As the well-respected Dutch pension system sits in a state of reform limbo, long-time trustee and MKB-Nederland representative in the recent round of negotiations on pension reform, Benne van Popta, has particular ideas on how to improve the system.
The combination of low interest rates, an ageing population and increasing life expectancy has prompted a discussion, and protracted negotiations among the social partners, about the structure of the pension system in the Netherlands.
The likely result is a move away from defined benefit to a defined-ambition pension system, which will mean a revolutionary shift in the system via a transfer of risks to the employee.
In the Netherlands this is a big deal, according to Dutch insurance industry figures (Verzekerd van Cijfers 2011) about 78 per cent of Dutch pension plans were defined benefit in 2010.
Benne van Popta, a former Ministry of Finance employee, has been a trustee in the Netherlands since 2000 and also sits on the European Federation of Retirement Provisions on behalf of the Dutch Pension Federation and is vice chair of the European Insurance and Occupational Pensions Authority.
He has some observations about the implications of the new regime and ideas of his own on how to link pensions and longevity for a more sustainable system.
“Under the proposed reform each fund can choose between the two types of contracts: a nominal contract with a nominal risk-free discount rate and some flexibility; and a real contract with a real, somewhat return-related discount rate and more flexibility. At the moment all Dutch funds have the same contract and the same nominal risk-free discount rate. The impact of the new second contract is a transfer of risks to employees.”
He says there is a fiduciary duty attached to shifting the responsibility to the member, which will mean providing a more transparent story about the risks and promises in the system.
The Melbourne Mercer Global Pension Index, which compares retirement-income systems around the world and rates them based on their adequacy, sustainability and integrity, has consistently rated the Dutch system as number one (see tables).
Melbourne Mercer Global Pension Index ratings system:
| Grade | Index value | Description |
| A | >80 | A first class and robust retirement income system that delivers good benefits, is sustainable and has a high level of integrity. |
| B | 65–80 | A system that has a sound structure, with many good features, but has some areas for improvement that differentiate it from an A-grade system. |
| C | 50–65 | A system that has some good features, but also has major risks and/or shortcomings that should be addressed. Without these improvements, its efficacy and/or long-term sustainability can be questioned. |
| D | 35–50 | A system that has some desirable features, but also has major weaknesses and/or omissions that need to be addressed. Without these improvements, its efficacy and sustainability are in doubt. |
| E | <35 | A poor system that may be in the early stages of development or a non-existent system. |
The Dutch pension system’s ratings as of 2011
| Score | Ranking | |
| Overall Index | 77.9 | 1st |
| Sub-indices | ||
| Adequacy | 75.9 | 1st |
| Sustainability | 70.8 | 3rd |
| Integrity | 91.4 | 1st |
Beautiful building, bad furniture
How is it then that the Dutch pension system, revered as the best in the world, is in trouble?
“I have a metaphor for that,” van Popta says. “You can build a beautiful building but the furniture is terribly bad. With regard to the Dutch pension system, the organisational and economic design is good, but if you don’t make good decisions it doesn’t work.”
He points to two pieces of “bad furniture”: the retirement age and the liability of the fund, which has increased by 12 per cent in the last five years because of longevity.
“We haven’t had the contributions or returns to fund the system,” he says. “Changing the retirement age is a political debate but it is also sartorial. People are working longer, it is a mental change, and important for social partners, if you don’t link them, there’s a problem for the pension. If you don’t meet return expectations, you don’t reach the pension ambition.”
The current level of contributions in the Netherlands is about 13 per cent of total wages, and there is a proposal that this will now be capped, but the Netherlands Bureau for Economic Policy Analysis (CPB) has said this will need to increase to more than 17 per cent of gross salary by 2025 to maintain the current benefit levels.
The van Popta proposition
Van Popta believes two fundamental changes need occur in the system. The first is to link the retirement age to longevity, and the second is a faster link between the return on assets and the pension ambition.
The current retirement age in the Netherlands is now 65, and the outgoing government proposed increasing that to 66 in 2020 and 67 in 2025.
“My view is that is 10 years too late,” says van Popta, who is also the vice chair of the occupational pension stakeholder group of the European Insurance and Occupational Pension Authority.
It is a difficult time in the Netherlands, with a temporary political platform in place following the resignation of Mark Rutte’s government in April and an election scheduled for September.
In the meantime the “in between platform” is proposing to increase the retirement age in 2013 by one month and gradually increase it.
“They are starting earlier with small steps,” he says. “Change is difficult in the Netherlands right now, confidence is low, there has been a fall of a cabinet, we’re in the middle of the euro crisis, there’s a recession, and a polarisation in public debate.”
