties differently to the others. I think the real value was that we had a good debate on the interests of the different parties and the fact that there were different strategies, each more tilted towards one interest than to others. Getting that balance, as chairman of the fund, was a very important element.”
As Leegwater adds: “During those discussions the focus was really on the goal of the board and not on the tool, because investment policy is just a tool in order to achieve that goal. We took the discussion away from the tools and focused on the goals.”
The outcome in terms of investment policy, as the board was told after making its decision, was a dynamic asset allocation strategy, developed in the summer of 2007, allocating between a matching portfolio and a return portfolio. At higher coverage ratios the board was prepared to accept higher risk, and therefore a higher allocation to the return portfolio. At lower coverage ratios the risk tolerance was lower and there would, therefore, be a lower allocation to the return portfolio. The new framework was developed in house and implemented using external managers at the end of 2007.
The matching portfolio is a typical liability-driven structure, investing in fixed income and using interest rate swaps to optimise the returns as much as possible to the cashflow needs of the fund. Two external managers execute the dynamic strategy, but all other managers remained in place at the time of the transition.
The return portfolio invests in developed and emerging market equities, Dutch property and credit, which was added this year. The components of the return portfolio are reviewed periodically, with decisions to add or remove asset classes taken by the board of trustees. At pre-determined points the actual weighting between the two portfolios is assessed and rebalancing takes place if there is a deviation from the weighting that the board has determined.
“With respect to the composition of the return portfolio we do an in-depth analysis and not only for risk return characteristics of asset categories on paper. We also clearly look, given the way we are structured and organised, at what are we able and willing to handle,” says Leegwater.
Since it is not necessarily clear-cut where credit should sit in a matching and return portfolio structure, this was up for discussion. “With respect to credit this was certainly an in-depth analysis on our side as to what would be the best place to have it. It’s then the pension bureau that does this analysis and whatever implications or proposals we have, we propose this to the board and try to give them all the aspects that we consider relevant, and the board takes the ultimate decision.”
There are some absences from the portfolio - notably alternative investments. In fact, commodities were removed this year, after an analysis which concluded that added value was expected to be too limited at overall portfolio level to qualify it for a position in the portfolio. Private equity and hedge funds are absent since the board believes it is questionable whether the fund, given its size and sructure, will be able to generate the risk-return characteristics that these categories might have on paper. Also, the dynamic asset allocation requires sufficient liquidity. Here it works on the advice and the initiative of the pension bureau and the investment committee, which is chaired by one of the board members and on which Meuter does not sit.
Leegwater continues: “Maybe on paper private equity generates very interesting returns but the historical returns do not mean we will get these results if we implement it. We were very critical already before we put them in the model. Can we certainly be sure once we select that category that we will get these returns? Is it operationally too complicated, or do we run too high risks? You also have to be realistic on what the added value of a small position can be.”
How did the structure work in practice through 2008 and beyond? Starting with a 50/50 split between the two portfolios, the fund actively reduced its weighting to the return portfolio during the year. When declining markets pushed the coverage ratio down, the return exposure was actively reduced.
“And due to this policy at the end of 2008 we had approximately 15-20% in our return portfolio, because of market movements but mainly also rebalancing. The result was that our plan in 2008 did not end up in a shortage position, given the rules of the Central Bank, as we reduced our exposure and thereby also our required solvency. If we had not followed this strategy our coverage ratio would have been considerably lower and it could not have been excluded that additional sponsor payments would not have been needed.”
Meuter is also happy that the fund exited securities lending in the first half of 2007 following the pension bureau’s analysis of risk in collateral cash pools. Following the problems faced by some custodians where re-invested collateral was not held in liquid or risk-free assets, this proved to be a wise decision.
The market disclocations of 2008 threw up a whole new set of opportunities and potential risks, and so in March this year the board again held a workshop to review a new selection of 10 strategies, with the same focus on outcomes for stakeholders. In the end the decision was to increase the allocation to the return portfolio to 38%.
“It was a good strategy, actively reducing risk the moment the markets were going south. But the flipside is that you have very little upside exposure,” says Meuter. “So we decided to increase our exposure again, based on the weighing of the interests of the three parties, because there was so little upside for the active participants and the pensioners and we believed we should now be taking more risk again.”
But the 38% exposure was a little unsettling: “There was a twist in my tummy when I heard that,” adds Meuter. “In this case the strategy was more than doubling equity exposure, which was the right thing to do, with hindsight. But when you are confronted with the implications of your own decision, which you don’t know before, it also gives you comfort, with hindsight, that you have an approach you can trust in.”
Otherwise investment policy stands until March 2010, when it will again be reviewed, and this annual focus will be retained, with no interim reviews planned. “We have had a long debate about this - should we get nervous at certain stages or do we take a long term view?” says Meuter. “Are we very much involved in timing the business? Clearly when major catastrophes happen we would like to be aware of it but we will not be timers and will not follow the herd. It has worked so far, both on the way down and on the way up. Two-and-a-half years’ experience is too short to tell us how it works in the long term but at least it gives us the comfort that we are there to focus on what we do, to focus on the interests of the different target groups.”
Leegwater sums up: “I think this also avoids uncertainty where emotional behaviour might impact decisions, that you take away some of these emotions. Our board can say that they have a risk framework and there is not yet a reason to deviate from it.”
So are the three parties equally happy or disappointed with the outcomes, given that no indexation was granted for 2008, even if the fund stayed above its legal minimum coverage ratio? “The bank is definitely pleased because they did not have to put any money into the fund and we did not have any cover ratio shortage,” says Meuter. “Are the participants happy? They like seeing indexation but they are happy about a healthy pension fund, which is a good indication for the future. I think the most important thing is that we can explain this among the three parties. If people don’t like it then we have a debate about where we put the risk, not, for example, about whether we bought equities in March or not.”
The fund has one important change in store. ABN AMRO itself was subject to what proved to be a disastrous takeover in 2007 and the bank’s future is still unclear following nationalisation last year. At the end of October this year, the Dutch government reached a preliminary agreement with Deutsche Bank on the purchase of the commercial bank assets of ABN AMRO in order to permit its merger with Fortis.
This will mean that some active participants will move to a new pension fund, and will accrue pension rights elsewhere, which will alter the balance of active participants versus pensioners, and therefore, potentially, the investment policy. However, those transferring to the new employer will have the option to keep their accrued rights with the ABN AMRO fund. Whether they do so or not will be a test of their faith in the fund to retain the purchasing power of these accrued rights over the long term - and that is something each individual will have to decide for themselves.