The Haves and the Have-Nots

As Dutch pension funds move from recovery to treading water, regulatory burdens have produced a two-tier pension system.

The Netherlands is fast becoming a nation of haves and have-nots: the pension funds with the resources and expertise to be able to innovate—and those without.

For the past couple of years, the financial regulator—De Nederlandsche Bank (DNB)—has insisted that trustees of pension funds should be “in control” of their portfolio and investment strategies. They must truly be able to understand and report on all investments, and be on top of associated costs.

At the same time, the consolidation of the Dutch pension fund industry has accelerated. As the need to be “in control” has taken effect, many smaller, relatively under-resourced pension funds have had little option but to throw their lot in with a larger peer. One Dutch news report suggested there may be just 100 pension funds left by 2020, a drastic reduction from the 340 or so around today.


Current government dithering over new rules to be introduced, which will force pension funds to offer either real (inflation-linked) or nominal pension funds, is slowing the tide of mergers. However, once this issue is resolved, many CIOs predict consolidations will speed up.

An unintended consequence of these changes has been a dramatic drop in Dutch investment innovation. The uncertainty and onerous new rules have meant the vast majority now only invest in vanilla assets. Hedge funds remain off the menu for all but the most sophisticated. Structured products are avoided by the majority. This wouldn’t be a problem if we weren’t in such a low-yielding environment.

A large pension CIO confided: “If I travel to the US, I still hear people admiring the Dutch pension system, but the reality is it’s getting more bureaucratic. We’re not innovating any more. We’re just shying away from complexity and interesting asset classes. We should be pushing more into innovation and embracing financial engineering. Of course we should be selective, there was a lot of crap out there… but we’re throwing away the baby with the bath water. We’re not creating an environment where innovation is embraced.”


Sizeable, Sophisticated, Strategic

Some larger investors, such as PGGM and APG, are sophisticated enough to have a dedicated CIO in place and a sizeable investment team through which they can invest innovatively.

The strategies of these funds are markedly different to their smaller cousins’. Many are adopting smart beta strategies for their equity portfolios, with some even investigating smart beta options for fixed income.

“Many pension funds are still exploring the idea, but the most popular smart beta approach is low volatility,” says Michel Iglesias del Sol, head of investments at Towers Watson in the Netherlands. “Now, a larger range of benchmarks—size, quality, cash dividends—are being combined into one product because that gives further diversification benefits.”

APG’s CIO Angelien Kemna speaks passionately about her pension fund’s approach to smart beta.

“This has been the best few years to start with smart beta,” she says. “Now we’ll have to see if it can continue to grab a few basis points here and there. Smart beta is our choice of the investment benchmark for a certain asset category, in the light of the total portfolio.”

The vast majority of even the largest pension funds are still heavily weighted towards fixed income, but they are willing to look at structured products such as asset-backed securities (ABS), collateralised loan obligations (CLOs), and commercial loans. The larger pension funds, with their improved solvency ratios, have also had the time, space, and expertise to look at their portfolio construction more holistically. APG tells of adopting a risk-factor-like approach, where the risk budget is set first and the building block assets are then built around it. 

“I still hear people admiring the Dutch pension system, but we’re not innovating any more. We’re just shying away from complexity and interesting asset classes.”

PFZW, one of the largest plans (whose assets are run by PGGM), is nearing the end of its famous “blank sheet of paper” project, in which the investment team imagines how it would structure investments if it were to start afresh today. A more strategic, less rigid approach is being widely predicted as the outcome.

The archaic investment strategies held by the majority see the investments rigidly set in silos, not allowing for any sort of strategic rebalancing. This is highlighted as a major stumbling block for the smaller pension funds.

“In the Netherlands, it is pretty much portfolio construction on a line-by-line basis, so the manager will run an allocation to US high yields, or an allocation to emerging markets, or an allocation to investment grade corporates,” says Michel van Mazijk, head of institutional sales for the Netherlands and Nordics at Pioneer Investments. “It’s more about collecting building blocks than trying to get the best asset allocation.”

Larger, more sophisticated funds can invest the time needed to understand the more complex products and broader mandates that are desperately needed in today’s low-rate, low-return environment.

“It is possible to obtain higher returns today, but you need more sophisticated solutions to do it and enable the clients to be in control of the subsequent complexity,” says PGGM’s Chris Limbach. “It’s a fine line for pension funds: Do you embrace the complexity of those solutions that can give you the higher expected return you desire to realise your ambition? Ideally you want to apply only basic conventional investments to do so. I doubt that’s achievable.”

Loans are becoming a key part of sophisticated investors’ portfolios, too. Alongside esoteric structured products, direct loans to small and medium businesses, commercial real estate loans and even direct mortgages are now on offer.

The €16 billion Philips pension fund has offered mortgages to the general public for several years, which is highly unusual for a corporate pension plan. CIO Rob Schreur has so far shied away from CLOs and ABSs (“They were not transparent enough yet and didn’t fit into our investment framework.”), but is thinking about increasing the fund’s exposure to real estate and infrastructure.

“Project finance might be interesting—that for us sits in the equity bucket. There are always opportunities, and it’s finding the right structure to make use of them in a skill-based manner.”

One of the few new ventures to hit the Dutch market is the preserve of the biggest pension players—at least for the time being. The National Investment Institute and the National Housing Initiative are two government-backed projects being designed to benefit both institutional investors and the economy. 

