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Post-crisis rays of sunshine are piercing the shadows that enshroud most financial centres, yet Amsterdam remains under a gloomy sky.
Once regarded as the jewel in the pension crown, the Netherlands was savaged by the crisis. Assets were hit, deficits grew, and pensioner payment cuts hurt the industry’s reputation-but the real damage has come afterwards.
The Dutch National Bank (DNB), a financial regulator keen to avoid further embarrassment after the banking sector crisis, came down hard on pension funds and their boards, demanding greater governance of investment strategies and a move away from sophisticated products very few understood.
Combine that with poor returns, low interest rates, and long-term problems such as longevity, and boards are cowering in their trenches. Not losing money is now the priority; making money has fallen down the list. The result is a static, frightened pension industry.
Arun Muralidhar, founder of Mcube Investment Technologies and AlphaEngine Global Investment Solutions, is among those lamenting the deterioration.
“When I first joined the business 20 years ago, I used to love to visit the Netherlands as it was the most dynamic market with some of the smartest CIOs and staff globally. It was brimming with innovation and an unusual focus on asset-liability management,” he says.
“What the regulator started as a good move to protect funding sadly morphed into a very static management of portfolios and an overemphasis on risk measurement, as opposed to risk management.”
Muralidhar isn’t the only one concerned. Patrick Groenendijk, CIO of the Netherlands’ pension fund for transport-Pensioenfonds Vervoer-notes sadly: “As a country, we used to be regarded as pretty sophisticated investors and were known for being at the forefront of innovation, always trying new things. Now people are afraid of trying new things.”
Growling at the Watchdog
The DNB is often blamed as the primary reason for Dutch pension funds’ newfound hesitancy.
Having experienced what one CIO referred to as “quite a number of accidents in the banking sector”, the regulator wanted to avoid any further misfortunes with pensions.
The DNB went on a mass recruitment drive, picking up many who had lost their jobs in the banking sector to increase its staff. It then dramatically changed how it interacted with pension funds.
Pre-crisis, the DNB would visit a pension fund perhaps twice a year and ask several questions about administration before finally inquiring, “and how are the investments going?”
After the crisis, it took a very hard line on certain investments-and not always consistently across the industry. These discrepancies, Dutch pension experts say, led to a lot of uncertainty. Pension funds were genuinely frightened to move their portfolio at all.
Today, the questions are more thematic, and the regulator is delving more deeply. “In the past, the DNB would come to us and say: ‘We’re going to look at your entire portfolio and see what we can find,'” says Groenendijk. “Nowadays, it wants to focus on hedge funds or real estate, and they’ll look at all the Dutch pension funds which invest in them and compare them…before generating a best-practice paper.”
The crackdown also saw the DNB calling for board members to only select investments they truly understood. Many decided to get out of any instrument they couldn’t fully explain.
The average Dutch pension now holds 70% fixed income, and according to Philip Jan Looijen, co-head of integrated client solutions at ING Investment Management, the new rules saw hedge funds wiped completely off the menu. “If you speak [to] the DNB, they’ll say they’re not telling funds not to invest in complicated assets, it’s just that their knowledge should be aligned with the complexity of their investments. But given the knowledge levels of the average pension fund, that means they cannot invest in complicated investments,” he explains. “There’s also a transparency issue: If you’re a hedge fund, you don’t want to talk with your clients about exactly what you’re doing, and you don’t want to be transparent about the portfolio. That basically blocks Dutch pension funds from investing in hedge funds.”
Derivatives have also become a tricky subject. While most trustees are familiar with interest-rate swaps, more complicated derivatives such as swaptions or equity hedging strategies are fairly new, making boards hesitant about using them.
Some believe boards have taken the regulator’s guidance too far, including Bart Oldenkamp, managing director for Cardano Netherlands. “It should be sufficient for stakeholders to understand the meaning and possible consequences of an instrument. But some boards seem to interpret DNB as if they need to understand every single detail of all products,” he says.
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Bart Heenk, former managing director for Benelux and the Nordic regions for SEI, agrees. After some initial confusion, the DNB clarified that boards just need to understand the important risk drivers of the instruments and funds used, he says. “This, to my mind, is an important and correct warning. Understanding the crucial risk drivers of an investment is crucial. If you don’t, you should not invest in it.”
Smooth Criminal
The introduction of the smoothing regime also caused much exasperation. Every Dutch person aiCIO spoke to hates it.
In a nutshell: In order to discount liabilities, pension funds are allowed to use the three-month average of the interest-rate curve. However, assets are calculated using mark-to-market valuations. See where the upsets could occur?
