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Recessions are a feature of the economic & market landscape. Yet are revealed with a lag, which is why investors often rely on recession probability estimates.
Aug 24, 2023
Five key things CIOs need to consider as transition plans unfold
As the Dutch Pension Federation calls on pension funds to prepare for the Future Pensions Act (WTP), three things are certain about the Netherlands’ transition to DC: it will be complicated, interpretations will vary, and each pension fund is likely to have a bespoke approach. In this quick take, we look to five key things CIOs might want to consider as they set out on their transition journeys.
“The compass guiding pension funds will shift from coverage ratio and discount rates to expected return and the levels of certainty in achieving this new return yardstick.” Hanneke Veringa, Executive Director Netherlands, PGIM Real Estate
The processes set to meet the regulatory and economic frameworks of the last 10 years will no longer be optimal in the future landscape. Investment structures will need to be re-drawn and ratified to integrate transition requirements and ‘endgame’ considerations. A revised catalogue of questions such as ‘How much liquidity will we need when investing in alternatives?’ and ‘How do we report on our financial and ESG performance in these asset classes?’ will need to be formalised to reform investment principles at the outset. Whatever the outcome of these revised principles, flexibility will be key, particularly when it comes to the allocation of alternatives.
Another factor to consider will be management of the ‘solidarity reserve’. Pension funds will influence how this ‘buffer’ of up to 15% of the fund can be filled, and when it will be used to navigate financial headwinds. A separate investment policy is likely here, as funds will likely look to low risk investments to bring greater equality and stability to benefits, with a view to levelling out the potential outcomes between different generations. Whilst the final purpose and size of this reserve may vary for each pension fund, most will target capital preservation and inflation protection.
“The new system allows regulators and pension funds to rethink asset allocation and private markets appetite.” Dr Bruce Phelps, Managing Director, PGIM Institutional Advisory & Solutions
The pooled, collective risk-sharing inherent in the new DC system allows for greater diversification, and better access to private market opportunities. However, while regulators see the potential benefits of larger allocations to private markets for better returns and inflation hedging, they are apprehensive about how these larger allocations may affect portfolio liquidity. To capture the potential benefits of private markets, regulators and pension funds will need to develop ongoing tools and analytics to determine how best to allocate between private and public asset classes, and particularly how to allocate across the spectrum of private assets.
“New risks will emerge as retirement income becomes dependent on investment returns and contributions; in particular the potential erosion of the real value of pensions by inflation.” Stephen Oxley, Managing Director, PGIM Institutional Relationship Group
As members’ allocations shift over time from growth assets towards matching assets to follow a lifecycle pattern, CIOs will need to think about maintaining exposure to inflation-hedging assets - even into the retirement phase - to protect the real purchasing power of beneficiaries. Annuities will be exposed to market volatility, leading to scenarios in which funds will need to consider leaning into the solidarity fund to maintain real retirement incomes. Whilst the goal of the WTP is to allow pensions to more directly adapt to economic developments to create greater pension benefits with more purchasing power, how real purchasing power unfolds remains to be seen.
“The transition goes far beyond solving for a new investment paradigm.” Anna De Jong, Principal and Head of Client Advisory, Benelux and Nordics, PGIM Fixed Income
The sheer volume of funds that will be leaning on their administrators to help them shift legacy DB systems into a new DC landscape creates an immediate capacity issue. An operation of this scale seems ripe for data errors. CIOs might need to plan for crisis comms should members be impacted by inaccuracies.
What’s more, funds will be grappling with the task of communicating to members in a way the helps them not just focus on the short term value of their individual pension, but on the long term projection of the pension they can expect to receive. The WTP introduces a second regulator – the AFM – which currently regulates personal finance products. Ensuring that members are adequately informed about pensions as ‘investment products’ will be a significant undertaking. The personalisation and optimisation of materials – both in content and across platforms – will be vital. Are administrators set up with the dedicated marketing, communication and digital functions that are likely required to ensure that pensions live up to the bar set by the personal finance industry?
Given that the new system will need to account for a broader range of outcomes, pension funds might simplify stochastic analysis of expected returns to communicate ‘good’ and ‘bad’ weather scenarios to members. But the issue of advice in general remains; individuals will need access to high quality, low cost guidance in the areas of asset allocation, withdrawal and spending rates, retirement age and more.
“It’s anticipated that a number of corporate pension funds may seek insurance based de-risking solutions which will ensure capital-backed guarantees for members.” Rohit Mathur, Head of International Reinsurance, Prudential Financial Inc.
Increased activity in the pension buy-out de-risking market will attract new entrants to compete for these insurance-based solutions; supply of capital from Dutch insurers may not be sufficient to cover buy-out demand. The market has already seen strategic partnerships form between local and foreign insurers to open up additional capital and capacity resources (for example Lifetri and Legal & General). Insurers may also turn to longevity reinsurance to manage their capital positions under Solvency II capital rules. Attractive longevity risk pricing and the availability of capital and expertise from global reinsurers will increase affordability of pension buy-outs, and drive the growth in the risk transfer market.
Bas van Zanden, Senior Pension Analyst Rabobank and Board member Rabobank Pension Fund
“It’s likely that most of the large industry wide, multi-employer funds will make the choice to follow the ‘solidarity’ contract. Some corporate pension funds for individual employers may choose the ‘flexible’ contract particularly for higher-paid members in professional services.
In ten years or so I don’t think much will have changed in terms of the asset allocation of the funds that take the ‘solidarity’ route. There will be changes in the matching portfolio – shorter duration because it will predominantly be there to manage the risks of pensioners and there will no longer be a funding standard to match.”
Hans de Ruiter CIO, TNO Pension Fund and Board Member of PMT
“I expect we will invest more in private markets – I like to think of our portfolio allocations in broad building blocks– Equity, Fixed Income, Real Assets – and whether they are private or public is less important. If we allow ourselves enough flexibility within the building blocks, illiquidity is less of a problem; it’s all about design. Private market investments have the benefit of providing smoother returns which will make the reported pension value less volatile. Also, if we are to meet the ambitious impact and ESG goals of our pension fund boards then private markets must play an important part as we move into infrastructure and other assets that will assist the energy transition. ‘Real ambition’ or inflation protection can be targeted by increasing investments in inflation-linked investments both private and public.”
Recessions are a feature of the economic & market landscape. Yet are revealed with a lag, which is why investors often rely on recession probability estimates.
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