Living in 'interesting times'
While pension funds elsewhere in Europe are concerned by the vagaries of the equity and bond markets and are focusing on the pros and cons of alternatives, the primary problem for Dutch pension funds is not investment but politics.
“We are not amused by what is happening now in The Hague,” says Bram van Els of PME Metalektro, the pension fund for the mechanical and electrical engineering industries. “The fund changed its pension scheme on 1 January 2003 in line with the requirements of the Witteveenkader provision, which was intended to assist pension funds to make the transition from non-capital-based early retirement schemes to capital-based early retirement schemes.” The Witteveenkader measures foresaw a tax-free pension accrual of 2% per year in final salary schemes and 2.25% per year for career average schemes.
“We adapted to working average rather than final salary in accordance with the then government’s wishes,” says Van Els. “We also restructured the early retirement option from a pay-as-you-go to a solid saving system, and we spent a considerable amount of money and effort on communication and the administration of the new scheme. Then nine months later the government decided that we had to change it again to cut down on the early retirement scheme.”
Van Els notes that the dissatisfaction is not restricted to the pensions fund community. “Our new scheme had been negotiated between the social partners and received the backing of the whole mechanical and electrical engineering sector,” he says. “Now it feels that the government is frustrating its independence to negotiate.”
“Pensions are a long-term investment and you need a long-term policy,” notes Karin Bitter, deputy director of VB, the association of industry-wide pension funds. “The greatest anger is provoked by the feeling that the government is changing its tax policy every two or three years, with the Witteveenkader measures having been brushed aside by newer measures.”
In fact, a raft of other initiatives have also unsettled the usually well-ordered Dutch pensions environment. Earlier this year the VB protested against a minister’s endorsement of the Staatsen Commission’s proposals which, among other things, recommended a cap on a pension fund’s holding in any one investment. Further confusion can be expected from the clash between the European Pensions Directive’s banning of quantitative restrictions on investments and the Staatsen proposal to tighten them.
Other developments include the financial regulatory framework (FTK), which was formulated by the industry supervisor, the PVK, and is due to come into force by the beginning of 2006 as part of a new pensions law. For Philips Pensioen Fonds, the pension fund for the global electronics firm, as for many other funds its announcement in early 2003 added to existing problems. Among other things, it will require a minimal amount of private capital, a level of security of 97.5% to ensure that a pension fund does not become under-funded, and will set a deadline by which pension funds must restore their cover ratio. There will also be requirements on the level of the actuarial interest.
“The main consequences of the FTK will be the introduction of fair value accounting with regard to the liabilities and new funding requirements including buffers which depend on the asset mix of the fund,” notes Gabriel van de Luitgaarden, CFO of Philips Pensioen Fonds. “Those buffer requirements clearly pose an additional constraint on the Philips fund's funding and investment policy. The introduction of the FTK will require every fund to clearly review its liability structure and its investment strategy. Consequently, we are carrying out an ALM study during 2004.”
Freek Vergunst, deputy director of SFB Asset Management, is also concerned. “We used to calculate our liabilities at a stable 4% rate, and the changes will require that we calculate the net value of our liabilities at a market rate,” he says. “And that will make visible what has always been the case, that there is a mismatch between the investments and the liabilities, which in turn will have an impact on the coverage rate. A fixed income solution is the most obvious. But assuming that the average maturity of liabilities is between 15 and 20 years, what type of paper in the cash market, apart from government paper with a 30-year maturity, has an average of 15-20 years? Then, with a normal asset portfolio with a long maturity one must consider whether this is the right time to expand the duration of the portfolio or whether there is a technical reason to postpone it. And this is what we will all focus on over the next six to 12 months.”
Then there is the introduction of international financial reporting standards (IFRS), notably of international accounting standard IAS 19. It had been thought that a Dutch translation of the standard for non-listed companies, known as R J 271, was acceptable but major international accountancy firms signalled that they were not willing to accept it as their home regulators required that they follow IAS 19 in its original form.
“The IAS regulations require contributing companies to carry their pension risk on their balance sheet,” notes PME Metalektro’s Van Els. “But we don’t accept that they have a risk. The apparent risk exactly matches the risk of a defined contribution system, while in fact we are a defined benefit system. The only obligation on our companies is to pay their contributions, and that’s all. If we have a problem, the companies do not have to pay extra and if our coverage ratio is sky high they don’t get any money back. Only the contribution varies, with a maximum of 3% a year. So why put risk on the balance sheet?”
