Dutch master of tactics
Fennell Betson meets the man controlling the pension assets of 95,000 Dutch posts and telecoms workers
Pension funds may be long-term investors, but this does not mean they can forget about the short-term issues. No-one is more conscious of that than Jan Willem Baan, investment head of the very successful TPG and KPN Pension Fund, based in the university town of Groningen to the north of the Netherlands.
He dubs the fund's investment approach as pragmatic", acknowledging the undeniable fact that the long term is indeed the sum of the short terms. This most clearly comes through in the dedicated use of tactical asset allocation strategies.
The strategic position of the fund, which had investments Dfl11bn ($6bn) and 95,000 active members in the Dutch post and telecoms services at the end of 1997, had been reset during the year to 56% in equities (45% in 1996), 37% in bonds (48%) and 6% in property (5%). Apart from real estate and domestic bonds, all assets are managed externally.
"We have the freedom to move tactically around these portfolio limits to the extent of plus and minus 5%," says Baan. "In exceptional circumstances, which are not easy to define, we can move to plus or minus 10%." The tactical approach is limited in practice to switching between bonds and equities. "We make judgements on a daily basis as to how the markets are moving." The strategy is implemented by the use of futures. Options are not used, Baan stresses.
"We do most of our TAA in-house, but we also use an external manager to help with an overlay strategy, though the amount managed is far less than we handle internally." The strategies are run independently. "We are not compensating for what they do, as then what would be the point in employing them?"
The strategies have been in force now for two years, so what has been the outcome in an area notoriously hard to addvalue? "We have had some good results and I am satisfied with what we have achieved internally. TAA is a very difficult field and you have to be very careful about coming to any conclusions in the short time we have been involved. You need longer than two years." However, the external manager's results have not been convincing so far, he adds.
"But you have to be realistic about the returns you can expect with the 5% limits in the portfolio and in not having too aggressive an approach." Additional TAA returns of three percentage points are not likely, but he would like to see on the positive side something of the order of 100 to 150 basis points, with a downside limit of 100bps. "Last year had been good on the TAA side overall and the first three months of 1998 was positive. The first quarter of 1998 was good for equities and we were moderately long on equities. The second quarter's results were neutral, with the same return for bonds and equities and both were flat in relation to our benchmarks. It did not matter which you were in!"
The third quarter was bad for equities, Baan says. "But we have been on a negative footing tactically speaking. In the last few weeks, we have been at the lower bands of our mandate and tactically that has helped us."
Then there is the point where being a committed long-term investor does take over. He says: "If you could have held less stock in the normal portfolio, then it might have been better, but you do not have this opportunity to go out of stocks, as we have our commitments as a long-term investor."
The additional returns from TAA pale in significance when contrasted with the stunning 20.8% return obtained by TPG-KPN last year compared with the average of 15.8% returns by Dutch funds. The overall result comprised a 36.4% yield on shares, 20.1% on property and 7.9% on bonds.
"Our role is to take the most important strategic decisions about asset classes and markets and the proportions there, in the light of the asset liability models we have undertaken, and delegate the decisions at a lower level externally. This is a matter of being as efficient as possible." The returns bear this out, with the external managers adding little value in 1997. "So a great deal of our performance is attributable to the strategic choice of assets and then country allocation."
Of the fund's current 10 external managers, most are active looking after equity portfolios, but one is a passive manager responsible for a worldwide indexed portfolio. Baan says: "We regard this as a low cost/high efficiency investment alternative to active management. It enables us to 'complete' our portfolio and investment in regions where we feel active investment is disadvantageous."
The equity portfolio is 25% invested in the Netherlands with the balance worldwide. The Dutch equity mandate is also handled externally. "It is only logical to do this as we see no difference between Dutch and non-domestic equities," he says. "Our global passive manager is currently managing around 40% of the world equity portfolio and 60% of the Netherlands portfolio." On the bond side, the Dutch portfolio is run internally, with one international portfolio with an outside manager.
TPG-KPN's method of recruiting external managers is certainly systematic. "The selection process for managers starts after an internal definition of the mandate, after which benchmarks are selected." But consultants may be used to arrive at a list of possible candidates that fit the desired profile, says Baan.
Potential managers are judged on their investment and portfolio management skills, and in addition to their past success and the quality of the team, the fund will also look at the robustness of their risk management, their back office strengths and what Baan calls "their intuitive skills". They also have to provide indemnities and comply with the reporting and performance measurement requirements, as well as having an acceptable fee structure.
But there is a fair dash of pragmatism in selecting managers. "We are pleased there are so many managers to choose from," he says. "We are quite active here, as we are not married to them - albeit that we have long-term relations with some of them. So there has been manager turnover. This can be when we feel a management style is no longer a style we like or the manager is no longer operating within the style we selected them for." But generally two to three years will be allowed to run before forming a definite opinion about a manager's performance. And he points out that it is never performance alone, but other aspects will be taken into account such as timeliness of reporting, willingness to add value in other ways, such as providing research.
For each mandate TPG-KPN sets its own benchmarks and the performance is measured rigorously in line with this, generally FT-World for equities, or customised benchmarks. "The process is very objective, the manager knows the benchmarks and risk tolerances, so he knows from the beginning where we want him to go. We operate an 'open skies' policy."
The fund's average return over the past five years has come out at a very strong 13.5% annually. Since its inception in 1989, returns have averaged 9.9%, more than justifying the decision in investment returns to break from the giant ABP scheme for civil servants, where the post and telecoms were covered. "When the new entity was created and became a limited company, even though the state owned the shares, it was felt that it was no longer appropriate to be covered in the civil service scheme and a new fund should be formed," says Baan.
With the PTT staff accounting in 1989 for 10% of the civil service, the new fund might have been expected to be in the running for Dfl16bn, equal to 10% of ABP's assets then. But in fact it only received Dfl3bn, once the liabilities for existing pensioners and early retireds staying within the ABP system were ac-counted for. Since then, pension capital has increased to Dfl11bn, up by Dfl2bn alone in 1997. This meant that at the end of last year, invested assets exceeded liabilities by 42%, up from 29.5% at the end of 1996, providing a buffer to cover fluctuations in asset values and enabling the long-term strategy to be maintained. This buffer will be affected by the recent market turmoil, but Baan adds: "That is the character of a buffer!"
But it is not just the violent market fluctuations that are challenging. Recently it faced the biggest change of its meteoric existence with the split between the post and telecoms operations and the pension fund being divided in two. Undoubtedly, this has big implications for the investment strategies, but as Baan says simply: "It is not possible to answer yet what these will be, but our organisation is fit to deliver the services for the two boards of trustees of TPG and KPN.""