Netherlands: In practice
Both the Frijns Committee and the DNB, the Dutch supervisor, have been clear in their assessments: pension funds need to bolster their governance in order to bring asset management and risk management more under control. Mariksa van der Westen and Miranda Schoutsen ask what pension funds are doing to meet these demands
Improving the situation must involve addressing the entire investment chain, according to Dries Nagtegaal, a consultant with Hewitt, who serves as chairman of the board at the Preachers' Pension Fund in his free time. "The objective is to efficiently organise the governance and structure of the investment chain in accordance with the goals and risk appetite of the board in order to put the board in control. That means you need good checks and balances and also to maintain a good grip on the implementation. And that goes for when implementation is outsourced as well."
That is easier said than done. How can you align the entire chain in such a way that the board has control, and an overview, of the investment process?
"First of all, this means a return to transparant processes and comprehensible investment products," says Erik Martens. As director of AHV, the industry-wide pension fund for the agricultural and grocery industries, he has recently seen the fund consciously adopting a new approach. "We are going back to basics and are deliberately choosing investments that we understand and have control over," he explains. AVH is now applying a strict rule when it comes to investments, Martens says. "If the board of trustees is not comfortable with something, we don't do it."
This new approach is leading to some tough choices. "For instance, the fund has decided to stop investing in hedge funds. We participated in a fund with a multi-manager structure, and we felt that gave us too little transparency and too little insight to the counterparties. So we decided to part ways, despite the fact that this category has definitely added value."
AVH would prefer not to participate in investment funds at all in the future. "You can try to determine the rules of play of these investment funds as well as possible, but you can't get a grip on everything. We would prefer to go back to discretionary mandates, where you as a pension fund are the direct owner of the assets."
This is more expensive than participating in an investment fund. "But maybe pension funds should be willing to pay that price. It is the only way to be completely in control of things," Martens says.
The emphasis on governance and transparency is also leading to increasing interest in passive investments. This has been the approach of the Ballast Nedam corporate pension fund for some time, says Lucie Duynstee, director of the pensions bureau: "We want to make the investments as simple and transparent as possible, including for the participants."
Ballast Nedam's pension fund started reassessing its priorities about a year ago. After a number of meetings with the investment committee and an external consultant the board came to the conclusion that things had to change. Investment performance had been disappointing for several years and were falling well short of the benchmark. Duynstee adds: "Considering this, we asked ourselves why we should be incurring extra costs."
The portfolio was split up into two parts: one to match the liabilities and another aiming for some additional return. The greater part of the equity portfolio was shifted into a passively-managed fund. "We first adopted an index and only then did we look for a manager." The pension fund chose a fund from Barclays Global Investors that had the MSCI World All Countries as a benchmark and an allocation of 10% to emerging economies. "We haven't quite decided yet, but we are considering a more passive approach for the fixed-income portfolio as well," says Duynstee.
Another way of keeping control over the investments is to bring part of the asset management in-house. The corporate pension fund of Heineken, the brewer, has organised its investment process in such a way that tactical investment decisions are taken internally instead of being outsourced. "The fund's management functions more or less as an internal fiduciary manager, employed by the board to direct the external asset managers and also to manage part of the portfolio in-house," says Frank de Waardt, the fund's director. Part of the fixed-income portfolio is managed in-house and the fund's management is also responsible for tactical allocation. "And we do that across the entire portfolio," says De Waardt. "If you outsource tactical allocation, then it usually concerns only a small percentage of the portfolio."
According to De Waardt, this approach has the advantage of allowing the board to keep control of implementation via relatively short lines of authority. Furthermore, it leads to much better performance: "By allocating dynamically, we have managed over the years to add some 20% more value than a static allocation would have."
A straight back
But it does makes heavy demands of the board. "You need a board that keeps its back straight. A board that understands that investment decisions can sometimes work against you," says De Waardt. "For example, we got out of Greek and Italian government debt as early as in 2005. We simply felt that the risk wasn't being sufficiently rewarded. It took quite a while for that decision to start paying off."
Boards must have the guts and the common sense to adjust their investment strategy, agrees Nagtegaal's colleague, Jan Willem Siekman. "Pension funds should look at the various parts of the investment process far more frequently and more dynamically, and they should embed this in their organisation, their structures and their processes." It is not enough to follow a fixed recipe that prescribes how to react if the cover ratio rises or falls by a certain number of points. "With all due respect, it won't do to define a glide path and give the rudders a tweak every now and then with the help of a rulebook. You also need to follow the economy carefully and take your decisions on the basis of that. And that's something I see very rarely."
That takes knowledge and expertise: a straight back alone doesn't cut it. Good governance requires that pension funds have sufficient knowledge and expertise ‘in-house'. But not every pension funds has the resources and staff to organise this efficiently. As an alternative, funds can decide to co-operate to realise in-house or ‘semi'-in-house solutions.
An oft-cited example of this is the multi-corporate pension fund, a new form of cooperation on the governance level that allows the boards of various corporate funds to merge without actually merging the pension arrangements themselves.
Industry-wide pension funds, too, are considering joining forces. Erik Martens has an example of this. AVH, of which he was director until this January, decided to spin off its management department as a separate entity. Besides AVH, the new implementation and management organisation has been administering Bpf Dranken, the occupational pension fund for the drinks trade, since 1 January 2010.
"The point is to achieve synergies by working together and sharing costs in terms of office space, staff and administration, and, if you do it well, also in terms of asset management and projects like the Pension Register," explains Martens. "The aim is not to merge the industry-wide schemes - in this sense it is a kind of multi-industry-wide pension fund."
A clear agreement
Although the AVH management office is now independent, it does not have any commercial aims and has no ambition to seek out clients in the marketplace. "It is a kind of joint self-administration," says Martens. "Except I now work according to a service level agreement instead of an employment contract."
This service level agreement sets out very clear agreements and instructions, so the board retains strict control over executions, Martens says.
"For instance, we have a very strict rule at AVH pension fund: an investment proposal is only adopted if the board agrees with it," he says. "If there is just one board member who has doubts, then the procedure is that we get two weeks to make sure that person understands the proposal and is convinced by it. If that doesn't happen, then the proposal is scrapped."
Martens is pleased with this stringent governance. "This is very defensive but I like it," he says. "Perhaps we're old-fashioned, but at least we still have our money."