So, Dutch pension funds are living in what the Chinese would describe as interesting times. But what about their performance? According to WM Universe data, the average return on investments for Dutch pension funds in 2003 was 10.7% nominal, 8.4% real, the highest level since 1999. This was based on a recovery of global stockmarkets, which posted a 12.8% return on an annual basis, a 3.5% return on fixed-interest securities and a 7.15 return on real estate, with real estate funds producing 17.5%.
During the year the asset mix of Dutch pension funds saw an increase in equities, to 40% from 36% at the beginning, a fall in fixed-interest securities to 47% from 49% and a slight fall in real estate to 10% from 11%, according to WM Universe.
“Our financial performance was pretty good in 2003,” says PME Metalektro’s Van Els. “We had a total return of 13.3%, in line with our own benchmark and exceeding the WM Universe-reported average Dutch return of about 10.5%. This came after a 2002 return of -4.6%, but we have done better than the WM Universe over a 10-, five-, three- and one-year periods. The result has a lot to do with our asset mix. We have 32% of our portfolio in equities, 10% in direct property, 53% in fixed income and 5% alternatives. The alternatives are commodities.”
Van Els says that the move into commodities was made during 2004 and was marked by a corresponding reduction of PME Metalektro’s equity portfolio. “The shift is not solely motivated by expected returns but also by a desire for diversification, the reducing of risk over the total portfolio,” he clarifies. “Our financial policy is based on our coverage ratio, with the level of risk that we accept depending on coverage. Our eight-quarter moving average coverage ratio had dropped so we had to reduce our risk. But we didn’t want to diminish our expected returns, so a move to commodities was a way of reducing risk while maintaining expected returns.”
Philips Pensioen Fonds also reduced its portfolio’s equity exposure as part of an adjustment to its investment strategy to eliminate short-term risks. “There was a 5% reduction in the strategic equity exposure by at the start of 2003 and some further reduction through the purchase of long put options,” says Van de Luitgaarden. “The board of trustees was concerned with the risk in equity markets, especially during the second quarter.” In the event, the return on the equity portfolio of 17.3% contributed most to the total return on investments of 9.5%, with the return on fixed income investments being 4.3% and on direct real estate of 2.5%. “The return was negatively impacted, by 1%, by the use of derivatives to control market risk on the equity investments,” notes Van de Luitgaarden.
“During the year equity returns came under pressure as a result of the euro’s appreciation against the dollar and the fund runs all currency positions unhedged,” notes Vergunst of SFB Asset Management, which manages both assets and liabilities for Bpf Bouwnijverheid, the industry-wide pension fund for construction workers. “The total return of Bpf Bouwnijverheid in 2003 was 8.1% nominal, with the return from equities being 12.9%, fixed income 4.2% and real estate 7.9%.
“The unpleasant situation is that, while there is definitely an upward trend for interest rates, which is not very comfortable for the fixed income portfolio, recent months have also seen equity markets losing steam. We have been reasonably overweight in equities in the last 12 months. However, Bpf Bouwnijverheid has a very heavy weighting in real estate and this was very helpful for the fund over the last decade and I have a feeling that over the next 12 or 18 months it will again be a very valuable item.”
Marjolein Sol, director of equities at PGGM, the industry-wide scheme for the healthcare sector, notes that the fund was an early convert to alternatives. “In the early 1990s indirect real estate, private equity and emerging markets equities where part of the fund’s assets,” she says. “We had, for example, a structural overweighting of emerging markets equities of 7.5% above the market capitalisation of world equities. In 2000 commodities were added to the mix.” The fund posted a 2003 return of 15% nominal with bonds at 4.7%, equities 23.8%, private equity 3.8%, real estate 8.6% and commodities 23.3%. Based on ALM studies, equities constituted 45.5% of the portfolio, fixed income 30%, real estate 13%,
private equity 7.5% and
“Going forward, we envisage further developments of our investment philosophy, moving away from the traditional parameters and increasing our expertise in hybrid investment vehicles and investment strategies,” says Sol. “However, we will ensure that our focus on the long-term is unchanged.”
According to the PVK, the most important change in Dutch pension funds during 2004 has been a shift from final-salary arrangements to career-average with indexation, with only 10% of total active participants still having a final-salary plan, down from 50% in 2003.
Such a move was one of Philips Pensioen Fonds’ recent highlights, with a new collective labour agreement endorsing the closure of the final pay scheme, which was closed to new members in 1997, and the transfer remaining members to an average pay scheme from the start of 2005.