The net value added of Dutch pension funds that participate in the benchmarking database of CEM, the Toronto-based global benchmarking firm, has averaged 0.5% per annum over the past seven years. This compares favourably with the US participant average of 0.2% per annum, but is below the Canadian participant average of 0.7% per annum.
Net value added is a key measure of implementation skill. It primarily reflects the value added from active management. It equals a fund’s total return minus its policy return. It is the value added over what could have been earned passively indexing a fund’s policy asset mix decision. Anything over 0.0% implies that a fund has performed well relative to passive alternatives. Thus pension funds in all three countries have benefited from active management over the past seven years.
Total value added can be further broken down into value added from asset selection within asset classes and value added from ‘mix’ effects. The Dutch funds had positive selection value added in all major asset classes. They performed particularly well in private equity where their value added averaged an amazing 16.9%.
The only blight on Dutch performance was their value added from ‘mix’ effects. Their average ‘mix’ value added was -0.6% versus -0.1% for both US and Canadian funds. Mix value added is caused by timing, rebalancing and differences between a fund’s actual holdings and its policy holdings.
One reason Dutch pension funds have performed well relative to their US counterparts is because they have lower costs. CEM research shows that, on average, for every basis point of additional cost incurred, funds lose 0.5 basis point of net value added. In other words, paying more does not get you more. Dutch investment and oversight costs averaged 0.20% versus a US average of 0.38% and a Canadian average of 0.32%.
The relatively low cost of Dutch participants is impressive given that they have a higher cost asset mix. In particular, they hold more real estate, which is the second highest cost asset class after private equity and venture capital. Seemingly small differences in holdings of these high-cost asset classes can lead to large differences in total costs. The real estate holdings of Dutch participants averaged 11.0% of total assets over the past seven years which is above the US participant average of 3.5% and the Canadian participant average of 2.2%.
Dutch costs are lower for two primary reasons:
q Dutch participants are generally larger so they benefit from economies of scale. There are 11 Dutch participants in the 2003 CEM database and their median size is e12bn. This compares to a median size of e4bn for the 151 US participants and e1bn for the 88 Canadian participants;
q Dutch participants have a lower cost implementation style. They manage an average proportion of 35% actively through external managers versus 65% for US participants and 69% for Canadian participants. External active management is substantially more expensive than passive management or internal active management for large pension funds.
What about total returns? CEM discourages the comparison of total returns because differences in total returns primarily reflect differences in asset mix policy. In turn, each pension fund’s asset mix policy should reflect their unique liabilities, appetite for risk and long term capital market expectations. Differences in liabilities are particularly large between countries because the liabilities are payable in different currencies.
Tom Scheibelhut is with CEM, based in Toronto