Fixed Income

Dutch PGB wins with focus on risk

Strategy at the Dutch €26 billion ($31 billion) PGB Pensioenfonds centres around dynamic asset and liability management. The fund’s matching and return portfolios, and an interest-rate hedging strategy, all move in line with its funding ratio.

It’s a careful balancing act that involves protecting the fund’s liabilities while keeping sufficient risk on the table to capture the returns to maintain an enviable 108 per cent funded status, up from 100 per cent in 2016. Last year, the fund returned 6.7 per cent.

“We adjust risk according to our funded status,” chief investment officer Harold Clijsen says. “When our coverage falls below 105 per cent, we dial back on risk, and when it is above 125 per cent we also dial back because there is enough money on the balance sheet to meet pension promises.”

Clijsen uses a strategic framework to adjust the equity, interest rate and credit risk, in a process that measures the risk premia of the different assets and takes momentum into account.

“When the risk premia and momentum are high, we can add risk to the portfolio; when the risk premia is low and momentum is also low, we have a lower risk allocation to certain assets,” he says, referring to today’s market to illustrate the strategy in action. Although risk premia is low across most assets, momentum is diminishing but still positive, so Clijsen is paring back equity risk.

“I am concerned that we might not be fully compensated for our risk exposures in the long run and scaling back in equity is the easiest way to adjust the risk budget.”

Success with interest-rate risk

Within this strategy, PGB’s dynamic approach to interest-rate risk has proved particularly successful, contributing 1 per cent to the fund’s returns over the last two years. It follows the same pattern as the strategy for equity and credit risk: when interest-rate risk is low, the fund calculates a lower risk budget and reduces its interest rate hedge; when rates move higher, Clijsen increases the hedge.

“If rates go above 4.5 per cent, 80 per cent of the liabilities will be hedged,” he says. The interest rate hedge at the end of 2017 stood at 45.2 per cent of the pension fund’s liabilities.

The fund’s assets are split 55/45 between a return and matching portfolio, respectively.

The matching portfolio comprises low-risk fixed-income investments, which are intended to keep pace with changes in the value of the pension commitments. They span European government bonds, rate swaps and futures, investment-grade credit and mortgages.

About 47 per cent of the return portfolio is in equities; other allocations include higher risk fixed-income assets, such as dollar denominated emerging-market bonds, plus real estate, infrastructure and a small allocation to private equity.

All management of the €14 billion ($16 billion) return portfolio is outsourced but the matching portfolio is mostly run in-house. Clijsen believes it is more efficient to outsource the return portfolio to professionals with systems and expertise than to build an internal team; he also seeks to avoid the operational risk of internal management.

“It is very difficult to compete with external managers in active management and we would rather have the flexibility to change managers than run an internal team,” he says.

In contrast, he likes contact with the market in the matching portfolio, where strategies are buy and hold and it is much easier to match liabilities internally.

The investment team of 28 is split into four groups: strategy and ESG integration; the matching portfolio; manager selection; and a legal division.Last year, the fund’s total investment costs were 47 basis points, coming in below the 55-basis-point average for Dutch pension funds. PGB achieved this, Clijsen says, by managing the fixed income portfolio internally and employing large passive and factor mandates in the equity portfolio, which costs less than using a fundamental approach.

Most of the equity allocation is in Europe and North America, with smaller allocations to Asia-Pacific and emerging markets, managed passively and actively. The factor allocation is confined to developed markets and comprises low volatility, value and momentum mandates. Clijsen is in the process of adding quality, and possibly one other, new exposure, which will boost the factor allocation to 35 per cent of the equity portfolio. He likes the way it is possible to attribute returns to specific factors and the cheaper cost of factor mandates, compared with traditional active management.

Other strategies that he says are working well include the mortgage allocation, which is still delivering returns above swap yields. He is researching whether put options would give the equity portfolio additional insurance from more extreme movements. He is also planning to increase the alternative fixed income allocations.Also, to begin meeting the UN’s Sustainable Development Goals, Clijsen is exploring building an allocation to small or mid-size buyouts in private equity that prioritises impact investment funds.

“We are investigating how to combine these two themes, particularly focused on energy transition.”


Benefiting from Dutch consolidation

Clijsen prefers fixed manager fees to performance fees, and seeks alignment with managers by building long-lasting relationships. PGB has particular clout negotiating fees because of the growing tail of larger pension funds joining the scheme as part of the consolidation in the Netherlands’ pension sector.

The number of Dutch pension funds has fallen from 1000 18 years ago to about 250 today, as smaller have switched into industry-wide schemes or liquidated. When Clijsen joined PGB in 2014, the fund, which originally provided pensions for the graphic arts sector but is now multi-industry with 2434 employers, had assets under management of only €14 billion ($16 billion). That amount has nearly doubled since then.

“Every time a larger company pension scheme joins PGB, we have another way to renegotiate investment fees,” Clijsen says. But he worries that pressure on the fund to keep fees low could affect PGB’s ability to diversify into lower risk, but expensive, alternatives. The way around this is to ensure robust communication with beneficiaries, he explains.

“It is important to explain to our beneficiaries why we are allocating certain fees to certain asset classes and the need for different beta returns.”

Indeed, every three years, PGB consults its beneficiaries across all age groups and its multiple employers.

“We consult with our beneficiaries to see how they think about their pension and what they would like to see in the portfolio,”he says.

It’s a consultation process that recently led to excluding tobacco and controversial weapons manufacturers and is also behind the drive for ESG integration at the fund, which began to formulate a climate policy at the beginning of 2018.

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