The medical profession in the Netherlands is facing a split – at least as far as its pensions arrangements are concerned. The SBA professional pension scheme for the medical doctors in the Netherlands is made up of two separate funds, run in an identical fashion since their formation in 1973 for the 22,000 members. Now preparations are in hand for their likely eventual separation.
The fund for the general practitioners accounts for 60% of the E9.2bn of total assets, the balance being for the medical specialists and consultants. “The funds have worked together for the past 25 years, they still look alike, but our view is that this will change over time, so we are now getting ready for this differentiation,” says Louis Chaillet, head of investments in Utrecht, where the funds’ bureau, responsible for implementing the strategy and running of the funds, is based.
The funds have doubled in size over the past five years and now the schemes are mature, with no net inflow of funds, though there is still a high rate of inflow from the doctors’ mandatory contributions, which are related to the turnover of their practices.
The asset allocation and other strategic investment issues, are handled by a joint committee with representatives from the boards of both funds, which is advised by two distinguished business experts, a former commissioner of the European Union and a professor of law. This committee meets quarterly, with the bureau’s director and investment experts.
“Our ALM study gives a shape to the portfolio, as to how much equity, bonds and other categories. We then work this out in detail to form a practical operational investment portfolio,” he says. Virtually, all the investment is handled in-house, with a team of seven portfolio managers, excluding Chaillet.
The current split for the past three years 45% equities, 52.5% bonds and 2.5% real estate, but this looks set to change as a result of the latest ALM study, conducted for the fund by actuarial consultants Ortec. “We in asset management are working on this currently and the outcome will decide where the regional and sectoral allocation should be.”
The equities are allocated 60% to the European region on a pan-Europe basis, 27.5% to the US, 7.5% to Japan and 2.5% each to the rest of Asia and emerging markets worldwide. “Regions have been divided according to the MSCI World Index and our allocation is to sector distribution within these,” he says. “We have been paying close attention to sector issues, with our five internal equities managers developing a sectoral specialisation. So although we do regional allocation, the specialist manager for telecoms, for example, will cover the sector in all regions.”
This structure, which has been in place since1999, the funds find very useful. “The dual approach helps us in gaining inside knowledge, which is the basis for the decision. At some points, the sectoral influences have been very strong, though they have been waning lately.” He attributes this partly to the dominance of telecoms. “They were so strong that when they collapsed they overshadowed everything”.
Regional allocation is still important, but in his view, it is declining in its effect. Chaillet points to one force driving sectoral and global interdependence. “Definitely, the world is becoming more sectoral, but it does depend on the sector. If you are looking at a sector where the product is physically heavy, then you have a natural limitation on corporate reach. Overtime, the weight to value ratio of products has been declining, making the world more sectoral as a consequence.” But other factors are clearly very influential as well.
The funds’ emphasis generally has been on larger market caps stocks, with some adjustment for home bias. “We make an arbitrary allowance for home bias, which we calculate to see if it fits comfortably with the ALM study – as a secondary check.”
The large cap strategy was adopted because in essence it is a ‘do-able’ approach, as by concentrating on the larger stocks, the universe is reduced considerably, additionally it fits well with the sector approach. “In our European portfolio we have about 100 stocks, for the US about 80, but in Japan we have significantly more, as it is a new region for us and we want to limit tracking error to 2%.” In the US and Europe, tracking comes out at 3%.
The Asia non-Japan region and the emerging markets are handled through two separate mandates for the last three years. The results have been good, he adds. For smaller cap exposure, the funds have invested through a long term holding in Orange Funds, originally a Dutch and now a European small cap fund, run by Kempen, part of Dexia group.
The funds’ bond portfolio is distinguished by an extremely high quality portfolio, he says, pointing to the triple A and double A ratings for some 90% of the portfolio’s issues, mainly in government, but with some agencies as well. Around 80% is euro-denominated and the rest in US$, with 50% in Treasuries. “We do not run the currency risk, since we do not think this adds to returns, so we have started hedging the dollar exposure in the beginning of 2002, which has worked for us in reducing risk. We use the simple methodology of swapping for one month periods.”
While there have been some corporates in the European portfolio, these have been long term holdings in large banks, supervised under Dutch law. “These have been held mainly for historic reasons.” This portfolio is also managed in-house. “While we do not do active tracking, we do active allocations of the government portion to duration and we use the opportunities to switch between the swap and the bond.” The aim is to monitor the portfolio closely for opportunities for additional yield pick up. So earlier this year, a significant amount of German Pfandbrief were sold, when the Landesbanken positions came under pressure from the rating agencies.
