Navigating the Dutch pension transition

Under the Wet Toekomst Pensioenen (“WTP”), the Dutch pension system will migrate from an essentially Defined Benefit framework to one more geared towards Defined Contribution. This change is the result of many years of debate between policy makers, pension funds and stakeholders.

The transition creates many action items for pension funds, with large changes to established processes. Amidst all of this, we believe that investment risks in the transition should be a ‘top of mind’ issue for pension fund CIOs, board members and other stakeholders.

Senior members of True Partner’s team have recently spoken at events in the Netherlands on investment risks in the transition, including at Pensioen Pro’s conference in Rotterdam.

Working in collaboration with Northern Trust, one of the world’s largest financial institutions, we have also published an article in Pensioen Pro magazine and written a white paper to help pension funds evaluate and navigate these risks, sharing market insights and expertise in risk management, hedging and transition management.

In the white paper we explain: 1) what is changing under the WTP; 2) how portfolios are expected to change, and why; 3) investment risks in the transition; and 4) how risks can be mitigated and considerations for transitioning underlying portfolios. As part of the paper, we include an illustration showing how our proprietary tools can model the effects of different market scenarios on the assets, liabilities, funding / coverage ratio and the distribution of assets in the transition.

Every pension fund has its own characteristics and our team can show how to apply this toolkit to a fund’s own particular situation. Please get in touch for a conversation.

Why does the transition make investment risks so important to consider?

The increases in interest rates over the last two years have led to improved funding / coverage ratios for many pension funds, though they have also led to capital losses on fixed income products. If funds are able to maintain funding / coverage ratios at similar levels, this will enable a smoother transition: pensions can be maintained, funds will be able to create solidarity or risk sharing reserves (where desired) and provide compensation for those groups disadvantaged by the changes. If funding / coverage ratios drop sharply, pension funds are likely to face much less attractive options. Our analysis suggests that many funds would see large drops in funding / coverage ratios in a severe recessionary scenario.

As others have also argued, we believe that the WTP changes are also likely to lead to more focus on capital growth for younger and middle-aged participants, leading to an overall increase in equity allocations and a decrease in very long-term interest hedges. This makes asset values relevant too, while underlying portfolio changes also need planning and expertise. Swings in interest rates could also lead to big changes in the share of assets received by different age cohorts.

While de-risking portfolios by reducing risk assets is a possibility, that also has a cost in foregone returns. With the cost of equity hedges in particular close to all-time lows, we believe pension funds may benefit from considering non-linear hedges to limit downside risk into the transition.

Where True Partner Capital can help

Amid all the action items in the transition, working with external partners can help. True Partner Capital is a global asset management firm established in 2010 by a team of Dutch derivatives specialists. The firm is specialized in trading volatility, providing its clients with tailor made investment and hedging solutions as well as commingled fund products. With offices in Amsterdam, London, Chicago and Hong Kong, True Partner Capital can assist pension funds to help secure a smooth transition.