Learning a new tune
There is a Dutch expression that says “De toon maakt de muziek” (the tone makes the music). If you listen for the tone driving Dutch pension funds at present you hear a combination of the jitterbug state of the markets and the ‘business-like’ announcement by the PVK Dutch regulator last September that it was getting tough with issues of pension scheme solvency. For the first time in a long while Dutch pension funds are dancing to an unfamiliar tune.
Regarding the former, there is little institutional investors can do but keep a keen eye on the market swings and hope they have put the right steps in place to not fall on their faces.
On the latter, while most observers in the Dutch market concur that their concerns lay not in what the PVK was saying – a number of pension funds had either breached or were dangerously close to their solvency limits – the way the information was presented as an open letter to the market raised hackles.
Nonetheless, while many in the Netherlands appeared to want to shoot the messenger last September, the PVK announcement had the desired effect in sharpening minds on the job in hand: ensuring that Dutch plans are effectively meeting their liabilities.
As one scheme manager comments: “Some people thought the PVK should have a bit more understanding of the specific problems of pension funds and that it should recognise that there are different kinds of sponsors and that the relationship is different from fund to fund.
“However, in my case it was useful to have such a letter from the regulator in order to convince my board about what was happening and to get an injection of money from the sponsor.”
Hans Rademaker, managing director of Mn Services, adds: “The average funding ratio of pension funds and insurance companies has come under a lot of under pressure. Thankfully, the Dutch market had a relatively high starting level, but it has come down for the average pension fund to about 100% and insurers are also near their minimum targets.”
This, he says, has left pension funds scrutinising their levels of premiums and benefits versus liabilities, as well as their investment policies.
The added headache is that the Netherlands is no longer immune from day-to-day jitters about pension plans (see Ahold – a former staple of Dutch pension fund portfolios) and accountability to company boards.
Rademaker notes that this has put everything up for debate: “The discussion is ranging from a full-scale retreat into government bonds to a stretching out of investment strategy into more stocks and increased private equity and real estate exposure, with the inherent short-term risk attached. “Most of the funds I see though are sticking to their long-term strategy and they are willing to bear this risk.”
And while the PVK prognostic was certainly a shake-up for the market, it transpires that the regulator is being more pragmatic in sitting down with pension funds to look at their asset mix and decide what the best course of action would be going forward.
Obbe Kok, managing director head of institutional clients at ING Investment Management, says that if a pension plan in trouble comes forward with a sensible recovery programme then it will likely be accepted: “You can’t tell a pension plan to make sure its assets grow fast enough to reach 105% as this could be risky and prompt funds to invest everything in equities.”
As a result, Willem Baljet, managing director at Lombard Odier Darier Hentsch Asset Management (LODHAM), says the consultants are busy: “The first thing many pension funds have done is to contact their ALM providers and ask if they can reconfirm their ALM outcomes.
“I have heard though that if you take a long date then the outcome of the ALM studies is not much different than those that were done three or four years ago. Then it does become tricky as to what to do…
“The quick solution is to ask the sponsor for cash, but then you need to secure the returns. Potentially this could also have a huge impact on the Dutch economy.”
Additionally, Alain Grisay, head of institutional marketing Europe at F&C Management, believes that there were some pension funds whose solvency ratios were sufficiently bad that they have been forced to dissolve, reorganise or be taken over.
“The big debate though raging amongst boards of pension funds at the moment is what the role of equities will be in rebuilding the value of the pension fund. There is no panic, but pension funds are asking the question.”
One knock-on effect of this uncertainty, according to Kok at ING, is that a growing number of smaller pension funds are looking at insurance contracts. “If they go down this route then they don’t have to deal with the PVK any more because the fund is reinsured and it’s the problem of the insurance company.”
Confusion over how Dutch pension funds have been approaching these strategic issues was captured in the surprising figures recently released by the Dutch bureau of statistics. These showed that Dutch pension funds had bought e8bn worth of bonds and e20bn in equities in 2002 – the majority bought at the start of the year. This meant many pension funds had been buying shares on the way down. As a result schemes were hit by falling share prices to the tune of some e61bn.
Ronald Nagel, head of institutional business in the Netherlands at ABN Amro Asset Management says this can be explained by pension funds defending their lower equity limits and buying equities when they reached the bottom.
