PMI is the principal pension arrangement in the Netherlands for employees in the metal and electro technical industry, covering firms working in areas as diverse as chip machinery producers, shipyards and motor repair shops with over 30 employees – the ‘heavy metal’ part of the industry. It is one of the country’s 82 industry-wide pension funds and in all it embraces 1,500 employers.
In membership terms, active members total 160,000, while pensioners number 120,000 and there are future pensions to be administered for 400,000 deferreds. Its asset base is E12.5bn, which for years gave it the dubious distinction of being the largest fully outsourced Dutch pension arrangement.
In May 2001, Roland van den Brink was appointed managing director of PMI. Formely, he held a management position with Mn Services, which lookes after the Metalworkers pension fund (BPMT), and before he was trainee at Shell pension fund. “Before I arrived, the board had been active in some ‘think tank’ discussions about what they should be doing. Their conclusion was that ‘policy’ was their role, but everything else should be outsourced. The fund would be run from a small office, but the structure would be a modern one, where the directors are responsible for day-to-day operations and opt out if things go below pre-set standards,” he says. “My first and most important assignment was to initiate and manage the complete turnaround of the pension fund. On the investment side, the board gave me as target in 2002 to add 30bps after costs.”
When he took up the reins there was a long-standing contract with PVF Achmea which controlled the pensions administration and virtually all of the investment activities since this was done through a global balanced mandate. “The old contract stated that the insurer should do its best, both on the administration and the investment side,” says van den Brink. “The feeling was that things had to change to a more business-like approach.”
In July, PVF Achmea was prepared to sign a letter of intent on changes. “By December 7 we had new contracts for the pensions administration. A lot of measurable criteria had been included, with, for example, around 50 performance targets that the administrator will be measured against. These covered matters as response time, picking up the telephone or responding to a member’s query.”
On the investment side, the situation was simple, says van den Brink: “Everything had been done by PVF Achmea - from the investment policy to the balanced mandate and reporting. Best practice tells you that you should carry out policy and control independent of execution.” He claims that the whole philosophy of moving to an independent custodian and specialised mandates came out in a relatively short period of time. But the challenge was to implement such sweeping changes in only a matter of months.
“It was done by having a lot of parallel projects, which were managed by Ger Goris, an interim manager with broad international experience. The whole set up was tuned to the beginning of 2002, with January being the month for the transition from the old portfolio to the new portfolio of 17 specialised mandates.” An independent consultant, Philip Menco was also used, who helped define and implement the new investment policy and select new managers. He adds:
“There was a lot of knowledge out there available and colleagues were very helpful. So we could build on their findings – we did not have to reinvent the wheel. That gave a huge impulse to the whole system. This enabled us to move fast, although each step was done according to the rules of a decent selection process.”
Why so many segments? “The aim was to segment the managers in the same way as the benchmark portfolio. We cleaned up the ‘Christmas-tree’-like benchmark portfolio – industry schemes have to have benchmark portfolios – and the result was a relatively simple benchmark portfolio. The mandates are structured according to the benchmark portfolio,” he says.
“So our asset managers are our benchmark more or less. That makes operations far more simple than they were.”
The whole set-up for the investment policy was changed. For instance, the investment risk (volatility) of the benchmark portfolio was brought in line with the outcome of the existing ALM-study.
On the risk analysis side, it was a question of looking at the benchmark portfolio, using London-based Quantec, one of the last independent risk analysis firms not tied in with an investment group. “Quantec did a risk analysis on the benchmark portfolio and did comparisons between the old and the new one. This gave PMI a relatively powerful tool to convince the board of trustees of the direction they should take – based on a sound quantitative analysis.”
London-based F&C Management obtained 12 of the mandates. As part of the Eureko arrangement, it meant keeping the business within the same grouping as Achmea. “I reckoned they would be pleased to have a direct approach from a client rather than indirect via PVF. So in F&C we found a party that was willing and able to help us achieve our plans”
But one concession was made; the fund decided to take the products that were ready-made. “Sometimes pension funds will accept them but only with some changes and tailored to their circumstances. We knew if we would go down that route it would take a while, so we decided for off the shelf products.” Having 12 mandates with one manager meant the products would be more cohesive, he agrees, including from the administration side, rather than going out and buying from 12 different managers.
