The Netherlands’ biggest pension fund has said it will not be able to maintain its current asset allocations and risk/return profile if proposed Dutch pension reforms do not go ahead.
ABP vice chairman, Xander den Uyl, has said that under the current system Dutch funds could look to scale back risk when they reach 100 per cent solvency levels, potentially disadvantaging future generations.
“The present system, which really is risk averse, will lead, in some cases, to sub-optimal investment decisions for young people,” den Uyl said.
“Funds will take too little risk, which means lower returns and, especially, younger people will get less pensions and have to work longer if we keep up the current system.”
The sweeping reforms to the Dutch direct benefit system have sparked fierce debate about how best to provide for a growing number of retirees who will live longer, while still maintaining pension levels for future generations.
Government, employers and some unions have agreed on a general agreement but the reforms need to be voted on by union members.
The reforms are recommendations that also seek to decentralise the system, with the employers and workers set to negotiate deals that will be tailored to various needs of different industries.
If a substantial proportion of the approximately 600 Dutch pension funds chose less risky investment strategies this could have major implications for European bond markets.
Dutch pension funds collectively have more than €750 billion ($1.07 trillion) of combined assets.
While it can vary across the funds, Dutch pension funds typically have between 40 and 50 per cent of assets in fixed income.
Den Uyl said under the current system funds such the $341 billion ABP, which recently reported 112 per cent funding levels, would be forced to de-risk to meet ongoing liabilities.
“In the present most Dutch pension funds have solvency rates around about 100 per cent, which means they guarantee the nominal pension right,” he said.
Den Uyl said funds would prioritise the nominal guarantee over indexing pension payment, resulting in more defensive investment strategies.
“Well if you say ‘I want to guarantee the nominal right’ and whether or not we can index will depend on investment return then you tend to be very defensive.”
The current system has a combination of nominal guarantee, based the average pay during the working life of a member and a real terms ambition to index the pension payout.
Nearly all Dutch industry-wide pension funds have some provision for conditional indexation of pensions. This is usually linked to wage increases in a particular sector and boards can adjust or abandon the indexation provision in a particular year if funding levels drop below set targets.
The current arrangements put trustees in a difficult position. They must simultaneously meet the conflicting aims of both covering the nominal guarantee, usually through less riskier fixed-income investments, but also seek higher returns to meet indexation ambitions.
The agreement seeks to formalise these conditional indexation arrangements and also improve the communication with members about the potential risks in their pension schemes.
“We would like to have the same asset allocations that we have had in recent years. Which is more or less 40 per cent fixed return and 50 per cent equities and real estate and those kinds of assets,” he said.
The reforms seek to open the system up to potential downturns in financial markets, with losses spread over 10 years.
In its most recent quarterly report ABP revealed that its current investment strategies had achieved a cumulative real return of 4.9 per cent, which is 1.6 per cent higher than the so-called “prudent real return”.
This is used to calculate the pension premium and also is a component in deciding the fund’s overall future liabilities.
As of March 31, ABP reported it had achieved a 0.9 per cent return for the first quarter of the year, increasing its assets by $3 billion.
The fund uses a subsidiary, APG, to manage its investments, but den Uyl said the parent company still took an active role in monitoring investments.
“There is a mandate for APG, and they have all kinds of limits and really run day to day operations of the investments. ABP makes asset allocations and makes decisions on risk,” he said.
“It is not that we only make asset allocations and say: ‘go your own way’. There are very intensive relations from ABP and there are some people (who) are day-to-day involved in the investments, but investment decisions are made by APG within the limits and mandates that we have set.”
ABP had 38.7 per cent of its portfolio in fixed-asset assets. Real assets accounted for 53.6 per cent of its portfolio and included developing market shares (24.8 per cent), emerging market shares (6.7 per cent), real estate (3.6 per cent, private equity (5.3 per cent), an opportunity fund (2.2 per cent), commodities (3.6 per cent) and infrastructure (1.7 per cent).
ABP blamed higher interest rates for minimal returns on fixed assets, with its government bonds portfolio making a 1.2 per cent loss. Its shares in emerging markets also struggled, recording a 4.3 per cent loss.
Its best performing assets were in commodities where it generated a 10.1 per cent return, real estate (+3.2 per cent) and infrastructure (+2.6 per cent).