“There were an increasing number of pension funds that stopped doing that during the second half of the year. I don’t think they have commissioned new ALM studies yet, which would give them the strategic option to buy more bonds, but they will probably be forced to do so.”
However managers agree that funds are not yet changing strategy en masse. According to Baljet at LODHAM, this has meant that equities have dropped to around 45% from a former level of around 53%, despite market impact representing a greater drop than that.
As elsewhere in Europe, with questions being asked about equity exposure, bonds are enjoying a renewed lease of life. Says Baljet: “I believe that the strategy will change to a core/satellite approach in fixed income with clients seeking to identify the drivers of return and managers looking to make sure that within the tracking error requirements set by the clients they add some value to the passive environment.
“The satellites will be high yield and investment grade, which will play an increased role going forward.” Certainly, managers report significant inflows into credits and US high-yield, often fully hedged back into euro.
The other talk of the town is inflation-linked bonds. Roel Knol, head of institutional business development at Robeco, says all managers are looking for the holy grail – a perfect inflation hedge. “There is a lot of talk about long duration products like 10–15 years with returns matched to wage inflation. We’re working on that as well. We haven’t got the product yet, but we’re close to it.”
Other managers note, however, that while this could be the perfect fit for pension schemes, the question mark is whether it really works in the European context. Which inflation do you follow when the only products being issued at present are by the French treasury and inflation in France is quite different than the liability profile of Dutch pension schemes? One solution could be the product created by Mn Services that separates the inflation-linked rental income portion from the underlying real-estate investments to provide a hedge against inflation.
Frans van der Horst, head of institutional sales at Aegon Asset Management in the Netherlands, points out that whereas previously the Dutch market looked to be developing as a carbon copy of the US and UK with more specialist mandates and the beginning of the end of balanced mandates, it now looks more like a market in a reflective retreat: “There are a lot of people looking for convenience solutions and pension funds are willing to talk about giving away upside and minimising the ups and downs. I’m inclined to feel that this is going to be the major driver in the market going forward, except for the larger pension funds.” To this end, he says clients are talking about asset management with guarantees or just fixed income, but with retention of administration which is very particular to each fund. “The big change for asset managers is to diversify risk and increase returns by bringing in more asset classes to their offering. Then tune them into the wishes of their client and, the regulator and insurance companies, as well as advising them on how this will fit into an effective recovery plan for the pension scheme new strategic proposition.”
Nagel at ABN Amro describes the quandary as the quest by Dutch pension funds for an asymmetrical return/risk profile. “This means that while pension funds have to deliver on performance, bonds are not good enough for that. However, on the other hand, they don’t have the buffers to take any new blows on equity allocations.”
ABN says it has been looking at options here to offer a product with a guaranteed structure via an aggressive derivatives tool. Says Nagel: “Effectively it would mean that you are protected on the downside but can receive the upside. Obviously there is no free lunch, but when the market turns against you, you might be better off. This has met interest and we have sold it to a couple of pension funds.”
Certainly interest in put and call options and dynamic asset mixes and the like has ballooned in the Netherlands recent months.
And Ruud Hendriks, head of institutional sales and marketing continental Europe at Goldman Sachs, notes that this increased focus on risk has helped the firm’s approach to the Dutch market toward selling currency overlay, global tactical allocation and enhanced indexation programmes.
“We’ve been very successful in picking up a few large mandates in recent months, but focus less on the plain vanilla type of things because there the competition is extremely tough and there are fewer mandates up for grabs in that space.
“For example, if you were selling US large caps then there are over 100 providers in the Dutch market. You need top decile performance to make it on to any shortlist.”
Another change in approach remarked by managers has been that pension funds are reconsidering their style of investment, with a number noting that the Dutch Bureau of Statistics also highlighted a net sale of real estate for 2002. They suggest that this is more likely a switch to indirect funds than an abandonment of the asset class altogether.
Peter Hans Budde at Kempen Capital Management, a specialist house in quoted real estate funds amongst others, believes that property is a neglected asset class in comparison to Switzerland, Scandinavia or the UK.
“I would argue that quoted property, while it behaves like real estate in the long term, has correlations with the MSCI World index that have gone down dramatically. And it is very liquid. Add these up and I think you have an attractive pitch for medium-sized funds in terms of diversification, income, low correlation and low risk.”
This increasing specialisation of the market under such difficult market circumstances, however, seems to have taken its toll on some of the smaller Dutch schemes.
