Pensioenfonds Metaal en Techniek, the €70 billion ($81 billion) Dutch pension fund for metal and technical workers, will introduce its own bespoke developed market equity benchmark at the end of this year.
The goal of the new benchmark for PMT isn’t necessarily to improve risk/return, although chief investment officer Inge van den Doel acknowledges this would, of course, be a welcome benefit. It is a requirement of the index that risk/return not deteriorate but the primary aim is to better integrate ESG considerations, particularly climate risk, and select companies with operations and activities that fit PMT’s long-term investment principles.
The developed market equity allocation is already passive and the fund is not increasing the allocation. Also, Van den Doel estimates that possibly half of the companies in the current standard benchmarks will fall out of the new index, which is now in the final days of construction by the fund’s in-house team, based at PMT’s fiduciary manager, MN.
“We think we are doing something innovative and are really excited about it,” she says in an interview from the fund’s headquarters close to The Hague. “It has taken us two years to get to this stage and we are almost there. After this, we might look at other categories, like emerging market equities.”
Aligning investments with beliefs
PMT’s push to develop its own benchmark is driven by a desire to better match investment beliefs and objectives with the fund’s listed equity investments. About $17 billion in equities will track the new index. It amounts to a distinctive view of what passive investment entails, in what van den Doel says is as an enhanced passive strategy.
“For us, passive doesn’t mean just following standard benchmarks bought off the shelf,” she explains. “Standard benchmarks follow certain rule sets that are unlikely to reflect our requirements and values. We are large enough to make a benchmark that fits our beliefs and objectives.”
It is a top-down process, explains van den Doel, who joined PMT five years ago from the Dutch central bank, where her roles included head of investments for the bank’s €20 billion portfolio.
“We started by looking at the companies in the standard benchmarks in our portfolio and asking what we think of their activities and operations,” she explains. “We want to select companies with activities and operations that fit our values. On that basis, certain companies may fall off the table.”
The decision to custom-build an index is just one of the results of PMT’s full-scale review of its investment framework two years ago, a process that specified the fund’s beliefs regarding investment, policy and risk frameworks. They’re all pillars that feed into a central investment objective that targets long-term excess returns of 1.5 per cent a year above the change in the value of the fund’s liabilities.
“This really was new, and a number we reached after an eight-month analysis of our ambition and risk appetite,” van den Doel says. “PMT consciously chose a relative performance target that is innovative in two ways: most funds have absolute return targets and hardly any fund explicitly states a specific number. The chosen excess return target strongly influences the portfolio construction.
“We wanted to make our investment policy easier to explain to our members and show them this is how PMT invests their money. We also wanted to make more use of our beliefs and principles in our investment strategy, rather than just using quantitative models. The investment framework also helps us build a bridge between the two different worlds of trustees and investment professionals, and make it clear to the asset managers what it is we are looking for, so they understand how we want them to invest, and that it is not just a matter of allocation.”
Return folio and matching portfolio
The portfolio is divided into a return and matching portfolio. The return allocation is structured around three asset clusters of equity, high yield and real estate – not to be confused with asset categories, which lie within the clusters. The equity cluster includes private equity, developed market equity and emerging market equity; high yield comprises classic high yield but also others classes, like emerging market debt; real estate comprises a domestic allocation to homes, offices and retail and a foreign allocation to direct real estate funds and listed real estate.
“The asset clusters help us get a grip on complexity,” van den Doel explains. “Each cluster has its own objective in the portfolio and well-defined strategic characteristics so we know what kind of risk is allowed and what kind of return we want.”
It also allows easy evaluation of any new investment products.
“We can see whether they fit with the clusters and if they provide added value compared with the existing investments of a cluster. If they don’t provide any added value, we aren’t interested. Right now, we are not looking for new products in the return portfolio.”
Equity makes up roughly 60 per cent of the return portfolio. At the end of 2016, PMT had a 34 per cent allocation to all equities, for a total equity portfolio worth €23.2 billion ($27.1 billion).
In the matching portfolio, finding the right asset mix while interest rates languish at historic lows is more of a struggle and something she acknowledges could keep her up at night. It is a balancing act that involves measuring interest rate and credit risk. The latter is a particular problem because PMT, like other pension funds, is forced to move up the credit curve for non-negative yields.
“The longer the duration of an investment product, the lower the spread should be,” she says. “Having a 30-year bond that has a high spread above our liabilities is a big risk, because the duration means that if interest rates change, our loss will be much higher.”
Van den Doel won’t contemplate more risk in the return portfolio, despite PMT having an enviable funded ratio at just above 100 per cent.
“Our funded ratio has come up from 75 per cent a couple of years ago but it remains very fragile,” she says. “It is still below the level set by the Dutch central bank of a minimum funding ratio of just above 104 per cent, and it is well below our long-term target ratio of 120 per cent. We see other funds taking on more risk, but we don’t think this is the right thing to do for PMT.”
The fund has also made huge progress in slashing fees, which are down by half the 2011 levels, through a process that works via her favoured top-down approach.
“We looked at all our asset categories and asked ourselves, ‘Do we want to invest in this and is it worth the fee?’ ”
This led the fund to shelve its hedge fund allocation, which was revealed as both expensive and not providing the required diversification. In contrast, private equity has proven its worth, with a 3 percentage point net return above public equity.
“In private equity, a 3 percentage point outperformance is worth the costs,” van den Doel says. “But that doesn’t mean we don’t look very sharply at private equity costs.”
A second phase of fee analysis involves looking at implementation. One way the fund has saved money is by switching to more passive strategies, particularly in the emerging market allocation, which used to be completely active but is now split between active and passive. In 2016, total management costs fell to €259 million (0.392 per cent), down from €273 million (0.445 per cent) in 2015.
“We thought we needed active implementation to get a return, but we now believe emerging markets are becoming much more efficient because liquidity has grown.”
She adds that she can envisage wholly passive management in emerging market equities two to three years hence. Emerging market debt is still actively managed she is looking at using more buy-and-maintain strategies there, to save transaction costs.
“We look at costs in all ways, not just fees,” she says.
A third step to keeping a lid on fees has been selecting only managers prepared to accept lower fees.
“Our fiduciary manager, MN, sharply negotiated with our asset managers on fees in 2012 and we divested from those that were not willing to move or accept a lower fee,” van den Doel says.