For the US component, North American managers were chosen, with State Street and Merrill Lynch both taken on for enhanced indexing on the equity side, while Vanguard covers the bond investments. “A remarkable fact is that though everyone is talking about enhanced indexing, we realised that our mandates in this area were among the largest issued.” The decision to include Merrill was not just because their approach was different. “To put all your money with one manager is committing too much money to them. As we were already one of the largest participants in State Street’s enhanced index product, we split this.”
Van den Brink says in making the changes, the fund may have been swift, but it was also thorough. “The change was implemented without skipping any necessary steps – even for the index managers we had the cycle of selection with a long and short list and final choice. We did not skip anything – but we did move fast. And last, but not least, the overall costs are about the same as with the old arrangement.”
When it came to the transition to the new portfolios and managers, this was taking place against a background of market outlook. The PMI board decided – in line with the existing ALM policy - to reduce its 40% exposure to equities to 35%, primarily due to the changed overall buffer during the year from 129% at the end of 2000 to 113% at the close of last year. So should an equally bad year occur during 2002, there could be a risk of a shortfall. Deutsche Bank (DB) was appointed transition manager. “When we did a selection process, we saw that between the top transition firms there was no significant difference. So we selected an independent bank instead of an asset manager with a large crossing network.”
Things had to be worked out carefully with DB for the transition, particularly in view of the market conditions. “We decided to implement the reduction of 5% of the equity content. As we had no views on the markets, we worked with DB to put this into effect straightaway since we did not want to be overweight in equities.” This was done on January 4, with the balance of the transition on January 22 and 23.
“In the aftermath we analysed the equity trades using the Plexus service, an American consultant specialised in this type of analysis. It was a fair job and from an optimal transition to the one we did, there was a small difference. The market conditions were not optimal on January 4. The market took off for a period at the middle of the day, then it behaved poorly as it went straight down!” He rules out the concept of being unlucky in the day: “What’s lucky?” From a benchmark viewpoint in January, the timing was perfect, he maintains. On the transition side, as the fund was moving from a balanced to specialised mandates, most of the assets had to be changed. “A lot of things had to go.” In total it was a E2.9bn transition.
There has been increasing recognition among Dutch pension funds not only about the dollar risk that comes as a result of a direct exposure to the dollar, but also the implicit dollar exposure can be high. For example, the profits of Ahold come from the US and not The Netherlands. Analysis by Quantec support this. “As we decided to move from a partially hedged portfolio to fully hedged dollar and yen positions, we needed a currency manager who could passively implement hedging strategies. DB could help us here too as they were selected among three competitors. For the hedge we needed, we came into the market on January 2 for about E2bn. Unfortunate, the euro was relatively strong that day. But without a well thought over opinion on the market, one should just implement the long term policy.”
Custody was another area, where van den Brink was able to tap into his network of contacts, since a number of funds had been through the exercise or reviewing their custodian. “The selection was done carefully and took us three months to finalise. Our new custodian Northern Trust takes over from Citibank, the custodian of Achmea in Amsterdam. This process is to be finalised by April 2, when NT is up and running.”
Looking ahead, he says: “We are currently performing a new asset liability management study as from the beginning of next year the pension scheme will change into a more flexible scheme, where members can opt for early retirement, for example from age 62 as against 65 currently. This will change the liability structure of the funds considerably, so the question is whether our 2002 asset mix is still appropriate.”
Before the summer, the intention is to consider starting a tactical asset allocation programme, he says. “But immediately my concern is to get administration and management information in a basic way to where we want it to be. You need this before you go the TAA route”.
Personally, Van den Brink thinks that we are moving into an era of single digit returns for pension funds. “This means that the simple strategy of ‘more equity equals more return’ is over.” Managing absolute risk will become much more important, which will involve looking at the non-traditional investment areas such as alternatives, commodities, below investment grade bonds and inflation-linked contracts. “By diversifying, you can lower the absolute risk of the fund and this risk reduction can be used for more traditional, but interesting investments.” He also sees that timing of these strategies will become increasingly important. Just the sort of issues, the ALM study may help to throw some light on.