Dutch funds go scheme-specific route
The phenomenon of peer group comparison as a benchmark to judge an internal or external money manager is, although extremely common within pension funds in the UK, not used in the Netherlands.
In Holland the use of scheme-specific benchmark is widespread. The basis for the strategic asset allocation is usually an ALM study, although with most providers the asset side of the ALM study is limited to the broad asset classes equity and fixed income. So the next step is to formulate a strategic benchmark for these asset classes. Benchmark selection is also becoming more important because fund managers are more and more focused on performance relative to a preassigned benchmark.
In the Netherlands there is a still ongoing shift from a Dutch bias on the equity side to a Euro-zone or a pan- European bias. In the past Dutch equity was a separate component in the customised benchmarks, which now is replaced by a fixed European component of between 50% and 70% of the equity portfolio.
Euro-zone portfolios were favoured in the beginning of the EMU to avoid a more than 35% representation of the UK in the benchmark. Many investors felt unhappy with such a large weight to the UK market. As a result investors experimented with different index weights for the UK in a pan-European index. Customised indices with a GDP weighting in line with Germany and France of the UK component in line with Germany and France were seen as a solution for this problem.
Besides the usually fixed European component in the benchmark, the global part in the portfolio is also often divided in fixed components for North America, Japan, Pacific ex Japan and Emerging Markets. You see money managers struggling with the fact that from an investment point of view they want to use a sector approach of investing, but with the customised benchmark they are given in mandates they have a problem in the different weights of Dutch equity and European equity and the fixed weighting of the other geographic areas.
The most popular and most frequently used equity indices are those of the MSCI (most widely used) and FTSE.
The start of the EMU in 1999 triggered a diversity of new bond indices. Government bond indices as well as credit-indices and composite indices, including both government bonds and credits.
The bond indices of JP Morgan and Salomon Smith Barney were most widely used for the Dutch government bond portfolios. Most pension funds have been shifting to EMU Government Bond indices as the bond portfolios were refocused on the European market.
The inclusion of credits in the portfolios leads to a refocusing on benchmarks. The credit benchmark is often selected on its own merits and certainly not per definition the Composite index of the current index provider (eg Salomon Smith Barney Euro BIG) is used. In case the credit component is benchmarked separately, the credit indices of Merrill Lynch and Lehman Brothers are fighting for the top position.
There is a still growing proportion of passive management in the Dutch pension fund industry. This is also an important aspect for the industry wide pension funds. The urge to perform leads to a more short-term approach and a better focus on benchmarks because the indices in the norm portfolio against which the performance is measured, are derived from the fund’s investment policy. The performance of the norm portfolio is compared with the actual performance to produce the so-called Z-score. The Z-scores were devised to allow companies participating in the compulsory industry-wide pension funds a means to exit in the case of a strong underperformance over a five-year period.
Although index tracking is particular popular among the larger pension funds, now small- and medium sized pension funds showing an increased interest in a passive approach for at least part of their portfolio. More and more funds are embracing a combined strategy ie partly active and partly passive.
For smaller pension funds life insurance companies play a substantial role in the Netherlands. This normally means that the assets are handled in one balance mandate by the insurance company or the asset manager within the group. The selection of indices within the benchmark usually comes down to those picked by the manager.
The larger funds invest in private equity and, with the equity markets struggling and future returns expected to be modest, are focusing on hedge fund strategies. Absolute return benchmarks have come to the fore recently as many hedge funds have an absolute return objective.
The fund of funds strategy of large money managers will make this kind of investments within the scope of smaller pension plans. The sector-wide fund for Dutch healthcare workers PGGM is one of the first large pension funds to include commodities for 4% in the strategic asset allocation. PGGM opted for the Goldman Sachs GSCI index as a benchmark.
With the further globalisation of the investments and with that more risks in the portfolios of pension funds, the focus on selecting an appropriate benchmark increases, as well as the focus on performance measurement and attribution analysis of the performance against the benchmark.
Frans Dooren is head of investment consulting at Aon Consulting in the Netherlands