Pooled funds with everything
By most measurements the Dutch pension fund market is the largest in continental Europe, and a highly desirable target for institutional fund managers. Domestic investment houses are the main providers of fund management services, but foreign groups continue to see success in the market. In March, Legal & General Investment Management won an equity index mandate for the pension fund of Dutch telephone directory company Gouden Gids.
A comment from H Arnoldus, chairman of the Gouden Gids pension board, sums up current themes in the minds of Dutch institutional investors: “As a result of the uncertainties of the market over the last few years, and the increasing requirements and regulations of the pensions and insurance supervisory authority of the Netherlands (PVK), (we have) decided to spread the risk of the fund in a different way. This … is in the interest of members and to ensure future pension liabilities are met.”
The funds most widely used by pension fund investors are the ‘fondsen voor gemene rekening’, or pooled funds, which are a legal entity specially designed for institutional investors. There are hundreds of them on offer. They carry no capital tax implications and pension funds can reclaim dividend withholding tax. They actually have an advantage over segregated accounts in that the annual management charge is free of VAT.
“Today it is quite common to put these funds forward in discussion with clients”, says Hewitt Netherlands practice leader, Dick van den Oever. Though they have been around for many years, pooled funds saw a revival about five years ago. Van den Oever says that pension funds are tending to move away from segregated portfolios and more towards the fund providers. “Funds are efficient. With a segregated account you have the cost of the custodian, reporting and so on. With a fund, there is no separate custodian needed – it is already built in.”
Funds have more appeal for the medium and smaller institutional investor because they offer access to world class expertise for smaller amounts of money and prove to be more cost effective. With a E2.5m investment, the minimum charge on equity funds would be around 0.7%, or 0.4 % on fixed interest. Some funds have a front-end fee, and there is usually an exit fee. Robeco says it only charges an exit fee which goes back into the fund to compensate ongoing investors, the manager’s remuneration being limited to the annual management charge.
For van den Oever charging levels are an issue. “Fund managers say the client is getting in depth reporting. They try to leverage the situation with more information. But we don’t really care about a daily NAV on our screens. So fees are not as low as I would like.”
The nature of a pension fund’s mandate is also relevant. Highly specific mandates tend to limit an institution’s ability to use funds. “The mandate might specify tracking error, credit ratings, use of options … if the parameters specified in the mandate are different from those in the fund, the fund can’t be used unless the pension board changes its profile,” says van den Oever.
Obbe Kok, managing director for institutional clients at ING, agrees. His expectation of a couple of years ago was that segregated business would grow compared to funds, but in practice the reverse has been the case. The reason, he says, is that: “More and more pension funds are stepping away from very specific customised mandate restrictions. They are realising that they can adjust their own mandate restrictions to those of the pooled fund.”
Roel Knol, executive vice-president for Institutional business development at Robeco, feels that sentiment towards the use of funds rather than discretionary management of assets has changed. “Ten years ago most institutions thought if they chose discretionary management they would get more attention and a better price. This is not true. Especially with performance standards like GIPs, you cannot have a big deviation. All portfolios with the same mandate are treated in the same way, whether discretionary or funds.”
The main concerns driving the Dutch institutional fund industry at present, says Kok, are a need for greater diversity in the portfolio. This does not simply mean a move away from equities and towards fixed interest. “That would mean accepting a lower return on assets, and pension funds can’t have that,” he says. The move towards greater diversity means looking at alternatives such as hedge funds and private equity. For medium to small funds it may mean looking at style diversity within the portfolio. And where fixed interest is concerned, it means a search for greater spread, with a growing appetite for credit and high yield assets.
The desire to hedge foreign currency exposure is also promoting the use of funds, says Robert Rijlaarsdam, general manager of the WM Company in the Netherlands.
In moving towards these different asset classes, says Kok of ING, funds “want to optimise risk/return. They need to develop an asset allocation model better than ALM (asset/liability management), which is OK for the equity/bond split, but not for when you have 10 different asset classes.” ING, he says, is currently trying to develop a more qualitative model.
A spectre overhanging the Dutch industry is the discussion round the fair valuation of liabilities. From January 2006 a change in legislation will mean that pension fund liabilities will be discounted at market rates as opposed to the current standard 4% rate. This “will have a dramatic effect on the volatility of liabilities of pension funds,” says Amin Mansour, managing director of consultants Fund Partners. Pension fund boards, he says, “are yield hungry and are looking for non-correlated exposure. They are looking at how they can protect against volatility on the liabilities side – it’s a very challenging theme.”
Knol underlines the point: “Reducing volatility is not difficult, but keeping returns is.”
The search for new products to reduce volatility is leading Dutch pension fund boards to consider unfamiliar assets, such as the swap structures now being proposed by the investment banks, and funds of hedge funds. “Large pension funds are holding beauty contests for funds of hedge funds, which has been a rare sight so far.” The introduction of hedge funds will come largely from foreign management houses. “The hedge fund business in the Netherlands is still at an embryonic stage,” says Mansour.
“You might find the perception that foreign providers are better at alternative investments”, says ING’s Kok. He points out that though the group’s alternative business originated in the US, it can provide Dutch-based funds. Given the complexity and uncertainty surrounding expected regulatory changes in the industry, “the advantage for domestic players is that they are perceived better to understand the environment,” says Kok.
The switch from DB to DC schemes in the Dutch market has been slow, and the industry representatives do not expect it to accelerate in the near future. Says Alain Grisay of F&C Management: “DB is still such a huge part of the culture in the Netherlands. I don’t see it disappearing.”
From the provider’s point of view, he adds, it is easier to bid for big mandates than for what is largely a retail product in the DC sector. “DC demands more resources than DB, but offers higher fees. It is not easy to see which of the two is better for the fund manager.”
“The move to DC is supposed to reduce risk for the plan sponsor, but whether it does remains to be seen, as the government may demand capital guarantees to protect the participants,” says Knol.
According to the WM Company’s 2003 survey results, Dutch pension funds achieved growth of 10.7% over the year. Grisay concludes: “The management of Dutch pension schemes is very mature and professional. They take the long-term view rather than panicking when things look bad. This market remains one of the most dynamic and attractive business propositions in Europe.”