On The Record: What is your equity strategy?
Unlisted is best
Our equity strategy is global and generally active. The portfolio is invested primarily in listed global equities, including emerging markets, which we recently introduced for the first time. At the same time, a limited share of the portfolio is invested in unlisted assets, primarily issued by small and medium-sized enterprises (SMEs). This share of the portfolio helps us maximise diversification. The board has decided to invest 7% of the portfolio in domestic bond and equity assets, excluding government bonds. We believe the country’s economy has intrinsic potential, particularly concerning the SME sector.
The main goal of our strategy has been, since the beginning, to control risk. Thanks to the pension fund, each member can benefit from a low-cost diversified investment portfolio, which members would be able to access as individual investors. That is why the fund is committed to explore the most innovative ways to maximise return while keeping volatility low. One way was to invest 5% of the portfolio in private equity, which the board opted for in 2015. At the moment, 10% of the equity portfolio is invested in four different private equity funds.
The listed equity portfolio is managed actively by external managers. Over the past five years, the scenario within which we operate has changed significantly. A number of new regulations have changed the levels of protection and the goals of occupational pensions for workers. The return requirements are such that markets cannot offer them at the moment. The high valuations of equity markets, particularly in the US, worsen the outlook. We are therefore compelled, more so than in the past, to find assets that can deliver returns without increasing our risk profile. This is why we are currently considering investment in infrastructure and real estate.
Small but powerful
We invest about 24% of our portfolio in listed equity and 6% in private equity. In the listed-equity market, we are mainly a passive investor. We invest globally, with only a few percentage points allocated to domestic equity assets. In 2016 we replaced part of our traditional passive investments with a smart beta approach, which we see as enhanced passive investment.
We expect future returns to be well below their long-term average and the levels we have seen over the past few years. There are plenty of risks and there is only a limited margin of safety.
When it comes to private equity, we invest directly in funds. We have built an ad-hoc governance structure for investment in private equity. We have appointed an external adviser, Wilshire, that helps us select and monitor managers and advises us on strategy. We then have a private equity committee consisting of three external members, including the head of private equity of a large Dutch pension plan and a general partner of a Dutch private equity firm.
The committee provides us with additional insights and contacts in the private equity market, as well as advice on our strategy. Despite being a relatively small pension plan, we are able to build a private equity platform that compares well with the bigger schemes.
Emerging markets still attractive
Our equity strategy is very simple. The allocation to equities, which is around 28% of the overall portfolio, is split between developed (80%) and emerging market (20%) equities. The developed market portfolio consists entirely of passive index-tracking investments. We see little value in active management given the high fees and the high transparency of information. We believe there is still scope for active management in emerging market equities. This is split between three managers, each with a different style of investing.
Around 18% of our portfolio is invested in private markets. This portfolio is part of our wider return-seeking portfolio and comprises real estate, private equity, infrastructure, private debt and real estate debt. The portfolio has performed particularly well, beating its benchmark over the past few years. The fund recently divested assets from public equity funds in order to acquire Gilts and property, including long-lease property and ground rents. The proceeds from the sale of public equity assets were also partly used to fund investments in infrastructure and illiquid real estate funds.
Later this year, it is likely that some of the passive equity assets will be switched from a physical holding to a synthetic holding. This will enable us to acquire additional matching assets and improve the hedging of interest rate and inflation risks, while preserving the return potential.