Time to call in the professionals
The 2006 investigation by our firm of some 80 investment managers managing assets on behalf of Dutch pension plans, reveals three key developments: the New Financial Assessment Framework (nFTK) has given a boost to outsourcing; Anglo-Saxon managers have profited the most; and turbulent markets have led to major changes in market shares.
According to the Central Bureau of Statistics (CBS), the total assets of Dutch pension funds totalled €635.6bn at the end of 2005, compared with €538.7bn at the end of 2004 - an increase of €97bn or 18%. This increase is substantially higher than market performance over 2005 according to the universe of The WM Company, which was 14.8%.
The increase in external asset management is even more than the increase of total pension assets. Total Dutch institutional assets managed externally totalled €502bn at the end of the first quarter of this year, compared with €353bn at the end of the first quarter last year - an increase of €149bn, or 42%. In 1993 assets managed externally totalled only €95bn.
There is little doubt that this substantial increase is strongly related to the introduction of the new financial assessment framework. Pension plans now consistently choose to outsource their asset management.
The figure of €502bn includes multi management and overlays, and includes double counting by overlay mandates - for example. tactical asset allocation, swaps and currency overlays - of €103bn (see graph 2). However, this amount should not be deducted completely from the figure of €502bn, since the sub managers in multi management portfolios will also be managers other than those mentioned in this survey. If this is taken into account, our estimate is that over 70% of total Dutch pension plan assets are externally managed.
Graph 2 shows that Dutch managers are strong in the field of fiduciary management and multi management. The providers here are mostly former industry wide pension plans.
Anglo-Saxon managers, in particular, have profited most from the enormous increase in external management. The top 10 players (Graph 3) includes four Anglo-Saxon managers who have seen a substantial increase in their market share. The increase of assets of the top 10 winners amounts to €88bn.
The top 10 largest managers now manage 61.7% of total external Dutch pension plan assets, or €310bn. The rest - about 70 managers - must do with the remaining 38.38%, or €193bn. Six Dutch asset managers rank among the top 10 largest managers. They have realised a substantial increase in their assets, particularly due to the positive market return over 2005 -2006. But they still suffer from a decline of their market share.
Foreign managers now manage over half (56.1%) of the external Dutch pension capital, up from 50% in 2005 (Graph 4) and Dutch parties consequently manage less than half (43.9%).
Anglo-Saxon market share has increased considerably. Market shares are now, by origin: Anglo-Saxon 50.7%, up from 44.6 % in 2005; Dutch 43,9%, down from 50% in 2005; French 1.5%, up from 0.7% in 2005; Belgium/Luxembourg 1.3% up from zero in 2005 - this increase is mainly due to classification of Fortis as Belgian company - Swiss: 1% down from 2.6% in 2005; Nordic 0.7% up from zero in 2005; German 0.5% down from 1.5% in 2005 and Japanese 0.4%, the same market share as 2005.
Over many years Barclays Global Investors (BGI) has been by far the largest manager of Dutch pension plan assets. BGI manages 11.5% of total externally managed Dutch pension plan money.
State Street Global Advisors (SSgA) jumps forward and is now number two behind BGI, managing 9% of externally managed assets. Their increase in assets under management was due mainly to fixed income mandates, cash management and separate investment accounts of industry-wide pension plans.
BGI and SSgA together manage €103bn. This is a sixth of total Dutch pension assets and over a fifth of total external assets.
The dollar/euro parity has changed in favour of the euro. This currency appreciated between the first quarter of 2005 and the first quarter of 2006 by 6.9%. This had a significant influence on dollar investments.
The year 2005 was a strong year for investments. The average performance of Dutch pension plans reached 14.8% in The WM Company universe. So a considerable portion of the increase in assets under management can be explained by market developments.
The Dutch institutional market has been stirred up by the introduction of a new Financial Assessment Framework (nFTK) and International Financial Reporting Standards (IFRS). Some people even say that the Dutch pension system will be scarred for life. The market impact is without a doubt considerable. Consolidation between market parties is one of the consequences. Pension plans, asset managers and consultants are reviewing their position. Many of them are looking with a renewed focus.
Corporate plans mainly focus on the constraints the new investment regime imposes on them. Stand alone investments in specific asset classes seem to have become a topic of a low priority. Nowadays, asset management is seen within the perspective of nFTK, the structure of the liabilities of the fund, indexation ambition and the required solvency ratios.
Industry wide pension plans are less hampered by the new regulations. Consequently, these large plans are still quite autonomous in their investment decisions and selections of asset managers. They still have a listening ear for specific asset management solutions. Z-scores remain an important constraint to industry-wide plans. The new financial assessment guidelines have increased the difference in focus between corporate plans and industry wide pension plans.