Van Popta’s view of how a proposed flexible defined-benefit, or a “collective defined-contribution” system should work means the defined-benefit expectation would be adjusted to certain changes in longevity and the market. It won’t be quite as individual as defined contribution.
“The proposition includes a change every five years to the official retirement age based on longevity research and then a subsequent change in pension,” he says. “There is a difficulty because on the one hand changes are necessary to make, but making change happen is more difficult.”
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Tail risk and hedge fund returns
Reducing equities, expanding the resources and changing the RFP process are on the agenda of New York City Retirement System (NYCRS) chief investment officer, Larry Schloss, as he makes structural and investment changes to turn the $123-billion fund around.
Two and a half years in to what is most likely only a four-year tenure – the CIO is appointed by the New York City comptroller, currently John Liu, who is an elected official with a four-year term – Schloss is making impact despite the structural hurdles in the way decisions are made and assets are allocated.
Schloss began life as the deputy comptroller, asset management and chief investment officer of NYCRS in January 2010, after spending his entire career in the private sector, predominantly in private equity, which included co-founding and leading Diamond Castle Holdings and as global head of CSFB Private Equity.
At the time he came to be CIO, the fund had roughly a 70:30 growth bias split and hadn’t done an asset allocation review for five years.
Over the 10 years before 2010 the fund had a return of 2.7 per cent, against an actuarial rate of 8 per cent, and one of the first things Schloss discussed with the board was whether they “really wanted a wild ride of the public-equities markets all of the time”.
“Once it was decided to reduce volatility, it followed that equities would be reduced,” he says.
Under his watch there have been a number of asset allocation changes.
For a long time the fund just invested in public equities and core fixed income, with high yield bonds introduced in the late 2000s and private equity in the mid-2000s
“We looked at the asset allocation and said what do you change? We missed most of the emerging markets rise, because we were very US-centric, so we thought we should allocate more to emerging markets, and decided to allocate less to US equities and less to total public equities overall.”
So the fund took about 10 per cent off its public-equities allocation and introduced hedge funds for the first time, allocating between 4 and 5 per cent, as well as 5 per cent to opportunistic fixed income.
“With opportunistic fixed income we had partners and allowed the mandates to move around,” he says. “We now have 10 per cent in smart, nimble money.”
The investment team also got a bit more aggressive in managing the asset allocation tactically and now can move within a 5-per-cent-asset-allocation band.
At the Big Apple’s core
NYCRS is made up of five pension funds – one each for the teachers, employees, police, fire and board of education – and each of those funds has its own asset allocation and own consultant.
Across the five funds there are 58 trustees, which is strangely juxtaposed with the NY State Pension Fund’s one trustee, the state comptroller.
The representation is equally split between the government and unions, with both Mayor Bloomberg and Comptroller Liu appointing representatives.
| The asset allocation at the end of March this year was: | |
| 41.36% | US equities |
| 28.1% | fixed income |
| 18.6% | international equities |
| 6.8% | private equity |
| 5.14 % | private real estate, hedge funds and cash |
When Schloss came on board as CIO, he suggested he should be on the board as the comptroller’s representative.
“It’s second nature for me to be on the board, I’m a private equity guy,” he says. “CIOs should be on boards of public pension funds.”
If there is a time at the board meeting when there is a discussion around management, for example, then they can leave, he says.
Across all the funds NYCRS employs 360 managers, of which 110 are in private equity and 50 are in real estate.
Globally there is a trend for pension funds of NYCRS’ size to expand internal resources, and it would be a natural progression for the fund. Since Schloss took up the job the in-house team has gone from 22 to 35.
“There is a resourcing issue within the asset management department,” Schloss says. “The fund finds it hard to attract the right people, partly because of pay levels.”
The fund’s asset management office is only a few blocks from Wall Street and the irony is not lost on Schloss. The average salary of the investment team at NYCRS is $100,000, the CIO gets paid $224,000 and there are no bonuses paid. Furthermore, the fund can only hire people that live in the five boroughs of NYC.
“If you work at NYCRS you have to live in NYC, so on a cost-adjusted basis the pay levels are dire,” he says.
There is still a lot to be done in terms of governance reform at NYCRS.
“We have five funds, five general consultants and five specialist consultants. I like having consultants but I think it is overly cumbersome,” he says.
While the CIO can be appointed from within, that has not been the practice in the past. Instead the position has been appointed by the comptroller. Succession planning is a problem that has repercussions on decision-making and subsequently returns.
“I would like to see the city hire a successor with close-to-market compensation. It’s in the world’s financial capital, that’s what frustrates me the most.”
