The new euro investment environment is proving an unpredictable element even for some of Europe’s most experienced pension investors. Hugh Wheelan reports on how the Dutch investment managers and custodians are coping
It would be difficult to argue that the Dutch pension fund industry was unprepared for the euro. Perhaps the most striking example of Dutch forward planning for the single currency was laid down in an advisory book entitled: “Euro Scenario – Manual for the Implementation of the euro by Dutch Pension Funds” published by the OPF and VB bodies for industry and corporate pension funds.
But as a nation of seafaring traders knows as well as any, you can prepare your boat for the voyage, but you can’t always guess the way the wind will blow. And the new euro investment environment is proving an unpredictable element, even for some of Europe’s most experienced and professional investors.
Rob ten Wolde, secretary of the OPF, says: “The euro scenario manual was very thorough, looking at every euro implementation issue facing Dutch funds, particularly for administration and internal processes. On the investment side we produced a checklist on issues such as Dutch to eurobond transfers and equity shifts towards a European sectoral approach, but they were purely advisory reminders for funds to look at the whole spectrum of the new post-euro European investment scene.
“And our members have not reported any significant problems directly related to the single currency, but there is certainly a great deal of work being done at the moment within portfolios on investment transition and reorganising of systems.”
However, Frank Kusse, senior vice president and head of institutional services at ABN Amro Asset Management, believes the arrival of the euro had more effect than predicted in the Dutch pension fund community. “I was surprised to some extent, because Dutch funds appeared well prepared. But in reality when we asked our clients about their pre-euro pan-European strategies we didn’t get much of an answer. They were far from ready for the actual portfolio shifts now being seen, and although Dutch plans are very professional they left things rather late. We actually only started hearing preliminary benchmark discussions at the end of summer 1998.”
Kusse believes that with hindsight the Dutch were as cautious as anyone else over the actual outcome of Emu. “Now we can see the single market and its indices rapidly coming together, without investors drastically selling their Dutch positions as some predicted, Dutch institutional minds are beginning to settle and take appropriate action.”
He adds that one of the restraints may have been the conservatism of Dutch pension fund boards, and believes there are still a good number that have yet to take the euro initiative.
Raymond Brood, managing director at Fortis Investment Management Utrecht concurs: “Even some of the very biggest pension funds have not significantly changed their asset allocations from a domestic basis yet. The picture is certainly mixed, and although there is an increasing pan-European perspective to Dutch portfolios, we still see a lot of clients hanging on to their Dutch equities – despite the flatness of the AEX so far this year. But then again a similar thing is happening in Germany. It seems that as soon as the Dutch market begins to rise, funds are selling off their overweighting in equities. There definitely appears to be a wait-and-see philosophy with regard to the overweighting to large-cap Dutch stocks and market impact inherent in any fund stampede out of Holland.”
Brood believes pension fund managers are also still trying to evaluate the correlation between stocks like Royal Dutch/Shell and the domestic economy, which he says is “about zero per cent”.
However, he acknowledges that the euro is not yet driving the Dutch economy either. “The investment conditions are pretty confusing at the moment and as a result it is very difficult for Dutch pension funds to decide whether they want to do their portfolio transition in one go, or over a number of years. We are advising clients to do the European sector switch as soon as possible, but you can’t push forward so abruptly a pensions industry as cautious as the Dutch. “On the equities side, probing questions are being asked, though, because even if people start talking about fixed-income credit risk, pension funds are saying you may as well take that sort of risk in the equity markets.”
One pension fund which did prepare early for the euro was Shell, as Kees van Rees, managing director of the scheme, explained when addressing a recent conference: “We made the assumption that some kind of Emu would happen in 1989 and so Dutch and German bonds were sold in favour of peripheral bonds. The consequence of these transactions has been an occasionally rocky but overall very rewarding ride.”
Van Rees said: Shell was prepared to put its money where its mouth was and believes the benchmark decisions made by the fund consequently turned out “very decent”. And he added that the integrated European financial market and continuing trend towards disintermediation is undoubtedly pushing the increased demand for ‘credit’ corporate bonds in the Netherlands.
“At the time of making the first ‘periphery’ bond trades Shell also started to run its European equities, including the UK, on a pan-European basis. Initially this portfolio had a strong home bias, but gradually the benchmark has been changed to reflect a more balanced approach to Europe – although currently we still have an overweight position in the core continental countries.” The fund’s benchmark for European equities allocates 19% to the Netherlands as against 18% each for the UK and Germany.
The flavour of Dutch pension fund investment has traditionally been international, resulting both from the relatively small Dutch economy and the liberal investment principles of Dutch investors and the country’s regulatory bodies.