A growing number of foreign players are opening an office in Amsterdam. Foreign asset managers are successfully increasing their market share and are managing an increasing portion of Dutch pension capital. Anglo-Saxon managers are among the main winners. Dutch asset managers hoped that they would succeed in obtaining more mandates as a result of the new legislation and the trend towards fiduciary management. They have indeed acquired LDI mandates for new and existing clients. A number of Dutch managers acquired medium sized and small sized fiduciary mandates. In the segment of ‘smaller’ pension schemes (that is, schemes with assets below € 250m) foreign asset managers are not so abundantly represented. In this area some Dutch managers are gaining new mandates. The smaller mandates are mostly regarded as not very interesting to foreign asset managers, given the relatively modest yields and the relatively high labour intensiveness of fiduciary management. Within the ‘smaller’ segment of the market, Dutch managers encounter competition from insurance companies.
The increase of total assets under management for Dutch players has been substantial, but clearly they could have done better. They are not in the frame for large mandates, and are rarely invited to the very large beauty parades or do not get through to next round.
A number of pension plans have yet not regained their trust in some Dutch managers. So how could they do better? The quality of the research is key to delivering added value. Therefore they should consider creating a combined Dutch research unit of top quality, building a powerhouse to regain the initiative. The chances of this happening are small, however, because the various interests are diverse and the existing research is globally spread over many locations.
Diversification is the name of the game. The ‘quants’ are back in business. By investing in uncorrelated asset classes, asset managers aim to keep the overall risk of the portfolio stable, while improving total performance. The whole array of structured products, private equity, (enhanced) commodities, real estate, overlays of global tactical asset allocation (GTAA), currency and swaps is applied. Hedge funds, private equity and commodities only attract modest interest, representing only 1% respectively in the average portfolio of Dutch pension plans.
The performances of so-called “high conviction managers” has been remarkable. These focus managers, mostly of Scottish and Dutch origin, invest only in a limited number of equities.
Liability driven investment (LDI) and fiduciary management are very much in the limelight, although the actual implementation of these strategies takes considerable time.
The funding ratios of the pension plans improved to an average of 128%, calculated with a 4% fixed interest rate. More duration matching means less interest rate risk, but it also means that the plan will profit less from a rise in the interest rate. This means that disappointing performances as a result of higher interest rates could be offset by higher funding ratios. In addition to that, if nominal interest rates rise as a result of higher inflation rates, the discounted value of liabilities declines, but the need for price indexation increases.
Pension plans have become reconciled to the nFTK but not to IFRS. It may be true that IFRS gives a better view on market value risks, but it has become clear now that this standard is misleading and conflicting with the Dutch pension system. IASB may come up with a new accounting standard for pension plans.
In this turbulent market, a number of skilled Dutch employees are joining foreign asset managers. Recruiting, retaining and incentivising talent is a big challenge facing the industry. If asset management is not a core activity of the respective financial institution, and ‘open architecture’ is introduced, the in-house portfolio management could be hollowed out. In those situations it seems only logical that employees prefer to work for a specialised company that is fully committed to their field of expertise. Foreign players hire local talent to provide fiduciary expertise. There still are rumours that Dutch asset management units are on a sales list. Clearly this does not contribute to the motivation of highly trained staff. In this industry, half baked solutions are no longer feasible. In this world, winner takes all.
The larger consultancies are also suffering from a loss of staff. It is reported that pension plans are often not prepared to pay the full price for their services. Therefore larger consultancies switch over towards multi-management. Some of the duties that traditionally belonged to consultants are now fulfilled by fiduciary managers.
Another aspect is the crying demand for talented sales experts. Consultants frequently switch over to asset managers. On the other side of the spectrum new small local consultants are entering the market, each bringing in their own expertise.
PGGM started up Careon as a ‘co-operation’ to sell lifecycle products to its participants. The introduction of a co-operation as a special purpose vehicle looks very artificial. Insurance companies are obviously not keen on this move. At long last a ruling that is satisfactory to both parties should be introduced. A number of former pension funds (like SPF offering private equity) present themselves as commercial suppliers of specific investment propositions. A hedge fund like Centaurus finds pension funds for take-over strategies. Hype or trend? Pension fund De Eendragt - converted into an insurance
company - takes in various small pension funds. The pension fund market is filled now with all sorts of suppliers and there is a slight trend towards commercialisation of this industry.
Frits Bosch is director, Bureau Bosch, based in Nuenen