Dutch fund tackles the cost and time of shifting to DC

For the team at the administrative office of Dutch asset owner PWRI, the €10 billion pension fund for people with disabilities, the country’s transition from defined benefit to a new defined contribution pension system is all-consuming. PWRI will transition at the start of 2025, although the deadline for the €1.45 trillion ($1.6 trillion) industry to transition  isn’t until January 2028.

Imke Hollander, senior advisor to the board’s investment committee, lists a complex process ahead of the deadline that includes frequent modelling of how the new portfolio will look; time-consuming board approvals for every change to ensure everyone understands, and long meetings with different stakeholders including unions and employers.

“Communication is the really hard part,” she says.

Political uncertainty has also been injected into the process following last year’s elections, and Hollander believes there is now a chance that policy makers might change course. Another element of jeopardy includes service providers readying their systems by the deadline. Like APG, PWRI’s pension administrator, which must provide changes to its software and administrative systems in time, ensuring this side of the process, including all data and formatting, connects to their investment managers.

One reason for the transition to a new DC system is to encourage the country’s pension funds to invest more in risk assets. Retirement income promises under the DB system will be replaced by a new system tied to contributions and investment returns.

While many funds are preparing to invest more in equity, Hollander says PWRI’s asset allocation will not change much. Mostly because the fund is on a de-risking trajectory because it doesn’t have many young participants joining (although it is still open) plus the fact it already has a 50 per cent allocation to equity and real estate.

Although she expects a deeper division between the portfolios serving PWRI’s different demographics, she is not expecting much change. “We won’t be investing more in equity and other more risky assets. Having half the portfolio in those assets, is already pretty risky,” she says.

A bigger impact from the transition will be felt in PWRI’s hedging policy. Like many other Dutch funds, PWRI has seen its solvency ratio improve off the back of higher interest rates and is now seeking to lock in those benefits before the transition. Increasing the hedging position in the short term protects against a reduction in the solvency ratio if rates go down, she explains.

PWRI currently hedges over 60 per cent of its liabilities, up from 30 per cent a few years ago. “Now interest rates look steadier we’ve decided to increase our hedging levels and de-risk to make for a smoother transition,” she says, adding additional hedging will be done via swaps. In January 2024 PWRI had a coverage ratio of 123.3 per cent

The transition is also adding a layer of complexity to decisions to invest more in illiquid assets. PWRI has room to invest more in assets like infrastructure, but she says the board is wary of doing so at this juncture. These types of assets will be more difficult to value in a new DC world where participants will want to know what they own, and how much they can expect in retirement, she says.

Moreover, the team is too busy to consider partnerships with other investors, something that could help PWRI, a relatively small fund, access these types of investment and build on successful allocations that resonate with beneficiaries. “I don’t know if we are large enough to expand our investment in infrastructure. You need to make large investments in these types of assets. There are ways to do it with others, but this is not the time.”

Preparing for the climate transition

PWRI is also focused on the other transition shaping institutional investment. The climate transition continues to push the portfolio in particular directions. For example, the board are reconsidering the role of convertibles because they haven’t done as expected. Sitting between equity and fixed income, this allocation was not as much of a downside buffer as hoped, and it has been difficult to integrate ESG into the convertibles portfolio.

“It’s hard to get the ESG scores right and have enough performance.  I’m sure people out there can do it, but in the last couple of years, convertible bonds haven’t worked as expected for us.”

Hollander is currently helping the board to explore how best to reduce emissions in PWRI’s high yield allocation in line with a recent commitment to achieve net zero across asset classes. The team have made progress in global credit and equity where it uses discretionary mandates to ensure ESG integration. But integrating net zero in high yield is complicated by the lack of data and the fact reducing emissions in the portfolio directly impacts performance. “We only have data on a very limited amount of the portfolio, and engagement is difficult,” she says.

And PWRI isn’t just worried about climate scores in high yield. It also needs the social scores of the underlying companies in the allocation to improve. It has developed its own restrictions on which companies it invests in, which it implements helped by fiduciary manager Columbia Threadneedle in a decades-long relationship. “As the biggest customer in a number of their funds, we have been able to introduce bespoke restrictions,” she says.

PWRI’s investment beliefs, reduced to five from ten in 2022, seek to guide the team on how best to balance costs, performance, and sustainability so that ESG doesn’t cost too much, or dent returns. The team hope it has hit this sweet spot in the move from active to semi-passive in equities. Using two managers across developed and emerging markets PWRI has given up some upside potential because the strategy isn’t wholly active, but the approach follows a benchmark which the fund developed with ESG-restrictions and only costs a few basis points in fees.

Still, beliefs do come at a cost. PWRI has wound down its private equity allocation because of a lack of transparency in the asset class and double fee layers. Although it still has around 1 per cent of the portfolio in private equity, it won’t invest more.

As the conversation draws to a close, Hollander reflects on the biggest winners of the Netherland’s transition to a new pension system so far. It might turn out the new system is cheaper, but the costs are mounting up, mostly in fees to consultants. For a pension fund enduringly mindful of fees and the impact they have on beneficiary returns, advisor fees is a growing source of angst. “Consultants are doing very well out of this,” she concludes.