New framework may change Dutch funds’ asset mix

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NETHERLANDS - The new supervisory framework for Dutch pension funds and insurers may lead to a move out of equities and into bonds, experts have suggested – though the government doesn’t plan to change its bond issuance strategy.

The Financieel Toetsingskader, or FTK, will be discussed in the Dutch Parliament next year. It is part of the country’s new Pensions Act, which will come into force in 2006.

One of the most fundamental changes is that the liabilities of Dutch pension funds will be valued on a mark-to-market basis.

“Under the standard model, cover ratios should not exceed 130% to cover the unconditional liabilities. This is new and gives a bias for funds to move more into fixed income,” writes John Maskell, an analyst with Barclays Capital in London, in a research note.

Last week, the Dutch government sent out a consultative document on the FTK to pension funds and actuarial firms.

According to Maskell, small funds holding less than 25% in equities are exempt from the FTK if they so wish.

Roland van Gaalen, a partner at Watson Wyatt Brans & Co in Amsterdam, says the new framework will lead to more demand from pension funds for index-linked bonds.

“Index-linked bonds have been issued in other European countries like France and Sweden for years. The UK and US governments have also used them for a long time. The Netherlands, however, have never issued one.”

Van Gaalen is calling for the Dutch Ministry of Finance to issue index-linked bonds, preferably linked to the European Harmonised Index of Consumer Prices (HICP). But he warns there might be “distortion in the market”.

“Dutch pension funds have hundreds of billions of euros in long-term liabilities. If they switch en masse to long-term bonds, that could lead to capacity problems in the market. The IMF also recently warned against that,” Van Gaalen says.

Van Gaalen’s comment echo those made by fixed income analyst Jitzes Noorman of Rabobank in a recent research note. Noorman says the new framework will lead to Dutch pension funds moving “out of equities into bonds”, particularly into long-maturity bonds and into inflation-linked bonds.

He argues the new framework will have “major consequences” for investment policies and liability management of pension funds. With interest rate risk being much higher at the liability side, Dutch pension funds will have to “raise the interest rate sensitivity of their assets”. Hence, the shift from equities into long-term bonds.

In addition, Noorman points out the search for diversification could also lead to increased demand for alternative investments, such as property, private equity or hedge funds.

A spokesman for the Dutch State Treasury Agency said that the agency would not be altering its issuing strategy in response to the new framework.

He said the agency has a very clear mandate from the finance ministry – “to issue at the lowest cost”. He added that issuing 30-year bonds – a regular request from institutional investors - was not on the agenda as it is more expensive and not as liquid. “It doesn’t fit our risk profile,” he said. “We want our bonds to be liquid.”

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