In equities, typical constructions in a 30–40% portfolio equity holding are around 45% domestic stocks versus 55% overseas, with 5–10% in property and the remainder allocated to fixed-income, according to Kusse at ABN Amro. And, although the euro itself is not cited as the driver for many of the asset shifts, it has certainly proved an investment watershed with most funds.
Says Peter Hans Budde, head of business development at Rotterdam-based Robeco: “Benchmark discussions began in 1997, although most funds remained pragmatic and waited for the euro’s arrival before taking any firm decisions. In fixed-income, the benchmark switch has been straight from Holland or Germany into euroland. Corporate credits are also in demand, although there is little in the way of ratings structures and sufficient quality company bond issues yet to develop this area.
“Most funds have taken a kind of hybrid investment approach in one or two countries, and then the MSCI Europe index. And those with Dutch versus rest of world, are now employing Europe 15 or euro versus global strategies, although I can’t see any definite trend towards either. Some funds are also keeping a close eye on the Japanese market.”
Another issue that has caught many in the Dutch market by surprise is the noticeable seachange in pension fund attitudes towards integration and collaboration.
Robeco’s Budde comments: “We did not predict this as a possible outcome of the euro environment, more as a result of IT costs and scarce availability of investment prospects in the Dutch market. Everyone talked of increased outsourcing as a ‘euro effect’ for pension funds, because of the complexity and labour intensity of managing primarily sectoral European investments within a global framework. Not many looked behind the scenes though and envisaged the rationalisation and education funds would seek to achieve through mutual help. It seems everyone is talking to each other at the moment, seeking advice on administration, res-ources, risk and manager selections.
Ten Wolde at the OPF says: “I have heard there is a significant initiative in the planning stage between six or seven funds to work together on administration and advisory issues. But this has always been the goal of the OPF in working together as an umbrella organisation for these funds, so I don’t think it is all that new.” Behind the scenes at Dutch pension funds the work needed to carry out pre- and post-euro securities transitions has been tentative but thorough.
According to Erik Van Dijk, chief executive officer at Palladyne Asset Management, part of UAM US Group, many funds sold significant portions of their exposure to Dutch small caps in stages to prepare for the euro, beginning portfolio transition through large-cap exposure, which could then shift to euro indices.
“This means that many are overweight in domestic large caps, although this phenomenon has been masked by good performance in the Dutch market over the last few years. The time is now ripe for action on this overweighting, and funds are looking to cover the exposure through indexing or straight transition.
“At Palladyne we carry out transition management, and I believe pension funds should now be putting out tenders for transition specific mandates, due to the importance of the process and the market impact involved.”
Van Dijk says the predominant equity shift is into pan-European stocks, ensuring exposure to the pharmaceutical and financial sectors. “And what we are seeing more than ever before are pension funds looking to two or three managers to manage this money, and then further down the line at different styles to get low investment correlations – albeit keeping similar benchmarks. This core–satellite approach is certainly more important at the moment than the Euroland/pan-European debate.”
Van Dijk adds that the transition itself will be crucial, both for funds and the Dutch stock market. “The timing is critical, particularly for stock performance and the faith that funds will need in some of their larger stocks. More importantly, you cannot have everyone getting the right transition idea at the same time, because this just renders it a wrong time. I believe the winners will be those that link transitions to their asset managers – if only to help extricate them from domestic preferences accumulated over the years. For instance, many will have to swallow hard and sell stocks they like and have traditionally relied upon.”
In terms of pension money, the 10 largest funds still make up a significant portion of the Dutch market, but with a wide variation in asset management strategies. Some large corporate funds like Philips and Royal Dutch/Shell do most of their investment management in-house, whereas big industry schemes such as ABP and PGGM tend to outsource investments outside Europe.
The Rijswijk-based metalworkers’ scheme is an exception to the industry funds norm, having developed full investment capabilities in-house, fuelling to some extent, along with consolidation talks between funds, the big question as to whether the larger Dfl15bn–20bn funds will look to develop in-house European asset management teams or continue to outsource the more labour-intensive mandates.
The ABP/PGGM joint purchase of Nationale Investinger Bank (NIB) has also set Dutch investment tongues wagging. Although no one doubts the primary reason for the move as the development of an independent vehicle for brokerage execution, corporate finance, private equity and economies of scale, many are asking whether other investment motives are at play.
“Logically you could argue that the next step for the top 10 pension funds in Holland would be to position themselves as money managers in the market,” says Kusse at ABN Amro. “However, I don’t think PGGM/ ABP will go down the road to asset management or back-office integration. Firstly because ABP will lose its civil service pensions monopoly in 2001 and will need to focus on keeping their existing pension contributors and offering flexible full-service pension packages to attract more customers. The NIB purchase will help ABP to target this core business by sidelining some of the fund’s investment elements.”
