Dutch fund bolsters bonds, chills on bricks

Things are suddenly looking cheerful again in the world of Dutch pensions.

The country’s famous tulip fields might not be set to bloom until April, but investors already have a harvest to delight at from a good year of investing.

For instance, Hans de Ruiter, chief investment officer of the €2.5-billion ($3.36-billion) TNO pension fund in the Netherlands, can look back on a 14.8-per-cent investment return in 2012.

It is a real sign of how positive 2012 was as an investing year that de Ruiter can label such returns as “unexceptional”. The TNO fund only just beat its benchmark after all, and de Ruiter can point to many other Dutch funds with similar or superior returns. De Ruiter says that younger pension funds in the Netherlands that follow liability-matching strategies similar to TNO’s boast even stronger 2012 results. The TNO fund, formed in 1939 by the TNO scientific research institute, has a medium average-liability duration of 15 to 16 years.

The investment returns are a definite relief in any case to the funding position of TNO’s pension fund. The fund has emerged from a deficit to post a 4.8-per-cent surplus at the end of 2012.

This surplus beats the TNO fund’s minimum requirements and therefore reduces the threat of the fund imposing benefit cuts on its 15,000 members.

It is not just a tale of miracle returns restoring the fund to health, however.

While supported by the investment gains, the 5.1-percentage-point overall boost to the TNO fund’s funding position in 2012 was largely carried by the introduction of the new ultimate forward rate in September as part of the Dutch pension reforms.

Fixed income switching

De Ruiter says that the TNO fund will be keeping its diversified, liability-matching asset mix broadly identical in the year ahead as it aims to build on recent gains. Among its alternative holdings, the fund has over 10 per cent of its assets in private equity, over 5 per cent in property and close to 3 per cent in interest-rate and currency hedges.

The most significant recent changes have been within the bond portfolio. These have seen the fixed income holdings increased from under 50 per cent to 56 per cent of assets.

Intriguingly, government bond holdings have been increased as part of the TNO fund’s fixed income drive. At 18 per cent of the fund, government holdings still have less than half the combined presence of corporate, high yield and emerging market debt, however.

De Ruiter explained that the recent bond purchases have been inspired by a reduction in the fund’s swap overlay. Interest rate risk is now just 55 per cent hedged at the fund, a reduction of some 10 percentage points. “We want to be less dependent on swap overlays and do more liability matching through physical positions” de Ruiter says. A desire to reduce leverage and counterparty risk on the balance sheet were cited by de Ruiter as reasons for this move.

De Ruiter admits he is concerned at the low yields offered by the German, Dutch and French government bonds that make up the majority of the TNO fund’s holding of state issues. However, with European corporate debt holdings also being beefed up, he is confident that the overall asset mix better matches liabilities with this move.

Cool on bricks and hedges

Real estate and hedge funds are asset classes that have stepped aside to make space for TNO’s bolstered bond position. De Ruiter explains that the fund has underweighted real estate to 5.5 per cent of the portfolio – half its 2010 position – following a disastrous minus 16.6 per cent performance in 2011. A one-off hit from since disposed-office structured-debt investments contributed to those poor returns. The asset class is proving to be “still disappointing” for the fund, however, with minus 6.6 per cent returns from real estate being the single blemish on the 2012 performance figures.

A globally diversified real estate portfolio has not been able to help things of late. “There are clearly a lot of issues such as overcapacity in various countries which have kept us from investing in recent years,” de Ruiter says. While he feels there will be a “difficult environment” for real estate in the next few years, he remains confident in the asset class’s long-term potential.

De Ruiter is, however, less keen on hedge funds, labeling the asset class “too expensive and lacking transparency”. TNO’s hedge fund portfolio performed worse than its equities in 2011, losing 7.2 per cent of value. De Ruiter explains that since then, the TNO fund has divested from a fund-of-funds position and is in the process of incorporating the rump of its hedge fund investments into its private equity portfolio. The TNO fund, though, will retain the option of investing in hedge funds on an opportunistic basis when it can identify good managers.

Private equity for its part has been overperforming of late, with 8.3 per cent returns in 2012 following two years of double-digit returns. The fund has decided not to make new private equity investments until the end of 2013, while allowing existing mandates to expire, in order to bring the asset class down to the 7-per-cent holding that it has strategically targeted.

Sitting tight with passive equities

The 16-per-cent return on the TNO fund’s $668-million-plus equity holdings was the strongest of all in 2012.

TNO has benefited from a wide geographic spread, with 39 per cent of equities invested in US firms and 24 per cent in emerging markets at the end of 2011.

The equity portfolio has been managed completely passively since the start of 2012. “There were no strong indications of the added value of asset management over a long time horizon, so we came to the simple conclusion it might be better to invest passively, as cheap as possible” says de Ruiter.