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How We Run Our Money: Hans de Ruiter, CIO of Pensioenfonds TNO

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“As a pension fund, the real risk is not realising your ambition, because that is the promise you have made to your members. Everything else is of secondary importance,” says Hans de Ruiter, CIO of Pensioenfonds TNO, the €2.9bn pension fund for employees of TNO, the Netherland’s Organisation for Applied Scientific Research. 

Stichting Pensioenfonds TNO at a glance

• Total assets – €2.9bn
• Location – Rijswijk, the Netherlands
• Members – 15,654 (end 2013)
• Returns – 2.3% in 2013 (14% YTD)
• Funding – 110.7% (Q3 2014)

This statement could imply that TNO members should accept uncertainty and setbacks along the path towards that end-goal, the promised pension benefit. But in reality, de Ruiter means that his pension fund should not feel too constrained by regulation and unduly influenced by debates on regulation, as the aim is to maintain that promise. 

In fact, since he joined the TNO pension fund in 2012, de Ruiter’s focus has been on ensuring that the fund has adequate command of all its investment decisions and on reducing the complexity of the portfolio. For de Ruiter, better control capabilities and a more streamlined portfolio are necessary for the TNO pension fund to lead each member to that goal, especially within a more challenging investment horizon and regulatory environment. 

De Ruiter oversees what he calls a “fairly standard” asset allocation, which has seen some significant changes over the past 10 years. In 2012, before his appointment, the fund completed a process of divestment from hedge funds after that part of the portfolio recorded a 7.2% loss during the previous year and underperformed its benchmark by 13.4%. 

De Ruiter notes that during his previous job as a senior investment adviser at Hoogovens, the pension fund for the former Dutch steel producer now controlled by Tata Steel Europe, the investment team there also decided to divest from hedge funds. “I think the reasons were the same. The lack of performance, both in absolute terms and relative to expectations, combined with high fees and a lack of transparency. That is not a very pleasant mix.”

However, de Ruiter stresses that the decision to divest from hedge funds was a strategic one – which leaves open the possibility to build tactical positions. “It does not mean we will never invest in hedge funds, it simply means we do not tie our strategy to this asset class. There is room to invest in hedge funds if we find a manager that has a good strategy, a good fee structure and reasonable terms.” 

In de Ruiter’s words, TNO’s portfolio today has “nothing in it that you would not find in other pension fund portfolios in the Netherlands”. There is one significant exception, however – a higher-than-average allocation to private equity. 

 Stichting Pensioenfonds TNO – asset allocation

Stichting Pensioenfonds TNO –asset allocation

This has been the case historically, as TNO’s allocation to private equity has been closer to 10% over the past 10 years. The current allocation stands at 6.6%, which is lower than TNO’s average, but de Ruiter has plans to bring it back to 7.5%.

This “positive stance” towards private equity, says de Ruiter, was backed by the ALM studies that the fund carried out, and reinforced by the solid performance of the portfolio during the crisis years. 

However, before increasing exposure to this asset class again, de Ruiter carried out an extensive review and restructuring of the portfolio.

Although the private equity investments have been among the best performing over a 10-year period, de Ruiter identified two problems when he arrived at TNO. First, was the fixed allocation of 7%, to the asset class: “If you invest in something that is illiquid like private equity, it is much better to work with ranges rather than fixed numbers. So we changed the 7% to a range from 5% to 10%”, explains de Ruiter.

Second, de Ruiter felt the fund did not have adequate control over the private equity portfolio, due to the large number of managers and funds it used. A similar situation was happening with the real estate portfolio. In total, when de Ruiter joined, the TNO fund was holding stakes in 21 private equity and nine real estate funds, through 13 private equity and three real estate managers, respectively. 

“In terms of size of the investment team, we are a small fund, with only two people working full time on portfolio management. That is why we needed a better control structure, particularly for private equity investments,” says de Ruiter. 

The fund essentially had two choices: hiring a manager to oversee the whole investment process, or using a consultant to focus on monitoring, reporting and strategic advice. TNO chose the second option, which de Ruiter says will offer better continuity, as the fund is more dependent on an organisation that provides resources rather than one offering individual talent, which would have been the case with a discretionary manager.

 Stichting Pensioenfonds TNO – returns 2009-13

Stichting Pensioenfonds TNO – returns 2009-13

Accordingly, the fund hired Wilshire to advise on the private equity portfolio and Kempen Asset Management for the real estate portfolio. This arrangement, explains de Ruiter, means the fund regains full command of its investments in these asset classes, as the focus for his team will be on asset allocation and portfolio decisions rather than monitoring and reporting.

