Dutch stick by their guns
Pension funds in the Netherlands are reviewing their position. Both the investment and liabilities sides of this very developed market are under scrutiny after a prolonged period of disappointing investment returns and diminishing pension reserves.
A model to follow for other European countries when it comes to pension provision, the Dutch market is now debating the sustainability of its system and even though, so far, it has passed the test, it seems some changes are needed to guarantee the future health of the industry.
According to figures released last month by the Association of Industry-wide Pension Funds (VB) and the Company Pension Fund Organisation (OPF) the average return for Dutch pension funds during 2001 was –2.8%, compared to average returns of 10% over the past decade. Although this figure has not translated into panic among institutional investors, it is giving them good reason to reconsider they way they operate.
“A number of company and industry-wide pension funds paid back a substantial part of their free reserves of the last couple of years and/or granted contribution holidays,” says Ronald Nagel, senior vice president and head of institutional services at ABN Amro Asset Management in Amsterdam. ABN Amro manages E17bn for Dutch institutions. “This added to the disappointing absolute and relative performance of the investment portfolios has resulted in critical reserve positions for some pension funds.”
In just over a year, the average of the reserves as a percentage of the liabilities has dropped from around 140% to 120%. “This means that if the average is 120% there must be quite a few pension funds that are below or close to 100%,” Nagel adds. “Pension funds also had to correct their liabilities taking into account the higher rate of inflation. As a result of all this, approximately 10% of the Dutch pension funds were not able to index their liabilities to the usual extent and this came as a shock for both the pension fund industry and politicians in the Netherlands.”
At Fortis Investment Management in Utrecht, CEO FIM NL Jan Lodewijk Roebroek agrees: “Pension funds here are reviewing their investment strategies and asset allocation. On the other hand they are considering adjustments on the liability side.” He adds: “For those pension funds with reserves problems, reconsidering their approach to equities will be top on their agenda.” Fortis manages E14bn for Dutch institutional investors.
However, and despite underperformance there has been no significant move away from equities and, on average, the exposure to stocks among Dutch institutions has even increased during the last year. According to the VB/OPF figures, 41% of the pension funds total assets were invested in equities at the end of 2000 and 44% at the end of 2001, returning an overall of –14.75%.
“The trend towards investing more in equities is still going on even after September 11,” says Frans Prins, director at VB in The Hague. “You could expect pension funds to shift assets from equities into bonds but the reality is that they stick to their long-term policy maintaining and, in same cases, increasing their exposure to stocks.” VB represents 82 industry-wide pension funds with a total of 4m participants and around 1.5m retirees. The total assets under management by these funds amount to more than E300bn.
The Dutch market has always been one of the most attractive playgrounds for international asset management houses trying to find their place among the big and strong local players. Their market share has increased, but the specific requirements of Dutch investors still allows domestic names to control the game. Although big in terms of assets, the concentration of the market makes it very difficult for foreigners and smaller local houses to grow. Firms like Robeco, ABN Amro, ING or Fortis, and the big funds such as PGGM, ABP or BPF dominate the market.
“In talking about the size of the market, it is necessary to distinguish between assets under management and assets that are actually available for external managers,” says Martijn Hoogendijk, director at Merrill Lynch Investment Managers (MLIM) in Amsterdam, which manages around E1.5bn institutional assets in the Netherlands. “So in terms of assets, the market is huge, but when you think that the top 10 pension funds with assets making up more than half of the Dutch market only outsource a limited proportion of their investments, you realise the market for us is not that big. Furthermore, the larger funds tend to outsource mainly specialist mandates which they prefer not to handle themselves.” He adds: “However, we do notice smaller and mid-sized funds outsourcing more to internatational asset managers, instead of just local players, which is quite promising.”
“In this market there are a few players that are extremely big, and the assets available for other providers are quite limited,” says Michel Ho, director of Benelux business development at Dresdner RCM Global Investors in Badhoevedorp. “However the particular current market conditions could help us gain ground. The market is now more focused on specialist products and alternative investments, and we have a very strong position to cater for this segment. At the same time we are able to offer our combined specialist products and those from Pimco within a balanced product, an area which is basically dominated by the local players.If you take out the top 50 funds, the rest are mainly invested in balanced products although the low fee structures in place at the moment also makes things more difficult for international houses.”
Fortis’ Roebroek comments: “Balanced mandates are still very important in the Netherlands and this will not change overnight. Even though the core-satellite approach to investments is gaining interest among pension funds, this applies specifically to the higher end of the mid-segment. But of course, the size that a pension fund will need to be to access these specialist products is diminishing and in the future specialist mandates will be part of much more institutional portfolios.”
As indexation and enhanced structures are becoming more popular; Anglo-Saxon names like BGI and State Street have seen their business grow significantly. “Passive asset management has been a very important element in some institutional portfolios for some time and this has helped firms like ours to enter this market,” says Marko van Bergen, head of Benelux institutional business at BGI in Amsterdam. “Also now there is an interesting trend towards low-risk active structures, with risk up to 2%, and we are well positioned in this area.”
Another obstacle for foreign houses is the trend among some of the big funds to offer third party services to other institutional investors. “If you look at their track records you will see they are sufficiently prepared to do this,” says VB’s Prins. “I don’t see any reason why they shouldn’t offer their services to outsiders and I believe they have a fair chance to see their business grow. For small and medium size pension funds it is going to be very attractive to work with them, because they are part of the pensions world and have a very good reputation.”
