NETHELANDS - Dutch pension funds lack sufficiently detailed guidelines governing their alternative asset portfolios and should examine the cost/return ratio of investments, regulator De Nederlandsche Bank (DNB) has said.

Publishing the results of research undertaken last year, the DNB also noted that investment managers overseeing hedge funds, infrastructure and other alternatives were not always subject to regular performance reviews, nor was the risk of investment always independently assessed.

The letter, signed by head of pension fund and investment company supervision Olaf Sleijpen, broke down the findings into four categories - investment, manager selection, monitoring and governance - with returns from alternatives specifically highlighted.

"The cost structures of alternative investments are not always in proportion to the added value of the asset class views," he said.

"The DNB has seen that this can lead to diversification benefits being overestimated and management and specific risk characteristics, such as tail and liquidity risks, being underestimated."

However, Sleijpen also stressed that the selection procedure used by some schemes when selecting managers was insufficient and risked exposing funds to risks greater than agreed on in advance. 

The DNB added that a formalised and predetermined selection process was "integral", as it would help disqualify investment strategies that were outside previously agreed risk parameters.

The regulator said due diligence for the acquisition of illiquid assets was particularly important, examining performance, strategy and the financial, operational and legal risk of any assets.

It said the process was more involved than asking a few critical questions and suggested site visits should be undertaken to understand an asset's governance structure and risk management procedures.

Outlining its proposals for best practice, the DNB recommended that investment committees outline their targets annually, followed by an examination of how many targets were met the following year.

It concluded by asking schemes a number of questions on whether there were formal processes for due diligence, as well as whether the depth of each review varied depending on the asset being acquired.

The regulator added that it hoped the letter would promote good practice, especially in light of the rise of alternative assets within portfolios.