The real estate portfolio, Challiet describes as a buy and hold. But it too has changed in character. “Years back, we used to hold direct real estate in significant amounts, with some success, even though there were some individual projects that did not do well.” The board changed their view and reduced the exposure as projects were completed. “The conscious decision is not to be involved in direct real estate and we now participate in limited partnerships and have done eight of these. This gives us the opportunity to be selective in region and sector, which is impossible to do in Europe by holding listed vehicles only.” The emphasis has been on limited life rather than evergreen funds, which better align the interest of the asset manager and the investing institution, he adds.
The real estate returns have turned out favourably, though there is no proper benchmark to measure performance against on the indirect side. “On the bond side, we have done reasonably well.”
The equity side has been very difficult, though the portfolio is doing considerably better currently. “We used to have a strategy to be biased to growth stocks, which did wonders for the fund, though obviously not in the recent past. Since the value to growth swings have become extreme, we went to a neutral strategy of a 50/50 split, at the beginning of this year. This has worked well and returns have improved. Stock selection is now the dominant feature in overall returns.”
Tactical asset allocation side has become much tougher this year, Chaillet acknowledges. The process used is a top-down, comprising a number of levels: the asset and regional, the sectoral and stock.
The rules regarding TAA are set down in established guidelines. “For TAA we do not use ‘tracking error’, but ‘band wide’ error.” On the bond side, ‘bucketing’ techniques have been adopted.
“The decisions are made on a monthly basis – frequently there are decisions not to do anything at all,” he says. But the area can contribute to return. “We do not use derivatives for TAA, but trade the underlying stocks. Our normal horizon is over a six-month period and we would rarely move into stocks for just a month or two.” They have looked at using exchange traded funds (ETFs), but have worries about the extent of liquidity of these in Europe. In fact, in the past the funds have used OPALS, MSCI’s precursor to ETFs in Europe.
The funds’ practice now is to rebalance every quarter, having changed from a monthly basis earlier this year in July. “After studying the question for a considerable time, we felt it would be a better methodology to do it quarterly.” The normal practice is to rebalance to the strategic allocation.
But before the last rebalancing was due, there was the announcement by PVK, the Dutch supervisory board, during the summer that it was reviewing the position of pension funds regarding the decline in equity markets. “While SBA does not have a financial problem, at the time there was uncertainty as to what the PVK would do. So the board decided not to rebalance to 45% equities in October.” This was particularly on the advice of the external advisers on the board, who believed it would be unwise to take this step.
This move coincided with the work that was being done as a result of the latest ALM study which would reduce the equity exposure overall to 40%, as well as bringing bonds down to 40%, while increasing real estate to 10% from 2.5% and the exposure to fixed income credits to 10%. These figures have to be formally adopted by the board, says Chaillet. The overall approach is to avoid increasing risk. So the aim to build up real estate activity on a worldwide basis through indirect property participations. “The credit portfolio is being introduced even though it will require additional risk capital from the PVK viewpoint,” he notes.
“This is certainly a big shift for us and in the investment department we have been working on the strategic implications, including the regional and sectoral allocation, which in fact we do not expect to change.” The decision to hedge the foreign currency exposures on equities is also to be ratified by the board.
When it comes to the financial position of the fund, this hedging of currency is a significant risk reducer from the PVK solvency viewpoint. Also, the action that is taken to reduce the levels of benefit indexation, which have been reduced to 3%, compared with 7% in the past. The funds have never had a contribution holiday and adjusting the benefits indexation is used to compensate for changes in the investment returns climate.
The ALM exercise had originally worked on the basis of looking at hedge funds, private equity and commodities, but these alternatives were excluded from the study at a late stage. “But they could be looked at next time around,” he adds.
This switch in approach was mainly due to the major operation to prepare for the separation of the two funds eventually, to give them both more flexibility. “This is a major task as it involves setting up an umbrella fund, where we can segregate the portfolios into different categories, so the pension funds will be able to hold these funds in different proportions.”
The investment department will become an asset management company, with just the two doctors’ funds as clients. “It’s not currently our primary objective to look for other clients. We want to serve our two clients better and update the governance structure. The level of information and servicing the profession requires is increasing all the time and these changes will help us focus better on our clients’ needs.”