At F&C, Grisay comments: “What’s happened in the markets has raised concerns over whether some of the small pension funds and their limited staffs are sufficiently well equipped to deal with all aspects of risk control and fund management, so the trend is to outsourcing and consolidation.”
Hendriks at Goldman Sachs argues that this has also made the Netherlands a good hunting ground for fiduciary management and says Goldmans is marketing on a performance-related basis to build up a partnership relationship with clients.
Marko van Bergen, head of Benelux institutional business at Barclays Global Investors (BGI), believes another factor gaining credence is pension funds looking more closely at manager risk as well as seeking more rational explanation for performance.
He believes the notable shift over the last few years towards index management in the Netherlands still has a vital role to play here. However, he points out that the new kid on the block ‘enhanced indexation’ is now a serious proposition in the Dutch market. “There is now an urge amongst schemes just to take a little more risk for reward in the short term. This can be done quite conservatively with a quant enhanced manager or low risk asset manager.”
So much so that the competition for enhanced mandates is now red hot, with local active managers such as ING and Robeco touting their own models based on low tracking error versions of their stock-selection models.
This broadening of product has no doubt been prompted by the fact that most Dutch managers have had a tough time in the past three years due to their predominantly growth-driven investment strategies.
This also implies that non-Dutch value managers might have noticed a window of opportunity in the Dutch market at present.
However, Dutch fund managers don’t have to look any further than their own back yards for competition. The increased presence of pension funds doubling up as asset managers – often with bulk assets under management from their own pension funds entities and the inside-track on the pension scheme network – while not a new phenomenon, cannot fail to make asset gathering that little bit harder.
Some pure asset managers are quick to dismiss the prospects of the pension fund asset managers in the third-party arena.
Rademaker at Mn Services, the largest of the pension fund managers operating on a third-party basis, strongly disagrees of course: “More than ever I think it makes sense for us to be in this market. We are not only an asset manager, we are a fiduciary manager taking care of pension fund assets.”
According to Rademaker one advantage of this for clients is that Mn critically examines all costs involved in pension mandate arrangements, including costs that are often disregarded by other managers. “This means that we try to avoid as much as possible the slippage that you experience if you don’t take care of the nitty-gritty within diversified instruments. So we have things like cash pooling, commission recapture, securities lending, transition management, trading costs, etc. These are areas that we monitor and manage for our clients. On their own they might represent only one to three basis points each, but several of these together is 10–15 basis points and people care a lot about this at the moment! We don’t position ourselves as a pure asset manager, but more an organisation that takes care of the whole investment process.”
Rademaker also notes that most of the assets Mn Services has under management are run through multi-manager arrangements with Mn managing only fixed income Europe, emerging market debt, European large cap equity and real estate in-house.
In the battle for Dutch pension fund assets the offering by pension fund asset managers is one that pure asset managers ignore at their peril. If anything, investment managers need to be constantly looking at their product lines, honing not just performance but service also.
Grisay at F&C, the result of a four-way European merger that included former Dutch stalwart, Achmea, gives an implicit idea of just how tough this competition is on the ground: “What we are doing now, which is different from our competitors in the Netherlands, is that we are delivering the standards of an Anglo-Saxon based institution in terms of management, performance measurement, risk and regulatory control, from a local Dutch centre.
“We also provide all fund administration and book keeping and are aiming for total transparency in respect of what we are doing for clients.”
However, Ronald Nagel at ABN Amro believes that if there is more competition from external managers it has been on the fixed-income rather than equity side – passive managers excepted.
And he argues that the differential Dutch/non-Dutch manager is something of a misnomer today. “We have been marketing our products to non-Dutch markets for a long time now and dealing with international consultants, so I think that we are as much a non-Dutch player as Dutch in terms of professionalism. Some others may lack the resources for this though.”
Taking into account the current direction of the Dutch market then it would seem reasonable to predict an inflow of more specialist providers offering different high-octane products, as well as a increased profile for full-service, one-stop pension providers.
The overarching question is how many providers will seek to specifically brand themselves in such a tough environment and how many will solely manage money for other institutions with a more visible presence – an underlying theme in the Dutch market that is readily acknowledged, but rarely elaborated on.
As Budde at Kempen opines succinctly: “I wouldn’t be surprised if the smarter managers will focus on just a few products and hire external managers through white label funds for the rest. “For the moment, though, competition is fierce and differentiation is everything.”