Big players dominate Dutch derivative use
When it comes to derivatives, Dutch pension funds divide into two, the VK, the Appledorn-based pensions supervisory authority, found when it carried out a survey of the extent of funds’ involvement in the area in 1996.
Only 163 funds, a quarter of the 653 surveyed, were authorised to use derivatives and only 64 were actually using them at that stage. Their use was very much the preserve of the larger funds, both the sector/industry-wide schemes and the bigger company pension schemes: 15 of those 64 funds were in the Dfl250m to Dfl1bn asset size range and 26 funds held more than Dfl1bn.
As was to be expected, the greatest activity was among the biggest funds, which used a range of equity, fixed interest and currency products for allocation and currency exposure management, both exchange-traded and over-the-counter (OTC).
At Goldman Sachs International in London, derivative specialist Sandy Rattray says that, with lower equity and higher bond allocations in portfolios, “some of the exposures they have had have been to increase equity exposures notionally”.
Talking to IPE in Groningen before its split last November, the TPG and KPN pension fund said it used the freedom to move tactically around its allocation limits to the extent of plus or minus 5%. In practice this has been limited to switching between bonds and equities. The fund has made its moves on a daily basis, using futures to implement the strategy. Investment director Jan Willem Baan said: “You have to be realistic with the returns you can expect with the 5% limits in the portfolio and in not having too aggressive an approach.” The returns he would like from such a tactical approach would be an additional 100 to 150 basis points, with a downside limit of 100bps.
At the $13bn metalworkers’ fund, run by MN Services in Rijswijk, use has also been made of tactical asset programmes using derivatives. This has involved leverage – for example, taking a short position in Japanese government fixed interest issues – but the maximum the fund can leverage is 9%. It also uses derivatives to manage currency exposures.
The Shell Pension Fund managing director Kees van Rees said the two main areas where the fund would use derivatives are on the currency overlay side and for tactical asset allocation. The fund has used currency programmes extensively: “On the currency management side in the forex markets, we have a large forward programme.” The fund’s aim is to manage its cash more effectively than in the past. “So now we can report on a weekly basis on the leverage position of the pension funds. One of the reasons we do this is to ensure that we do not have too much cash. Preferably we like to be in a negative cash position, as we want to put our cash into the market as much as we can.” This strategy requires use of appropriate derivative strategies and products.
“On the TAA side, when we look at our models and decide to move between markets, we would decide to do that in terms of futures and then fill in those futures.” He stresses that “exotic options” are out, as far as Shell funds are concerned.
There have been discussions within the fund as to the extent of leverage allowed. “At present, we do not go very far. Last year, we were operating on a benchmark of 5% leverage, but this year we do not operate under a leverage benchmark.” He adds that in current market conditions it is hard to see leverage adding value. “In the past it has added a lot of value.” It is essential to have a set of rules and to develop systems that enable the fund to time and control its moves involving leverage.
But tactical asset allocation and currency are not the only uses for derivatives. Groningen-based energy group Gasunie uses swap strategies to implement its asset allocation approach (IPE May 1999).
Rattray at Goldmans contrasts the approach of the Dutch funds with the pure risk control focus found elsewhere, such as the UK. “A number of Dutch funds have large investment staffs, who are able to perform the risk controls. If you have people to look after this, then it makes sense to look at other areas. They are open to suggestions as to how to make additional money from their assets.”
He also points to the funds’ “model-based approach”, usually accompanied by a high level of professional competence among the managers. “The Dutch focus on the big liquid markets, such as the European futures markets, which are very well developed.”
In VK, things have moved on since the survey, with the monitoring of derivatives, now being an important part of its new supervisory approach, involving the production of quarterly figures by funds on all aspects of their investments. The authority’s GastonSiegelaer says: “On the derivatives side, we have set a standard for derivatives accounting, which is somewhat different from the accountants’ approach of fair value. This does not give a good insight into the actual risk position. The way we want them reported is to use the delta-rho method.” This gives very precise details of positions.
Under Dutch law, pension funds are free to use derivatives. There is just one guiding principle – that funds must invest in a “sound manner”. The new reporting system will provide an early warning system to pick up funds with exposures that are out of the ordinary, such as “unusual performance figures or strange derivatives positions,” he says.
The question of leverage will also be a crucial one, Siegelaer points out. While this is permitted by law, pension funds must know what they are doing, and that they are in control of the risks and have adequate risk systems. “Even for those pension funds with experienced staff and adequate risk systems, nobody would agree that an enormous amount of leverage is within the definitions of prudence.” One of the signals in the VK’s warning system will be the amount of leverage a fund takes. But he recognises the problem: “There is no clear figure that you could take as the amount that would be prudent ex ante. But of course, when using an early warning system, you have to fix some threshold values, so it won’t be a surprise that we do not make this public.”