Being experts in this field, the fact that some funds want to share this expertise with others is quite a natural development and, it seems, is not being considered as a major threat among fund managers. “These funds will face the same problems we are facing because they don’t have the distribution networks the local asset managers have,” says van Bergen. “Whether they are going to be successful or not remains to be seen but it will depend on the type of services they are planning to provide. If they are thinking of running a full asset management operation it is going to be very tough for them because investors will always have a choice of global providers like ourselves.”
But some, like Mn Services, have expressed interest in acting as multi-managers, and in this case their presence in the market could benefit fund managers both local and international. “As providers of multi-manager structures, these funds would look at the market to find the best managers and this is already one of their strengths. So more than competitors we see them as potential clients,” says ABN Amro’s Nagel.
Another important trend in the market is coming directly from the boards of the pension funds themselves. Under pressure due to underperformance and problems on the liabilities side, the boards are keen to increase both the quality and integrity of pension funds in the Netherlands. Cost and accountability are now more important than ever and keeping a close eyes on the managers is crucial. “Some pension fund boards want to change the way pension funds operate on both the investment and administrative side and they are planning to set up small offices with only one goal: to manage the managers,” says Prins. “If you don’t manage the managers you can end up paying too high fees and obtaining disappointing results. This is a very significant development in this market where pensions are a very important instrument during discussions between the social partners.”
As pension funds review their portfolios and follow their managers moves more closely, risk budgeting becomes crucial. At this point in time, investors are not that keen in trying new products but are instead focused on managing the risk of their existent portfolios. Because of this, exposure to alternative investments is not expected to grow in the months to come.
“There is a lot to be clarified before alternative investments become a significant part of the total pension fund assets in the Netherlands,” says Dresdner’s Ho. “The big players are already investing in hedge funds and private equity, but as far as we can see it is still quite limited.” He adds: “Pension funds need more information about practical things like for instance how to value private equity, how to control the risk within these products and, especially important, how they can report this to the supervisory authorities. All this is limiting investors’ interest in alternatives.”
At VB, Prins adds: “At this time, people like to stick to more familiar instruments. The interest is there and in practice the trend towards alternatives is growing, but it is not a booming market.”
Inflation-linked products are also becoming more popular. “We see more pension funds taking into account the impact of inflation on their liabilities and deciding the asset allocation accordingly,” says BGI’s van Bergen. “Specialist products like inflation-linked bonds are attracting interest from investors.”
As well as reducing risk, investors are also focused on reducing costs. Management fees have always been important in the Netherlands but now even more so.
“For the social partners it is very important to get the best fee possible, but we don’t want pension funds to focus only on fees because this means looking at the short term too much,” says VB’s Prins.
At ABN Amro, Nagel comments: “What is crucial is to improve transparency in the fee structure. Local player’s fees are relatively low, mainly because of historical reasons as most of them are linked to banks and used to receive their revenue from other routes. We were one of the first to abandon this principle some years ago and we don’t have any hidden revenue. What clients pay is what they see, because transparency is the key.”
As one of the largest pension markets, the discussions regarding socially responsible investments (SRI) going on all across Europe are also taking place in the Netherlands. Once again this issue has been debated between the social partners and although the interest among Dutch investors is still less explicit than that of some of their European counterparts, the commitment of the Dutch market to look at these issues is already a reality.
“A few years ago, the unions asked their representatives on the board of the pension funds to take into account SRI criteria and this has become an important debate,” says Peter Budde, director of institutional relations at Kempen Capital Management in Amsterdam. “The fact that funds like PGGM have taken a quite strong position on this and that many other investors are looking into it, is increasing the interest among investors.” Kempen, which specialises in small caps and real estate securities and manages around E6bn for institutional investors, is launching a product investing in European small caps following SRI criteria. “Because we expect strong client demand for these products.”
At VB Prins agrees: “Certainly this is something we are discussing and we will have to make decisions about it. Obviously the responsibility of the pension funds is to achieve the best return they can, but more and more both employers and employees take the view that sustainable investment and good corporate governance can add value.”
The months to come are expected to be busy. Pension funds have reconsidered their strategies and hopefully some of their decisions will be put into practice soon. The first results of the Z-scores (see page 31) have just been published and a new rolling period starts. The general opinion in the industry is that the system that has been successful for years will remain strong, as long as some changes are made.
“In my opinion one of the the big problems in the Dutch market is the portability of pensions entitlements,” says Kempen’s Budde. “Things would be much easier if we had a hybrid defined contribution (DC) system adapted to the specific requirements of this market. There is a lot of debate at the moment on this and I expect there will be more room for DC in the future.”
For Prins at VB, the well-developed three-pillar system in the Netherlands should be maintained as it is but there should be a reviewing the communication lines between the second and the third pillar. “We try to provide the best complementary pensions and also give individuals the option of a third pillar on top of that. It is a mixed system and this is why it is successful.”
He adds: “ But we cannot forget that we are working for a collective system which is based on an amount of solidarity and not to provide personal plans for individuals. Insurance companies would like a larger market share of the second pillar and there is now a lot of discussion regarding dividing lines between the pillars.
“On the other hand as far as investment is concerned we will always be in favour of freedom because our experience says that this way you get the best results.”