The performance measurement legislation just passed by the Dutch government applies only to industry-wide pension funds: funds that are the only pension provider for employers within an industry.
This will put them in a league closer to company pension funds like Unilever, Philips or Shell, who are forced by corporate sponsors to add maximum value. A recent example is Unilever's planned funneling back of pension fund surpluses into the corporation's bottom line of $175m a year for at least the next five years.
If an industry wide pension fund's total five-year performance does not pass the test, employers can 'opt-out' of the pension fund, introducing competition for money managers and insurance companies.
The system does not look at total returns, since differences in total return are primarily due to differences in investment policy.
Instead, returns are looked at relative to policy return; how the fund would have performed had it invested passively in its strategic policy weights and selected benchmarks.
This is meaningful information, allowing funds with very different liability structures to be measured in a comparable way. On top of this, the measurement system also considers costs of managing and overseeing the pension fund's investments.
Each year a fund must supply their strategic asset mix and benchmarks, which are subject to review by an independent panel. At the end of five years, a statistical calculation will be made determining whether or not a fund's cost and performance relative to their policy is within the 'passing range'.
If a fund falls below this point, employers have the opportunity to take their pension money elsewhere.
The comprehensiveness of the measurement system signals the future for the Dutch pension fund industry: Total return comparisons are a thing of the past. The test, while posing a minimal but visible threat for industry wide pension funds is supported by the industry's leading professionals.
The measurement system also functions to introduce some guidelines similar to those governing pension funds in the US.
Whether a fiduciary is managing the fund in a prudent manner will be determined by the funds five-year performance results and by the suitability of their strategic policyand benchmarking selections. The test will likely lead to an increase in passive management style, which has low implementation risk and is low cost.
If funds follow such a route, it is very likely that we will see a failure rate of 0%. While this will not change the pension fund managers within the industry, it will likely introduce a positive effect on industry wide pension fund Value Added (actual return minus policy return) performance. The measurement system's introduction is also likely to affect the corporate pension fund industry, as governing fiduciaries will want to measure corporate fund performance against the same guidelines.
The measurement system was introduced retroactively, taking place from January 1998. For the first year, actual holdings will be used as a proxy for strategic policy weights. In future years, however, it is stipulated that policy weights and benchmarks must be determined at the beginning of each year.
Overall, the measurement system functions to take the Dutch pension fund community, already highly sophisticated, a step further ahead. Not only does it insure 'apples to apples' comparisons for industry wide pension funds, it holds a threat for under-performing industry wide funds.
Beneficial are the smaller Dutch companies whose pension funds have been pooled to share actuarial risk. They are now ensured that there is also pressure to deliver a good return on their investments.
Jane Amachtsheer is with Hall/CEM in Amsterdam