Both projects are at the blueprint stage at the time of writing, but PGGM and APG are involved in their creation and so are able to mould its development to suit their purposes. “We have conditions that must be fulfilled,” says APG’s Kemna. “We need to be able to justify investments in infrastructure in the Netherlands compared to opportunities we see elsewhere. One of the problems in the Netherlands is the majority of the infrastructure investments are too small and too scattered. You need an intermediary who consolidates that and makes the deal more attractive. We have the money, but you can’t expect us to totally create the deal, negotiate with the government and corporates, put projects together—that’s something that should be done by an intermediary.”

PGGM’s Limbach adds: “There is a trend to invest more pension money closer to home without damaging expected returns. However, it is challenging to find investments with long horizons on good terms. For that reason we’re participating with the government to set up this investment institute.”


Unsophisticated, Unloved, Under Pressure

At the other end of the spectrum are the smaller and medium-sized pension funds. Having struggled hard to regain their solvency position after the onslaught of the financial crisis, many have moved from recovery mode to simply treading water.

Credit has risen up the agenda, but most pension funds remain in vanilla products. “Managing even these simple instruments is actually very complex, and it makes sense to continuously monitor how those instruments are being invested,” says Hanneke Veringa, head of Netherlands for AXA Investment Managers. However, she has been talking to some smaller funds about whether it’s worth investing time and energy in learning about complicated structures.

Smaller pension funds’ allocation to direct real estate used to be high, but investors have since looked more critically at their risk/return assumptions, decided they want more liquidity, and found it in listed funds, says Veringa.

The DNB’s reporting requirements are also playing a part. Pioneer’s van Mazijk notes: “More complex structures provide challenges in visibility, transparency, risk management, and so on. I think the regulator plays a big role in the way this sector is developing—or not developing.”

Until recently, Evalinde Eelens was the senior investment strategist at A&O Services, a fund for painters and decorators. On April 1, it merged into PGGM, taking Eelens along too—but she remembers the frustrations of being in a smaller fund.

“Big pension funds are listened to and have access to the regulator,” she says. “It is frustrating for both sides, as it might lead to new rules being created that aren’t useful for pension funds of all sizes. Everyone would benefit from more communication.” The problem, she says, is the regulator is not very accessible to any but the biggest pension funds. It is rarely invited to seminars, and when it is, its representatives often run straight out of the door, leaving no time for investors to talk to them.

Among the key things they would surely like to discuss are what Eelens describes as the contradictory mandates of lower costs and the need to be “in control”.

“Smaller funds are being forced to change their governance structure in such a way that it will cost them a lot of money, and they still probably won’t be sufficiently in control, according to the supervisor,” she says. “I see a lot of smaller pension funds that have to hire experts to sit in on board meetings, which costs a lot of money, and that’s a huge strain. You might be ‘in control’, but your costs will be too high. Mergers are accelerating because of rising costs, but there is no innovation—it’s about struggling to survive instead. I know why the supervisor is doing this, but in the short term it’s hurting.” 

APG Blazes Its Own Trail

During the sovereign crisis of 2011, Angelien Kemna, CIO of APG, the €350 billion pension investor, and her team realised their traditional rebalancing approach was harming returns.

“We felt the rebalancing rules we had were too strict and too technical in terms of timing. They were too mechanical,” she told CIO. “When you use rebalancing strategies with a greater degree of freedom, you don’t have to suffer that sort of underperformance.”

The solution? Begin by examining the balance sheet and seeing where the risk budget allows APG to invest. Then only use relevant benchmarks, rather than ones set by the market—and create a propriety smart beta framework.

For example, APG separated developed equities from its overall €40 billion quant equities strategy because these assets’ characteristics were so different from the rest of the portfolio.

It also deliberately abandoned Goldman Sachs’ well-used commodities index because it didn’t want exposure to some of the benchmark’s categories.

“We look at each asset class as a building block, then establish how we get a cost-effective performance first, given its role in the whole portfolio. Then we’ll look at the benchmark, only because we have to measure it somehow,” Kemna explains.

Alpha has come under extreme scrutiny—if an alpha strategy doesn’t outperform smart beta picks after fees, it’s scrapped. APG’s total target for alpha is 60 basis points (bps) after costs. Last year, its alpha strategies returned 100 to 150 bps, but Kemna is acutely aware that was an anomaly.

“We tend to always make the 60 bps outperformance, net of costs, which is modest. But we do everything we can to prevent anyone or anything eating into that, whether it’s regulations like the Financial Transaction Tax or excessive fees for external managers.”

The biggest opportunities for the fund, Kemna says, will come from two new government initiatives designed to get pension money back into the Dutch economy. The National Investment Institute and the National Housing Initiative (NHI) are still in the blueprint phase at the time of writing, but APG, along with PGGM and other institutional investors, are already involved.

The NHI could be a “showcase” for transferring mortgage assets from banks to institutional investors, Kemna says, adding that the scheme “could be made available to do much more, if it’s run smartly”.

With Kemna’s influence continuing to rise—she met Barack Obama and Angela Merkel last year—and her significant expertise, the founding fathers of these two national initiatives could not hope for a more sophisticated investor to be on board.

Charlie Thomas