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Impact Investing

IPE special report May 2018

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Dutch performance in the balance

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A balanced pension fund mandate has a great advantage when being sold: its name. Balanced sounds reassuring, that nothing too risky will be undertaken and everything will be done in moderation to provide a proper level of returns.
Dutch pension funds like this as they are dealing in the long-term and want to avoid unnecessary risks. It also helps small pension funds if the balanced fund manager can handle reporting requirements and prevents it dealing with too many providers.
But there is unhappiness that what has been sold has failed to deliver as expected in the near past. As a result there has been a marked change, often to something promising to improve on a balanced manager in some areas, such as picking best in breed fund managers at all times or diversifying into alternatives or using derivatives to match liabilities, although these can then have issues in other areas, such as cost or unexpected risks.
Underperformance is a key issue behind the unhappiness with the traditional balanced mandate. Dutch pension funds have an average of 40% in equities and the top 15 largest fund managers are Dutch-owned. Bart Heenk, head of the Netherlands operation of SEI Investments, a US multi-manager company, says that smaller pension funds are faced with past performance that is not particularly impressive and they realise no one can be experts at everything.
Johan Cras, managing director of Amsterdam office for Russell Investment Group, a US-owned multi-management firm, agrees. “Dutch investment manager performance has largely been disappointing since the market falls from 2000. The move from balanced mandates to more specialist mandates is a quest for control but once shifted pension funds themselves have to organise monitoring of the managers,” he says.
In 2003, for example, the Pensioen Stichting Transport pension fund gave about half its assets in a €280m balanced mandate to Aegon Asset Management from F&C reportedly to spread risk and after concerns about performance. Anecdotally, such manager turnover in the last few years shows the degree of relative
unhappiness.
A survey in 2001 showed that less than half of Dutch pension funds had changed even one fund manager in more than six years. The report by Vrije University in Amsterdam - in association with Russell - says this was due to a lack of time and experience and the majority of small - to mid-size Dutch pension plans are happy to leave investment strategy decisions to their external managers.
Cras says that over the next two or three years, 50-70% of total pension fund assets is expected to go either to banks with specialist asset classes or to balanced mandates in a specialist way, such as by using a wider range of asset classes, eg property or hedge funds and private equity. Smaller pension schemes remain attracted to the idea of balanced management – whether provided from the existing fund managers or from those selling related concepts, such as multi-management, because they have specific needs, particularly resulting from a lack of resources when compared to most larger pension funds. “They want a balance portfolio and to deal with a firm in their own language and one that can help with the intensity of reporting and dealing with the regulator,”Cras says.
To take account of the shift, balanced managers have bought a multi-management business. Last year Aegon acquired TPG KPN, Gronigen, which runs the Netherlands' telecom and postal services groups pension plans and has a multi-manager business.
Hans Braker, director at Aon Consulting, says one factor mitigating against changing from a balanced mandate was the cost, especially as future returns are unpredictable in any investment style. He says the cost of moving from a balanced mandate was often between 40 and 50 basis points, although less if the change was to a more passive fund management style. “Small pension funds have been disappointed by Dutch insurers’ investment returns because of their growth equity style. So pension funds are looking at specialist styles rather than a balanced mandate but by doing so they have to face up to requirements of the proposed FTK and IAS19 rules [that are more onerous than current standards and effectively penalise performance_volatility]. Smaller in-house managed pension funds, therefore, are considering going the other way and moving to insurance or balanced mandates.”
He says there was also a trend to invest in alternative investments to try and provide stability and diversification. But this increase in alternatives, such as real estate, private equity, commodities and hedge funds, are coming from the fixed income part of the portfolio rather than from equities. This is because of the shift in the interest rate cycle, meaning rates are expected to increase and bonds likely to underperform in the short-term. Balanced managers have traditionally focused on actively managing equities to provide returns, while bonds have been passively managed. But the fall in the equity markets exposed them to relative underperformance and Dutch managers have responded by building up their fixed income desk to generate alpha, or positive risk-adjusted returns.
Hans Benenga, head of institutional sales at Deutsche Asset Management in Amsterdam, agrees that looking longer-term smaller pension funds are trying to move more into bonds and other asset classes, although short-term concerns about rising interest rates are delaying the change. “There is a duration mis-match in assets versus liabilities. The duration of the assets is normally around five years but the liabilities often have a duration of 15 to 17 years. Pension funds are looking for ways to close this gap, for instance by using an overlay programme. Timing of this duration trade can be important as an increase in interest rates would mean the market value of liabilities drops so funding levels would automatically rise.”
Benenga says that to try and
boost returns on the asset side, investors are moving away from traditional balanced mandates, where equities play a dominant role, to new balanced structures that use different asset classes
and investment types. But only a small number of very large fund managers are able to offer ‘new’
balanced services covering hedge funds, quantitative investments, commodities or an tactical asset allocation overlay program. He admits that ‘new’ balanced managers were facing challenges in
trying to best in breed in all
areas. “Sometimes we use outside solutions.”
Maria Ryan, client adviser for Dutch institutional clients at JP Morgan Fleming Asset Management, says smaller pension funds are continuing to shift from balanced to specialist managers but are slower to move into hedge funds and private equity, even though global equity returns were expected to be lower.
This would follow the pattern also seen in the UK where 25% of funds are now balanced as opposed to 60% three years ago, a shift accelerated by the downturn.
But the picture in the Netherlands is less clear-cut. As a result, although balanced mandates might be less popular after recent underperformance, pension funds like the concept of a one-stop shop promising diversification and good returns, and so appear to be looking for a variation on that theme, whether it is called ‘new’ balanced, risk and portfolio management consultancy or multi-management.

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