APG, which manages investments for Dutch pension funds including the giant ABP, has finalised its strategic investment plan for 2010-2012. Amanda White spoke to managing director of strategic portfolio management, Ronald Wuijster, about why there is a continued trend to diversification away from developed market equities and how the portfolio construction methodology has altered.
The exact mix of assets managed by APG will depend on the clients’ risk attitude and liability profile, but its largest client, the 208 billion ($274 billion) ABP has been trending to reduce its exposure to developed market equities for the past six years.
Every three years it writes a strategic plan, and the 2010-2012 plan has just been completed.
Ronald Wuijster, managing director of strategic portfolio management at APG, says this strategic process involves an analysis of strategic asset allocation, the outlook for the world, and portfolio construction.
“We always do scenario analysis looking at economic growth, inflation, and the interest rate expectation,” he says.
While this year that analysis involved stress testing a number of scenarios including increased boom/bust cyclical activity and deflation leading to lower interest rates – the scenario that Wuijster and his team see as the most likely outcome, is a larger role for governments, watchdogs and lower overall growth, as a reaction to the credit crisis.
This economic analysis on asset class returns is factored into asset liability matching analysis and portfolio optimisation.
“It had an effect on the overlay we are constructing and we are looking at increasing interest rate hedging and duration lengthening, but only at certain levels of interest rate. We also look at an increase in inflation hedging.”
This economic analysis has had the effect of altering some of the asset class weightings in the portfolio, most notably a continued reduction in equities, with a weighting away from developed markets and towards emerging markets.
This has been a trend for some years, with ABP reducing developed market equities by 2.5 per cent and increasing emerging market equities by 1.5 per cent in its previous strategic investment review moving from the 2004-06 strategic plan to the 2007-09 plan.
A shift towards private markets at that time continues with the 2010-2012 strategic investment plan, so the whole portfolio is less dependent on the developed equity markets.
It also continues its trend towards inflation-indexed bonds.
ABP has significantly reduced its target allocation to developed equities from 27 to 20 per cent according to the strategic mix, and down from its actual allocation of 24 per cent in 2009.
The other significant shift has been reducing the allocation to corporate bonds from 21 to 16 per cent. [See table below]
In APG’s strategic mix Wuijster says in addition to a reduction in the weight of credits, there has been a continued search for alternative risk premium, and an exploration of systematic risk exposures or alternative betas.
The fund, which previously had a 100 per cent currency hedge, has reduced that somewhat but has expanded its hedges, by including the pound and yen alongside the US$.
While the asset class weightings continue along this longer-term path of reducing equities, a fresh approach to portfolio construction has also resulted from this strategic investment plan.
Previously APG managed assets in two separate portfolios the growth and income portfolios with specific asset classes in each one. Now the idea of having strictly separate portfolios has been abandoned.
“That is not in our vocabulary anymore,” Wuijster says.
“We still have two portfolio parts, one is dedicated to following liabilities, what we call mimicking liabilities, and the other is used for earning good returns, but now our 14 asset classes became the central focus points to build an optimal portfolio for our clients.”
Previously the income portfolio contained: cash, treasuries, index-linked bonds, credits, infrastructure, absolute return and liability hedging; and the growth portfolio contained: developed market equities, emerging market equities, private equity, real estate, commodities, innovations and return optimising strategies.
“Now the total portfolio is managed as one and there is only one overlay,” Wuijster says.
“Initially there were two or three overlays, one for the first portfolio and two for the second, we have abandoned the separate portfolios because of the complexity in overlay management.”
The desire to reduce complexity was the main driver for the change in portfolio construction, but with that there is also a reduction in cost.
For APG, overlay management includes duration lengthening, currency, inflation, equity risk hedging, and tactical or dynamic asset allocations, although most of its clients do not engage in dynamic asset allocation choosing instead to rely on methodological rebalancing.
In addition to an overall simplification of the investment management process, Wuijster says the new strategic plan provides further focus on liabilities.
Within this in mind there has been an increase in weighting for inflation, for the most part through inflation-linked bonds although other ways to consider inflation are being discussed.
APG has more than 600 investment staff, with the process organised around 14 building blocks, the asset classes, as well as a team in strategic asset allocation and overlays.
The investment management process has recently been made “a bit stricter, more formal, and more process orientated, according to Wuijster.
“We have paid more attention to risk management and there is more focus on the pureness of our exposure and understanding of risk in a broad sense,” he says.
In line with this, one of the portfolio building blocks named innovation, has shifted its focus from investments per se to implementation and process innovation.
About five years ago, 2 per cent of the invested capital was made available to the innovation committee which focused on investment innovation, finding opportunities to invest in areas such as intellectual property, energy efficiency, insurance risk and early stage start up investments.
Now that innovation focus has shifted to process and implementation around investments.
“This is logical because the result from the innovative investments process was more than 100 ideas, so it is natural the ideas will dry up,” Wuijster says.
Another part of the focus with this last review was an improvement in liquidity management, processes and systems.
“We are stress testing and more closely monitoring our liquidity needs.”
In addition risk management has been heightened and in particular a focus on improving the links between ways to manage risks.
“Risk is more than just a statistical analysis. We’ve been looking at the overall risk management and individual risks in individual asset classes and how we are bringing it all together.”
ABP strategic investment portfolio
| Investment mix | 2009 | 2010-2012 |
| Government bonds | 10% | 10% |
| Price indexed bonds | 9% | 12% |
| Corporate bonds | 21% | 16% |
| Alternative inflation | 7% | 7% |
| Global TAA | 2% | 3% |
| Equities, developed markets | 24% | 20% |
| Equities, emerging markets | 5% | 7% |
| Private equity | 5% | 5% |
| Real estate | 8% | 9% |
| Infrastructure | 1% | 2% |
| Commodities | 0% | 1% |
| Opportunity fund | 4% | 4% |
| Hedge funds | 4% | 4% |
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