Overall on third party management, the consensus is that the larger funds may start to manage Dutch securities for their small to mid-size counterparts, but that the investment buck will end there.
Says Budde at Robeco: “I just don’t think all these funds will be able to put together the necessary analytical teams for pan-European/euro sectoral investment, because it is so labour-intensive and alien to their core concerns. Furthermore, pitching for commercial business and offering the levels of reporting and value-added services needed for clients is a fiercely competitive market .
“And I doubt whether there is the right corporate culture in these funds to compete.”
However, Budde adds he is certainly expecting structural changes ahead in the 1,100-strong Dutch pension fund arena. “Put simply, there is just way too many of them. Something has to give.”
Dan Allen, consultant at Wilshire Associates, in Amsterdam, adds: “Consolidation is also necessary because of the investment transparency demanded these days. Dutch funds must be able to justify performance, resources and staff numbers – so this is where working together benefits plans.”
On overall pension fund investment strategy, Allen says the trend away from balanced towards core passive management, satellite specialist mandates, pooled funds and derivative techniques, is now the norm.
“Dutch funds, like most European plans, are looking for more sustained alphas, because they have found it difficult to add value through active management. They are certainly looking for consultants to be very pro-active in finding balances between active and passive management, with the pointer tending to favour passive – as evidenced by the fact that BGI is the largest pension fund asset manager in the Netherlands today.”
Hilary Smith is managing director at the Barclays Global Investors office in Amsterdam, opened last year after previously operating out of London. She says the passive issue in the Netherlands goes back around 15 years, and sees no sign of it slowing yet. “At that time Dutch funds were looking to increase equity weightings, but wanted to find a risk-conscious method of generating international exposure – hence the core–satellite approach. Now this has a firm hold in the market, the larger funds are looking to enhanced index/alpha approaches and upping the ante through active index management, which is representing an increasing amount of our assets under management.
“The approach is slightly mixed with a cap-weighted Eurozone strategy complemented by bolt-on Swiss, UK or Nordic components predominately – depending on a fund’s investment strategy.”
BGI manages Dfl70bn of assets for Dutch clients, and Smith says she is beginning to see the euro effect in the Netherlands through benchmark shifts to a broader pan-European strategy, with most investors agreeing it is probably too soon to shift to a sector-based European strategy. “BGI restructured its sectoral possibilities last year in preparation for Emu, and I believe we are ready for every investment eventuality though.”
However, the predominantly ‘active’ Dutch asset management community believes the passive dog may well have had its day in the Netherlands.
Martin Nijkamp, general manager, institutional clients international, at ING Investment Management, says: “It is fashionable to index portfolios these days, which has much to do with the fact that markets have been trading up for long periods. However, if markets start to trade sideways, index portfolios may face more difficult times against actively managed funds.”
Van Dijk at Palladyne, whilst acknowledging the passive attraction, also senses a change in the air: “In truth, active management is a little like chess, in that there are many players but few grand masters, and the advent of performance measurement has brought the reality of returns to the fore. Passive management looks tempting in terms of guaranteed results, but if you see some of the style work being done these days on the changing variables of value and growth in today’s European investment market, then you see the core satellite approach as important – but increasingly difficult to judge, so ‘good’ active management is worth its weight in gold.”
Allen at Wilshire also sees increasing use of derivative and alternative investment strategies: “Private equity is popular with funds looking to add value at the peripheries, both in terms of upping allocations and commitments. And I can see this going the same way as the US market, although presently it is still the domain of the larger plans. It is just an education and resources issue, and if you’re a small to mid-size plan you have to use a fund of funds at present, but I believe this will change rapidly.”
Allen confirms the credit risk trend on the fixed-income side, seeing both high-yield and emerging market debt returning strongly after last year’s market glitch. “On a long-term basis, pension plans know this is a good place to be, and Dutch funds are noted for their commitment to asset classes.”
Nevertheless, Van Dijk at Palladyne says he is seeing more talk than real money on the derivatives side. “This is a new ball game for institutional investors. Those schemes using derivatives do appear to be erring on the side of caution when using them, with risk control firmly in mind.
“However, they are certainly open to less correlated long/short hedging strategies, where the investment argument is compelling – particularly following Dutch research on asset allocation within asset liability frameworks showing derivatives as a way of reshaping risk/return profiles and getting downside protection in the short term within long-term equity profiles, or as a portable alpha tool to create different excess returns. And some of the larger funds are already developing more sophisticated products in-house to reduce costs.
