NETHERLANDS – Dutch pension funds could raise their equity allocations as a way to cut underfunding risk, according to ABN Amro.
“Pension funds should still find it appropriate to reduce the duration gap of 10-years between assets and liabilities for the purpose of risk management,” the bank said in a research note.
“This can even allow higher equity allocations – which should appear to many pension fund boards.”
It said the “optimal path” to reducing the underfunding risk over one year is to reduce the duration gap between assets and liabilities. The comments come against the background of changing pension regulation in the Netherlands in the form of the Financieel Toetsingskader, or financial assessment framework, and the new Pensions Act.
ABN Amro said funds would have the scope to adjust portfolio allocation between risky and non-risky assets. A fund “can increase the weight of equities in the portfolio at the expense of bonds but at the same time also reduce the duration gap to still arrive at a lower funding risk on a on-year horizon.”
It said this was appealing “for many reasons”.
“Firstly, the cult of equity for long-term investors still exists no matter the recent theoretical and actuarial discussions that pension funds are much wiser to move to a liability benchmark model and consequently shift in large part to bonds.”
“Dutch funds are no different and many pension fund boards will find the concept of higher equity risk and therefore higher expected returns appealing.”
The report said that funds, aiming for indexed benefits, view long-dated obligations linked to wages are “better hedged in the stock market”.
And it said that bonds are not an attractive investments during next year when the new financial framework is being implemented before legal enforcement on January 1 2006.