All compulsory industry-wide pension funds in the Netherlands have ‘passed’ the first performance test of the Z-score system introduced in 1998. The results were published last month by the Asociation of Industry-wide Pension Fund (VB) and the Company Pension Fund Organisation (OPF)
Under the Z-scores system pension fund boards have to specify a standard portfolio prior to each new investment year, taking into account the risk the board is able and willing to accept. Once the asset allocation is decided the board has to choose an index reflecting a similar allocation of assets. At the end of each year the results of the standard portfolio and the specific benchmark are compared.
“Under the Z-score regime pension funds have to set their own investment portfolio in advance, deciding the asset mix and the indices they are going to compared themselves with,” says Frans Prins, director at VB in The Hague. “They are a comparison between what you thought you were going to get and what you finally achieved.”
The system was designed to be used as a tool for rating investment returns of the compulsory industry-wide schemes. The performance test is the result of successive annual z-scores divided by the root of the number of years taking into account. The results published in April were taking over a 3.7 year rolling period and show that most of the funds improved the performance of the standard portfolio.
Since they were introduced, the role of Z-scores in the market has been extensively debated. There are concerns regarding the system’s precision, effectiveness and its rational validity as a tool. “Only a few weeks ago we wrote a letter to the minister of social affairs regarding our view on the system and its effects in the market,” says Prins. “We are not opposed to this system but we think the way it works should be improved.”
The first point the association is worried about is that the Z-scores are promoting passive management among pension funds. “The system is pushing investors towards indexation instead active manager. Our experience says that when you follow an index you can’t go wrong, but you might get results that are worse than those you could have achieved investing actively. Funds in a negative Z-score zone will tend to go more passive and I don’t think this is the best solution for some of our members. The Z-score formula is based is based on market conditions from 1992 to 1996,” Prins explains. “We would like the minister to adapt the formula to current market conditions.”
“And finally we also think the testing period is too short,” he says. According to VB, the performance test as it now stands presents and excessively high statistical risk of ‘unwarranted failure’. The next assesment period will be 4.7 years and from then on the test will be conducted over five-year periods. Under the system, those funds whose test result is lower than –1.28 will be granted exemption from mandatory membership on request.

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