“We were looking for a pure consultant because we make the investment decisions,” says de Ruiter. “When we come up with an investment plan, I want the consultants to give inputs and their views on the market, as well as to assist us with manager searches. They are involved at the beginning of the process, when the objective is to review the market and the managers. But as we go further down the line, our role becomes much more important, as it is we who do the shortlist, lead the discussions, and make the ultimate decisions.”

De Ruiter is therefore reluctant to call Wilshire and Kempen ‘fiduciary managers’. That is the remit of BlackRock, which the CIO describes as the fund’s strategic adviser: BlackRock has differing responsibilities compared with the other two managers; it is also “actively involved” in TNO’s annual design of the investment plan and implements the fund’s matching strategy. 

At the moment, the fund is drawing up an investment plan for both private equity and real estate, and new searches will begin in early 2015. However, given the nature of these sectors, it will take time before the two portfolios change.

Next year, de Ruiter says one of the priorities will be analysing the alternative credit market, including infrastructure debt, real estate debt and direct lending. In credit the most exciting asset class by far is Dutch mortgages. 

The TNO fund is soon going to join its peers that have already invested in Dutch citizens’ desire to own their own home. Spreads for Dutch mortgage-backed securities are very high compared to other credit instruments – ranging from 250-350bps depending on the types of mortgages – but the risk profile, in terms of potential losses, is very low according to de Ruiter, as the rating is close to AA. 

The spreads are so high as the country’s lenders fund mortgages mainly through the capital markets, rather than clients. This makes funding more expensive, and the additional cost is passed on mortgage holders, who in turn pay high rates. 

The regulatory environment, adds de Ruiter, is also making Dutch mortgages increasingly attractive for credit investors. Mortgage interest is tax deductible, which keeps demand stable. But new rules mean that from next year all home purchases will have to be funded through amortising loans, which reduces the risk profile of mortgages. 

Investors such as TNO can therefore benefit from high-yielding securities with a low-risk profile. “It almost seems a no-brainer. There is only one trade-off, which is liquidity. But we would see it as a an instrument that matches our cash flows,” says de Ruiter.

Looking at alternative sources of yield in mortgages and other credit instruments is clearly the line of defence in what de Ruiter describes as a negative backdrop for investment in 2015 and beyond. “Next year will not be easy. We do not see a lot of growth in the economy but at the same time we see valuations on the high side. That makes a lot of markets very vulnerable to disappointment. Also, there is a very unfortunate mix of policy measures and I don’t think we will be able to solve the main European problems next year.”

Nevertheless, de Ruiter says one thing that will most likely not change at TNO is the interest rate hedging strategy. The overall portfolio is hedged at 55%.“You could argue that with such low rates, you could gain something by taking more interest rate exposure,” the CIO says. “But we do not see any triggers for interest rates to rise by much for some time, and if that is the case then lowering the hedging would not be the best way to spend the risk budget.”

TNO’s emphasis on better decision-making is what de Ruiter believes will help the fund navigate through a perilous investment environment and, at the same time, meet demanding regulatory requirements.

De Ruiter has a generally positive opinion on the new Dutch financial assessment framework for pension funds, FTK. The new rules, he says, help pension schemes absorb financial shocks better, as schemes are allowed to spread out shortfalls in funding over a longer period, and the coverage ratio is calculated over an average of the past 12 months. 

However, he questions whether this is the right time for the regulator to demand that funds build higher buffers. “We should be counter-cyclical rather than pro-cyclical. In other words, it would be better to do it when things are going well rather than badly. With a higher buffer bar, combined with a new curve to calculate the liabilities that will lead to lower coverage ratios, investors can feel constrained, as taking on more risk could significantly increase the probability of having to cut benefits.”

De Ruiter says that for TNO, which had a funding level of 110.7% at the end of the third quarter of 2014, cutting benefits is not on the cards, and the fund can still aim to increase risk in the portfolio, if required to meet the fiduciary duty to members. 

As de Ruiter puts it, the only real risk is not living up to your pension promise, and that is what every debate on regulatory funding should lead back to. He says: “In the Netherlands, there is so much debate about the coverage ratio and its implications. But the coverage ratio is just a snapshot of a pension fund – it’s what you see at one point in time. Pension fund management is really about the whole film.”

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