If interest rates tumble quickly, fixed-income asset values increase because they are marked-to-market—but liabilities won’t, because they’re pegged to figures from three months before. That tremendously helps coverage ratios. However, if interest rates suddenly rise, pensions will be in the opposite situation—assets will go down in value, but the liabilities will stay the same.
“Smoothing is basically a disaster. It has all kinds of perverse effects,” said Vervoer’s Groenendijk. Roland Van der Brink, a pension lecturer who formerly oversaw the PME fund, calls the current system “awful”, adding: “Changing the discounting factor is just bookkeeping, and smoothing distracts funds from their real responsibility.”
Others, like Heenk, said it provided a much needed wake-up call for pension boards. “One can argue that quite a few pension funds had their heads in the sand before,” he offers.
A committee looking at the smoothing procedure is due to report early next year. Options include using mark-to-market for both sides of the balance sheet, using an average of the funding ratio rather than liabilities, or smoothing the liabilities over a year instead of the current three months.
Pensioner Payment Cuts and
Recovering Losses
Pensioner payment cuts angered the proletariat, dismayed financial quarters, and produced increasingly “vanilla” pension portfolios.
“Since the crisis, passive index investment is the name of the game, and thus almost no pension fund feels the obligation to study in detail the underlying investments,” says Van der Brink. Groenendijk admits that any change to investment strategy is prefaced by boards warning: “as long as we don’t have to cut pensions…”
“It’s also given them less incentive to take risks,” Groenendijk adds. “That’s not sustainable in the long term. Not putting risk back on the table, and not even thinking about putting risk back on the table, is worrying.”
Where do you turn when alternatives and equities are terrifying board members? Asset managers are heralding derivative overlays as an option for nervous pension funds seeking alpha with a safety net.
Hanneke Veringa, head of the Netherlands for AXA Investment Managers, says that for barely solvent schemes (the DNB demands a coverage ratio of 105%), derivative overlays would ensure an effective safety net to keep them in a safe zone. “We’re looking to define a path for their long-term ambitions, which might be perhaps the required solvency level, say 130% or 140%. Then we define an allocation to return-seeking assets on the basis of the size of the risk envelope that a pension fund can afford,” Veringa explains. “By putting a mechanism in place, you can bridge the long-term and short-term possibilities.”
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The Future
It is decision time for Dutch pensions.
The first decision is whether to provide a nominal pension fund—with less certainty of outcome for members—or a so-called “real” pension fund—with inflation linking. The deadline to choose is the end of this year.
Second, the cut in pensioner payments has led to heavy discussions over the makeup of pension boards. Should pensioners be represented? Or, given the DNB’s requirement to understand all portfolios risks, does having laymen on the board limit investment options? And are the unions likely to give up their seat, having already lost sizeable amounts of political influence in the past decade?
A direct consequence of these discussions has been the trend towards pension fund consolidation as corporates seek to throw their lot in with the sophisticated industry-wide funds. All the experts we spoke to believe it will continue.
Buyouts have fallen in volume as the Dutch insurers shy away from putting risks on their balance sheets, but an appetite remains. “My sense is that the demand for buyouts is still here,” says AXA IM’s Veringa. “This year there are more than 30 corporate pension funds which have to be solvent by the end of the year. That amounts to €10 or €12 billion, and we think the corporates will consider buyouts to achieve that. Foreign insurance companies are exploring ways to assist Dutch pension funds, particularly through buy-ins of pensioners. I think the trend that you’ve observed in the UK will happen in the Netherlands.”
The elephant in the room is defined contribution (DC). Every asset manager we spoke to said there was little appetite for DC funds. But there is at least one man determined to prove them wrong.
Folkert Pama is executive board chairman of BeFrank, a DC administration platform created by insurer Delta Lloyd, online savings broker Binck Bank, and BeFrank. With 15,000 members, it’s still a small player in a defined benefit (DB)-dominated world, but Pama is convinced the need for DC will grow—and quicker than everyone thinks.
“Several things will drive the shift to DC: the ageing population, low interest rates, and pension funds getting in trouble with their coverage ratios,” he says.
When asked about “DC denial”, Pama smiles: “Asset managers and board members of DB pension funds are fond of their current situation. They are in charge of billions of euros and want to stay in charge.
“What they don’t see is that if you look at all the big administrators for the pension funds, like APG, PGGM, and so on, they’re all setting up DC administrations too. Why would they do that if they don’t believe DC’s coming?”
DC is not the clunky, poorly performing, and expensive beast it once was, either. BeFrank’s default fund returned 16.9% in the past year and cost employees just 0.19%, with the employer paying another €30 to €100 each year in administration costs. That’s quite different from a guaranteed DB pension returning 3% and costing the employee three times as much.
Amsterdamned? The Netherlands has been shaken to its foundations, but there are bright opportunities on the horizon—if they’re only brave enough to take them.