Changes in regulation and increasing pressure on pension funds to bridge the gap between assets and liabilities has resulted in schemes looking at liability-driven investment (LDI) strategies as a solution for the long-term funding problems. Although the number of pension funds that have already put LDI strategies in place is not as high as predicted some years ago, the trend seems to be here to stay and some have already made the move.
This is the case with the Stichting Laurus Pensioenfonds – the pension fund of Dutch food retailer Laurus - which recently decided to review its investment strategy by introducing an LDI approach in its investment portfolio.
Established in 2001 after the merger of two pension funds – Vendex Food (Edah) and De Boer Unigro – the Laurus pension fund now manages around €400m in assets, with around 12,500 active members, 15,000 deferred members and 1500 pensioners.
Regulatory change was the main catalyst behind the decision by the board of the pension fund to review the scheme’s structure and investment portfolio. “We came into this situation because of the introduction of the market value environment by our regulator,” says Dick Kamp, manager, pension affairs at Laurus. This, added to the advent of a new regulation that ends the favourable tax treatment of early retirement and pre-pension provision in the country, made it clear that changes to both the structure of the scheme and its investment policy had to be introduced.
Under the new structure the pension plan remains an average-pay scheme and, in compliance with government policy, is based on a retirement age of 65, up from the previous 62. It consists of a basic scheme and a top-up one that follows a defined contribution (DC) model. However, employees will have more flexibility in terms of early retirement and part-time pension options.
Mr Kamp explains that this new environment required a change in investment policy to reduce interest rate risk. “We decided we needed to have investment returns well above market interest rates just to make sure that the nominal pension could be increased,” he explains. “It is all about managing the coverage ratio. It is a very holistic view of assets and liabilities management.”
The starting point was the conduct of both an asset-liability modeling (ALM) study and a risk budgeting study. “We really wanted to achieve a balance between risk and reward,” he says. In order to get there it was necessary to come up with an optimal strategic asset allocation, trying to find the best managers in the world and an increased focus on governance.
“In reducing the interest rate risk for a large part of the portfolio through duration matching, we were able to expand on the riskier asset classes and increase our allocation to equities and alternative investments,” Mr Kamp says.
Currently the fund invests 66 per cent of total assets in fixed income, 30 percent in equities and around 4 percent in alternative assets. The alternative part is mainly invested in European real estate but the board is considering an additional exposure to commodities and funds of hedge funds. “We think we have found a balance between risk and reward,” he says. “We have a duty of care towards our participants and we think we have achieved that.” On top of this the fund has no strategic views on interest rate developments because “we can’t afford to make interest rate bets”.
The new asset allocation has brought greater diversification to a portfolio that is now better designed to meet the medium and long term funding requirements of the fund.
“At the moment we are quite happy with what we have so far but we are looking at increasing the alternative assets allocation,” he says. “In the end, based on research and taking into account the financial position of the pension fund, we would like to have a situation where we still have most of our liabilities invested in fixed income – so we don’t run into risk there – and all the extra monies we might have, our reserves, invested as much as possible in riskier assets like equity and alternatives.” He explains that in order to achieve that they will have to arrive at a situation where they have a lot of reserves and “at the moment this is not the case”.
In order to put theory into practice, and with the help of investment consultants Watson Wyatt, the fund started its manager selection process. On the fixed income side, Pimco was awarded a €240m mandate to be managed following a tailored benchmark with a 3 per cent tracking error. In order to outperform a benchmark which closely matches the fund’s liabilities, the asset management firm will be investing mainly in Eurobonds but also in other markets where they can find opportunities for generating excess returns. In equities, the big winner was AllianceBernstein, which managed to secure a €100m global equity brief. These two managers replaced ING and Robeco, who under the old structure were in charge of two balanced mandates for the fund each worth €170m.
In terms of custody, and as part of this restructuring, Laurus picked Northern Trust as global custodian, as well as choosing Northern Trust Global Investments – the firm’s asset management arm - as a transition manager to supervise the transfer of assets to the fund’s new managers. At the time of the announcement Mr Kamp said that being able to work with a single provider on both assets would be a major benefit for the pension fund.
He says he is happy with the way the fund has been performing since the changes were introduced. “Certainly the performance is better than it would have been if we had continued with the old strategy.” He is particular pleased with the flexibility that the new structure gives when it comes to assessing the work of their managers. “We can quite easily get another manager in if we need to. We came from a situation where we had balanced mandates and now we have moved into discretionary investing with a number of asset managers,” he explains. “We are much more flexible in the hiring or firing of managers.”
However the new framework also means more dedication is forthcoming from both the investment advisory committee and the board. “Certainly this way of investment requires more energy from the pension fund,” Mr Kamp says. “You have to be much more on top of things than in the previous situation.”
As a consequence everything related to governance issues has assumed greater significance. “Every two years we will perform an ALM study and a risk budgeting study and from there we will reassess to see if the strategic asset mixed is still where it should be and if we are still satisfied with the risk allocation given the circumstances,” he says. “Also, we have a quarterly review of the performance of the asset managers where we look at their skills, their internal administration and processes.” This assessment will establish whether the asset manager still delivers the level of service they did when they were hired or whether there are any significant reasons for concern.
“Obviously you choose your fund managers by looking at the people, processes and past performance and we follow them up to see if there is any reason to adjust the portfolio,” he says. “On a quarterly basis we look at other asset managers in the universe to see if there any ‘new kids on the block’ that are doing considerably better than ours,” he says adding that the fund also performs compliance monitoring on a daily basis.
The challenge for the future will be to see whether the new set-up proves to be successful in the long term. In the current regulatory environment the Laurus case will no doubt attract the interest of other pension funds in the same situation. “Slowly in the Netherlands you see more pension funds following a
LDI approach, but this is not happening on the giant scale we expected two or three
years ago.
Summarising the changes implemented by the scheme to date, Mr Kamp concludes: “We have been driving this car for a year and so far, so good. We’ll take one step at a time.”