So with potentially only 18 months left on the job, Schloss is focusing on what he thinks he can achieve, which is to change the procurement rules, the way the fund issues RFPs to become more nimble and assure the selection of the highest quality managers.
“My aim when I got here was to leave the fund better than when I found it,” he says. “One of our key initiatives is trying to change the procurement rules. To do that we would have to change the law, if we could get that done it would be very impactful.”
Formerly, the process was an advertisement placed in various media and managers applied based on the ad. Managers could only be selected from those who applied.
Now the fund still advertises but consultants can also give their recommendations and managers can be selected from the consultants’ recommendations.
“Before we came it took 18 months to select a manager; we want to get that down to six months.”
Investors should reconsider their currency hedging strategies as an undervalued US dollar is predicted to strengthen according to Colin Crownover, State Street Global Advisors global head of currency management.
The US dollar is as much as 10 per cent undervalued relative to other major currencies, says Crownover, who also forecasts that the economic-growth gap between the US and emerging markets will narrow in the coming year.
“We are bullish about the US dollar and not because the US economy is without the problems it certainly has,” Crownover says. “But currencies as always are a relative endeavour and of the major economies, the US economy has lesser issues than the others.”
Crownover’s views on the US dollar are within a context of slowing global growth and the eurozone “slightly slipping into recession”.
“Regardless what people say about China, the United Kingdom or Japan, there are really only two games in town and, in terms of large liquid investments, there are US-dollar denominated assets and euro-denominated assets,” he says.
“So, whether you are central bank or an institutional investor, if you have concerns about the euro-project – which it is valid to have – then at the margin that causes an allocation away from eurozone assets into US assets.”
Crownover cautions that the attractive relative valuations of European equity markets compared to potentially expensive US equity prices may mitigate some of these allocations away from euro assets.
The US dollar has shown counter-cyclical characteristics in recent times, with the currency strengthening when investors look to shed risk at times of market uncertainty, according to Crownover.
He notes the US dollar is now “a good diversifier” in the basket of currencies an investor holds, balancing out other pro-cyclical currency exposures.
Crownover recommends US-based investors look to slightly increase their ratio of hedged assets, given the likely appreciation of the US dollar.
“Our analysis would tend to indicate that 50 per cent is not a bad hedge ratio for the US over the long term. But you probably want to do a little bit more today because the US dollar is undervalued.”
Slowing dragon, emerging markets
The softening in world growth is set to hit exporting countries in Asia, and Crownover predicts that China will slow more than many market pundits suggest, while Japan could be a potential bright spot in the region.
“Relative to what is happening in the global economy, you are seeing a bigger impact on emerging markets this time around than you did at the advent of the GFC.”
Crownover notes that the Organisation for Economic Co-operation and Development’s leading economic indicators for the US and Japan show that they are holding up in the face of slowing growth, with China showing signs of its deceleration picking up pace.
“The leading economic indicators look gruesome for China, dropping by about 3 per cent year on year. So, in our opinion China is slowing down by more than what the official statistics would have you believe,” he says.
State Street’s view is that the Chinese economy will grow by 7 per cent and could even slow further if the central government decides not to carry out fiscal stimulus.
The company is not alone in its pessimistic outlook for China, with fixed income giant Pimco also warning at the start of the year that China could slow by more than many were forecasting.
Like State Street, Pimco sees growth as closer to 7 per cent than the 8 to 9 per cent typically predicted.
Buy and hold doesn’t pay
While acknowledging the underlying fundamentals of emerging markets generally, Crownover is quick to dispel what he sees as a myth regarding currency exposure to emerging markets.
It is common to hold broadly unhedged positions in emerging markets, with the view that over time emerging market currencies will appreciate against the US dollar on the back of relatively strong economic growth and healthy sovereign balance sheets.
Crownover says there are times when this buy-and-hold strategy for emerging market currencies has played out, such as the period leading up to and during the financial crisis, but over the long-term this approach has not paid off.
“For a US-dollar investor a market capitalisation basket of emerging market currencies has lost almost 10 per cent over the last year. If an investor simply bought and held that same basket of currencies over 10 years, they made exactly zero,” he says. “So there are periods when it looks quite good, but over the long run this has not added much alpha to a portfolio.”
Crownover says the underlying fundamental strength of emerging markets is already built into the price of most of these countries’ currencies.
Despite the recent sell-off, most of these emerging market currencies are overvalued, according to Crownover.
“Our advice to investors right now is if you hadn’t done emerging-markets-currency hedging previously, this might not be a bad time to do so,” he says.