The Netherlands: Not an easy game
Anton van Nunen examines why pension fund-owned fiduciary managers have been less successful than other competitors
It seems so easy: you are a successful pension fund for many years with a close relationship to the regulatory authorities, opening a business line to offer the same services to third party pension funds. Every element is on hand to turn this exercise into a success: proven track record, brand recognition, economies of scale, target pension funds lacking a comparable infrastructure and a low-cost fee offer on top. Yet, Dutch pension funds have not been very successful in getting new fiduciary clients on board and fiduciary suppliers with differing pedigrees have not hitherto been confronted with the unbeatable competitor many feared or hoped for. Even more remarkable, the latest trend is for these new fiduciary suppliers to retreat from the mar ket, at least for the time being, under combined pressure from their parent companies and from the regulatory authorities.
A few years ago, several large Dutch pension funds de-merged their asset management and administration departments and created independent so-called pension delivery organisations, separate from the pension funds themselves. In setting up these independent departments with a focus on asset management in relation to liabilities, they clearly challenged commercial fiduciary managers by offering fiduciary services not only to their pension fund parents, but also to other pension funds and institutional investors. Most of them, in their own words, were driven by noble objectives such as reducing costs for their own members, offering fiduciary services at a fair price, sharing know-how and rescuing the Dutch asset management industry. In fact one senior executive reported using this strategy to strengthen the unique Dutch system of collective pensions (see Bendert Zevenbergen, Het Financieële Dagblad, 18.6.10).
But other motives might have played their role as well: growing bigger is not an uncommon objective in business. On top of that, the pension funds in hand had a good motive to spin-off the delivery organisation. Their notion was that providing a good pension product and at the same time running a huge organisation of investment professionals is not an efficient combination.
Not only do the two activities require a different skills, more importantly, investment results are evaluated with greater objectivity when they are produced by a department at arms' length than when direct colleagues are responsible for them. Finally, the budgeting of additions to the workforce and other investments are assessed on more sound arguments when the spending department has its own bottom line to watch.
After a short period of mandate wins, albeit at a very modest pace, 2009-10 became a watershed, and the spotlight was directed at two major developments. First, the executive organisations were not as successful in winning mandates from third parties as their starting position might have suggested; second, some parent pension funds voiced dissatisfaction with the services and investment results of their subsidiaries of late and called for a reassessment of the new organisations.
This poor commercial success seems to hint at a very delicate relationship with new clients. It might be an indication that this new group of suppliers is encountering difficulty convincing prospective clients that they will be regarded on the same terms as the parent, even though their assets under management would be dwarfed by the latter. From an objective point of view, this idea indeed appears hard to sell. One does not have to be a cynic to realise that it is unclear whether in stress times, when every hand is needed, that the parent will not assume a preferred position both because of its size and because of its ownership of the executive company. Even in normal times it is hard to conceive that a client representing less than 1% of assets under management in most cases will have a real status in the overall organisation, let alone equal status with the largest.
A second explanation for this less successful development probably has to do with the basic characteristic of the organisations and their pedigree. Operating commercially and marketing products - where they were once the only or at least the preferred manager - is apparently not germane to these organisations. Potential clients see proof of this attitude in the fact that asset class choices are restricted to the asset classes already in use for the largest client. Client-friendliness apparently does not match the prevailing market benchmark.
However, both these weaknesses have been overcome by the second wave of pension funds offering fiduciary services. Very recently, some smaller Dutch pension funds have made it publicly known that they also intend to offer their services to fellow pension funds. Being more used to competition, they may be more service-oriented. Their size is not a disadvantage and they can still offer economies of scale. The first two elements may make the difference and could enable them to succeed where their largest counterparts have not.
As to the second element, parent pension funds' dissatisfaction with the performance of their service provider subsidiaries does seem to be related to the combination of credit crisis-induced financial losses and Dutch pension fund regulations. The total disruption of financial markets in the aftermath of the credit crisis and the massive monetary intervention worldwide created reductions in short-term interest rates not seen in very many years, if ever.
This created difficulties for all Dutch funds. The discounted value of liabilities rose strongly because the declining swap rates are prescribed as the discount rate. This led to dangerously low funding ratios, which in their turn, induced the regulator to strongly prescribe risk reduction(1).Hedging interest rate risk, one of the ways to reduce risk, aggravated the problem by causing even lower interest rates and the other, obvious, method of selling riskier assets at fire-sale prices also added to the problem. Lower prices of riskier assets caused problems for other pension funds, which in turn started offloading risk.
Larger pension funds could not even contemplate hedging their interest rate risks, as the swap market turned out to be too small for the required transactions(2). These dire circumstances, with the largest Dutch pension funds showing funding ratios below the required minimum level, may well have contributed to the idea that independent former pension fund asset managers did not do a good job. The sad conclusion with this regulation is that it was impossible to save funding ratios from a very serious decline, whatever effort was made in terms of hedging or changes in the asset mix. The parent organisations may well have been wrong-footed in their assessment by the disastrous, regulations induced results.
The regulator is playing a remarkable role in this changed relationship between the pension fund parent and asset management subsidiary. It is questioning the rationale of these reorganisations and, referring to the deterioration of funding ratios, is reminding pension funds that they remain responsible for the ultimate investment results. One could object, however, by emphasising that the pension funds still own the asset management department and there is no objective reason to believe that reorganisation as such would negatively affect performance.
Moreover, by winning third-party mandates, they create a sound basis for increased investment in both skilled personnel and equipment. The regulator's argument, that pension funds lack in-house expertise because their former specialists now work in the other department, seems far-fetched. A mere re-organisation does not rob the pension fund of the required expertise. But even if new clients were to own part of the asset management department, the obvious situation is that of a management company devoted to good governance for clients in a sector from which the pension delivery organisation originated. Nothing wrong with that, I would suggest.
1. On many occasions, the fallacy of the funding ratio as defined by the Dutch regulator has been brought forward. See for instance, Duffhues and Van Nunen, ‘Zijn pensioenfondsen "in wezen bankroet"?', De Actuaris, volume 1, September 2009, pages 32-35.
2. December 2008 saw the swap rate decline by 120 basis points during one week in which no specific macroeconomic event took place. Interestingly enough, this was the same week in which Holland's second largest pension fund tried to hedge part (!) of its interest rate risk. This decline in the swap rate caused the average Dutch pension fund to lose 20 percentage points in funding ratio. It goes without saying that this kind of a decline cannot be compensated by any investment policy.
Anton van Nunen is principal at Van Nunen & Partners and adviser to institutional investors