NETHERLANDS - Dutch pension fund managers are unable to predict market movements, and should therefore focus on the best strategic asset allocation and rebalancing, a DNB study suggests.

On average, both the market timing proposed by the administration, and the actual timing by investment managers, leads to negative or zero excess returns, according to a survey of schemes' stock market performance, commissioned by pensions regulator De Nederlandsche Bank.

Researchers, who looked at the period 1999-2006, found pension funds tend to base their investment decisions excessively on recent stock market performance, rather than on long-term trends.

Schemes respond asymmetrically to stock market shocks, with a higher equity reallocation after underperformance of equity investments than after outperformance, the study showed.

"In particular, only 16% of positive excess equity returns is rebalanced, while 48% of negative shocks results in rebalancing," according to the researchers.

In contrast, larger pension funds revealed an opposing pattern. When market valuations rise, they tend to buy additional equity, thus increasing the equity stake in their portfolios as the larger schemes apparently to have a greater risk tolerance, the study suggests.

All pension funds adjust their portfolios in response to negative shocks - even small ones - mainly by buying equity, the researchers also found.

Every quarter, pension schemes rebalance 39% of the extra returning equity on average. "The remaining 61% leads to higher or lower equity allocation as a result of ‘free floating', which is further rebalanced in subsequent quarters," the researchers pointed out.

They also found large schemes tend to invest more assets in equity, and their equity allocation is more strongly affected by actual equity returns. "This implies that large schemes rebalance less, possibly because managers have more freedom in implementing market timing strategies," they commented.

Rebalancing of equity portfolios by the smaller and average-sized pension funds also has a stabilising effect on the equity markets, the study said.

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