Van Dijk says balanced mandates are still being outsourced by smaller Dutch funds, but believes it is only a matter of time before they become sufficiently technical to go down the specialist route.
Expansion of defined contribution (DC)-style top-up pension provision is also leading the louder call for better returns, but for the moment DC is definitely an add-on, and not part of any intrinsic change to the DB-dominated Dutch pensions system.
Explains Budde: “The DC trend is happening, but it is a European-driven need for benefit flexibility in companies with strong foreign commitments and mobile workers. Certainly, everyone is preparing themselves for some sort of defined contribution move in Holland and other European countries. The cultural propensity to pass over the risk completely from employer to employee – like the US 401k – is just not there, so we are more likely to see a DB/DC hybrid with a basic DB platform and a DC collective top-up arrangement being introduced at some point by governments.”
Nevertheless, the scramble for Dutch institutional business among asset managers is feverish. Although Dutch investors have never shied away from putting their money in overseas hands, the investment management community is fighting back and taking the game to its foreign counterparts. The list of the top 25 players in the Dutch pensions market is shown on page 27.
As in most of Europe, merger and acquisition activity is producing a two tier investment management arena of supergroups and niche operators.
“In the future the Dutch asset management field looks like it will resemble the grocery store versus the large hypermarket scenario – each important, but for completely different reasons,” says Budde at Robeco.
But the belief today is that the Dutch market may well have reached critical mass in terms of new arrivals in the market, so Dutch managers are focusing their sights firmly cross-border towards foreign market potential.
Comments Kusse at ABN Amro: “We have only had a truly external focus for the past six years. And just in this time we have seen institutional assets rise in the Netherlands from $6bn to $35bn, so we are now seen very much as a professional global player in asset management – not just for banking and insurance. We know what it is to fight against the Anglo-Saxon houses these days, and have the reputation and requisite track record to do so.
“We’re winning back business in Holland from the Anglo-Saxons, and in Scandinavia, Switzerland and Spain we are winning specialist global mandates, so I think the potential is now there for us to carry on expanding.”
The Dutch managers certainly no longer doubt their ability to win business overseas, and the sales pitch is both competitive and pragmatic – but the question still remains as to whether they can win serious international money and manouevre themselves into a global position on a par with their overseas rivals.
Nijkamp at ING, operating worldwide under a variety of groups and stake interests, including Baring Asset Management, Furman Selz in the US, BBL in Belgium and BHF in Germany, says they can. He believes ING Asset Management’s global expansion proves the seriousness of the Dutch challenge.
“We are on the look-out for opportunities to branch out wherever it makes strategic business sense. Our preference is to keep local market branding and work with this where possible. It isn’t necessary these days to have greenfield sites everywhere following the opening up of the markets. Group convergences are obviously coming to the fore and when looking to new acquisitions ING is seeking out opportunities with complementary groups in the GARP vein – (growth tilt with reasonable price/value) – which we believe has been a particularly pro-active and succesful approach.
“The major issues for the future I believe are going to come in IT capacity and product flexibility, and you can already see this in some of the investment products being launched to complement the European low interest rate environment.”
He adds that France and Germany are potential markets where ING is sizing up new business opportunities for the future. Consequently, ING, like many Dutch managers confirms its intention to be AIMR/GIPS compliant as soon as posssible, although none currently meet the full standards.
Nijkamp adds: “When investment was a predominately domestic issue I think clients were sufficiently knowledgable about investment managers in the market to negate such standards. But moving out of the home market and seeking business elsewhere it will be essential to be GIPS compliant as a mark of quality to present to institutions that may not be so familiar with the investment house.”
The proficiency of Dutch pension funds in investment matters appears similarly to be one of the main reasons why the country’s consultancy market has proved a relatively tough nut to crack for foreign companies. Says Budde at Robeco: “The Anglo-Saxon-originated consultants are not taking off here at all, for a couple of reasons. Firstly, I think the Dutch are quite frugal and down to earth, and they want to see the added value in the flesh before they give away their money. Second, Dutch actuarial firms tend to take care of the benefits side of pension funds, and then institutions will ‘cherry-pick’ for asset consulting – they don’t need someone to hold their hands all the time.”
Adrian Putters, senior consultant at Watson Wyatt in the Netherlands, concedes that the impact of the Anglo-Saxon players may not have been as dramatic as expected because of the well informed Dutch market. Nonetheless, he feels pension fund trustees are beginning to use their services more as investment approaches become increasingly complex and globally orientated. “We are tending to see ALM studies as the hot topic in the market at present, and are seeing good business prospects for the future as trustees look to sharpen up their skills in this area."