Although they had to acclimatise to a new Pension Act and get to grips with recently introduced and elaborate pension fund governance principles, Dutch schemes proved to be in good form last year. According to investment performance firm WM Performance Service, which surveyed 700 or so pension funds, Dutch schemes saw an end-2006 return of around 7.2%.
The returns included strong growth in the second half and the effects of currency hedging, which boosted the total return by 1.4%. Equities and real estate were the real winners and the main positive contributors in an environment of increasing interest rates.
The two largest funds, the €211bn civil servants’ fund ABP and the €86bn healthcare and social workers’ fund PGGM, benefited from their massive equity portfolios (€75bn and €36.9bn, respectively), with ABP returning 13.5% and PGGM 16.3%.
Also the €21bn industry-wide pension fund for the mechanical and electrical engineering industries, the Pensioenfonds Metalektro (PME), had happy equity tidings. It implemented a geographically more diversified spread for its equity holdings with a 1% cut in its exposure to US equities and an increase in exposure to Japanese and other Asian stocks. The fund has 32% of its total portfolio invested in equities, and it posted an overall return of 13.7%.
Chinese and European equity performed particularly well, according to spokesman Bram van Els. “The Chinese market showed a spectacular figure, with a return of 117%,” he says. “Within the developed regions, Europe performed best with a return of 18%, while Japan lagged with a 5% return.”
Pension funds also benefited from alternative investments, such as private equity. ABP says it sees much value added in the often-vilified private equity investments.
“It is an asset class that is more risky than most, but the returns are high, which helps us provide inflation-indexed pensions and keep pension premiums affordable in the long run,” says chief investment officer Roderick Munsters.
“Furthermore, we expect an extra return premium on private equity versus public equity because of the illiquidity of the asset class and the investment skills we get through AlpInvest.”
One of the world’s largest private equity investors, AlpInvest is responsible for the private equity investments of both ABP and PGGM. “We realise that recent market conditions are less supportive to the leveraged buyout market in particular, and that ABP will not be immune to adverse developments,” adds Munsters. “Nonetheless, we believe that waves are inherent in the asset class and we can benefit long term from having a structural exposure to it.”
While lavish equity and real estate returns alongside good alternative investments pushed up managed assets, leaving the majority of funds ending the year to their satisfaction, 2006 also created head space for some innovative ideas.
For example, the €12.1bn Dutch Railway Pension Fund (SPF) launched its ‘opportunity portfolio’, a new mandate with new investment categories and strategies. “It is intended to quickly add new investment possibilities to the SPF investment mix which do not fall within an already existing investment category,” says Marcel Andringa, head of investment strategy at SPF Beheer, manager of the SPF fund. Ultimately, SPF wants to invest 5% of its entire assets in the opportunity portfolio.
So far SPF has started investing in infrastructure, global tactical asset allocation (GTAA), micro financing and development projects via the new portfolio. “Next to this we are seriously looking at a number of new ideas,” says Andringa. “However, investments that qualify need to have an economically well-founded, expected return, while a low correlation with other investment categories is also desirable. He adds that certain investments could even grow into an independent investment category.
ABP created a new innovation committee as part of a plan to seek out new classes of assets and to harness internal expertise to both seek out ideas and to assist with the various stages of implementation.
In particular timberland made it to the top of the committee’s agenda last autumn and now ABP has committed funds to real land and trees - something few Dutch, or European, investors have done.
The approach is part of a new investment strategy, dividing the portfolio into two components - one using liability-hedging assets, with cash flows and low volatility to create an ‘indexation portfolio’ and another ‘return portfolio’ that involves riskier assets that aim to gain the highest possible return.
Similarly, PME launched its ‘special projects’ asset class, which include investments in timber, US life insurance policies and local Chinese equity. And PGGM further developed the pioneering ‘portfolio of strategies’ that it launched in 2005 as what it described as “a diversified portfolio of innovative investment strategies designed to systematically and efficiently exploit structural market inefficiencies”.
The portfolio aims at “long-term investments, where most would say ‘this is not for us’,” according to its manager, Jelle Beenen. It is a quasi alternative alternatives portfolio dedicated to investments in beta assets with an alternative risk profile, he says.
The portfolio, currently valued at 2.9% of the fund’s total assets but targeted to grow to 8% by 2008, dedicates investments in beta assets with an alternative risk profile, enabling investments in timber, catastrophe bonds and concentrated risk. Beenen says the investments in the latter two will increase in the coming year.
But there were losers among the assets classes. Commodities was one. “In particular, the price of oil fluctuated in 2006, making the commodities market tense for most part of the year,” says PME.
Also, euro-denominated investments were down 0.2% in 2006 despite improved performance during the second half of last year driven by lower oil prices and a more neutral European Central Bank monetary policy. Last, fixed income showed negative returns of 1.7%, its first year of negative returns for Dutch schemes since 1999.
According to WM, this was caused by the negative currency impact in international bonds, which account for around 20% of total fixed income investments. Andringa notes that rising interest rates also depressed fixed income returns.
Corporate bonds are expected to continue to underperform: “For some time we have been negative on corporate bonds due to the credit spreads which, in our opinion, sank too far, in combination with the rising risks on the credit market,” says Andringa. “So we don’t have very high expectations.”
Nonetheless, in the coming year analysts expect even more investments in the equity sector as risks have become minimal while coverage ratios of the respective pension funds are showing notable improvements. The only growing risk factor for investors at present is interest rates overall.
Earlier this year, Philip Menco, chairman of pension insurer De Eendracht, told the local press that pension funds would increasingly have space for new investments, especially in equity.
Analysts said ABP and PGGM, based on their expected higher coverage ratios, would also show an increased willingness to reinvest or increase overall equity investments.
ABP agrees that the long-run odds of achieving full or partial indexation improved, while at the same time both the short-run and long-run probability of under funding have decreased.
Nevertheless, in the new strategic mix, planned exposures to equities have been adjusted slightly where the exposures to emerging markets increased somewhat at the cost of developed markets, notes Munsters, “Actual exposures are close to the strategic weights,” he says.
SPF is more upbeat: “We are halfway through the year already,” says Andringa. “Equities are performing well until now, relatively surprisingly well.”
Other possible moves by pension funds may include putting part of their investment portfolio into private equity for give higher yields.
Munsters predicts that his own fund’s private equity investments will yield around 10% per year and that even in a declining market, ABP would benefit from private equity.
ABP’s 2007-2009 strategic investment plan shows slight changes to the asset mix while continuing in the longer run to increase exposures to real assets, private markets and ‘alternative’ investments in general, he adds.