There’s a whole new world facing the Dutch pension fund market. New coverage ratio requirements, increasing life expectations and an aging workforce are causing pension funds to take a hard look at their pensions strategy. This includes considering ways to decrease future liabilities, by re-examining their investing styles, and considering new contribution minimums and the basis on which benefits are calculated. At a macro level, similar pressures are even forcing consideration of a switch in the national retirement age.
Within the industry, at least one fund has lobbied to allow for the creation of more flexible retirement plans for workers between the ages of 62 and 67, announcing plans to begin calculating benefits based on lifetime average salary instead of the more generous final salary. And, this year, the Netherlands Association of Industrywide Pensionfunds (VB), expects to see a 17% average rise in contributions, as the PVK calls for funds to maintain a higher asset-to-liability ratio.
But understanding the complexities of the Dutch pension fund market requires an in-depth look at its investment performance track record. In Europe’s second-largest pension market, where assets as a percentage of gross domestic product are higher than any other European nation, investment returns and asset allocation strategies illustrate the changing landscape.
After a slow start to 2003 due to weak equity markets, Dutch pension funds had their first gain in three years, returning 10.7%, according to The WM Company.
The analysis of 155 funds, representing more than half the assets in the Dutch pension fund market, found that overall fund returns were driven by the year’s 12.8% gain in equities, the biggest since 1999. Total equity exposure increased over the year from 36% to 40%. Of the available cash flow last year, equities received e6bn and bonds received e3.7bn.
Nationwide, at the end of 2003 pension funds held 47% of assets in bonds, 40% in equities, 10% in real estate and the remainder in cash, currency hedging and private equity investments. (Because the results are meant to be representative of a countrywide approach, allocations for the nation’s two largest funds, Stichting Pensioenfonds ABP and PGGM, which account for about 50% of the market, are not included.)
Despite last year’s upturn in the stockmarket, Dutch pension funds remained weighted toward bonds, which returned 3.5% last year. European fixed income investments – including bonds, private loans and mortgages – attracted 39% of assets, returning 4.9% in 2003. Investments in international bonds had 8% of the assets and posted a 3.3% loss, according to WM.
Still, the drive to optimize returns is forcing Dutch pension funds to make some tough choices about their own asset allocation strategies and appetite for risk. They’ve traveled a long way from the start of 2000, when the average pension fund had about 47% of assets in equities. Today, pension funds are faced with a dilemma about where to invest to get the most appropriate return. Equities remain volatile, but they tend to produce the highest long-term return. Fixed income, while less volatile than equities, is still subject to price uncertainty as interest, yield and inflation expectations vary. The trade-off between greater short-term certainty, from bond investing, and the higher long-term returns expected from equities underlies the dilemma facing all pension fund investors.
Last year, pension funds were willing to take the risks from – and were rewarded by – equity investing, particularly in Europe. Among 2003’s equity investments, half were in European companies, which gained 13.9%. North American stocks attracted 12% of assets, but returned less than their European counterparts, at 6.9%, influenced by the weak US dollar. Some of the e5bn in net new money that came into Dutch pension funds in 2003 went to invest in North American equities, WM data show. Any move to greater equity internationalisation will prominently feature North America, as the dominant global equity market.
With a 28% gain, emerging market investments topped out the equity category in 2003 but this had a limited impact on the average pension fund, which only had a slight (c2%) exposure.
Of the remaining assets, 10% reaped the year’s 7.1% gain in real estate, and 3% was divided evenly between cash, currency hedging and private equity investments, another area, along with hedge funds, that has room for growth under the banner of ‘Alternative Investments’.
Last year’s positive returns were welcome news for Dutch employees and sponsoring employers in both public and private sectors which suffered a greater than 30% loss from domestic equities in 2002. Preparing for the future, though, remains the industry’s greatest challenge.

Re-examining options
As pension funds examine their options, there remains a great opportunity to create efficiencies within their own operations. And for many schemes, outsourcing investment operations services may be the place to start.
Until recently, investment operations outsourcing was viewed as a distant solution for pension funds and asset managers that may be contemplating a new strategic plan. ‘The Age of Outsourcing’ was a well-talked about concept, but proven examples were few and far between.
Today, large pension funds and asset managers actively engaged in discussions and negotiations with financial services firms are beginning to overcome their initial reluctance. They are starting to see proof that outsourcing offers a tactical solution that can not only reduce costs and increase efficiency, but provide competitive benefits as well.
Outsourcing investment operations services, for example, allows a pension fund to turn a fixed expense – which may account for about half of its capital investment – into a variable expense. At the same time, it may also reduce certain operational risks, which would transfer to the outsourcing partner, which vowed to maintain the advanced technology needed to support the operations. If, for example, a scheme lacks straight-through-processing, performance reporting or sophisticated compliance reporting capabilities, outsourcing would give it access to those capabilities without the added expense.
As investment operations outsourcing turns from concept into reality, more financial servicing firms have decided to give it a try. And while more providers could serve to increase business, financial services firms should consider that publicised mis-steps from a newcomer could set the entire effort backward. As a result, those new to providing investment operations outsourcing services must do it right, or lose the opportunity for a second chance.
At the same time, the more experienced providers must maintain high standards for existing clients as they take on new ones. Execution and delivery is paramount.
For pension schemes and asset managers that may be considering dipping a toe in the outsourcing waters, be prepared to stay awhile. The decision to outsource creates a long-term commitment, and, as such, requires a painstaking vendor selection process.
While some new providers may be offering tempting benefits such as upfront cash payments to sign a contract, that money won’t come near what it could cost to regain a reputation or pay for losses created by an incompatible or inexperienced provider.
As more than 900 Dutch pension funds weigh the increased potential for mergers and consolidations in light of a more challenging marketplace, choosing the right third-party vendor is critical to future success. For those who do choose that route, success could hinge on their ability to choose a partner. Key components in that choice are:
q Commitment to the business. Stability and credibility are key criteria when it comes to selecting a service provider. A successful provider will have had a track record in the investment services business, and show every sign of remaining there. Consider the long-term implications of the partnership and how the business will work a decade from now, not just in a year or two.
q Understanding of back- and middle -office functions. A pension scheme’s back and middle offices are not just ‘systems’ or ‘activities’, but broad collections of operations that must be tightly coordinated and integrated. Providers should have spent years living with back and middle office challenges to design and implement outsourcing solutions.
q Technological expertise. Firms should seek out providers that are committed to investing in technology. A seamlessly automated, real-time platform is the true value proposition. Data must be accurate and prompt for the investment process to run effectively.
q A proven track record. With so many more providers from which to choose, schemes can now use history to their advantage. Obviously, the best choice is the provider that has demonstrated outstanding ability.
If the Dutch pension market is ready to move to the ‘Age of Outsourcing’ both providers and pension schemes must do some work. For it is only through a record of productive partnerships that outsourcing will achieve its true potential.

Rod Ringrow is a senior vice president and head of investment services for the Netherlands at State Street Corporation

Michael S. Walsh is managing director of The WM Company