When comparing Dutch pension funds’ investment returns, PDN’s returns are relatively low relative to those of the 100 large Dutch pension funds. Why is that?
There are three reasons for the low returns:
1. PDN opted for a low interest rate hedge
We use special investments to limit the consequences of a fall in interest rates. We call this ‘interest rate hedging’. PDN opted for a relatively low interest rate hedge. The majority of Dutch pension funds opted for a higher interest rate hedge. If interest rates fall, a high interest rate hedge results in positive returns. Interest rates have fallen in recent years.
Why did PDN opt for a low interest rate hedge?
PDN based its strategic investment policy on a global perspective of low economic growth and high government and company debt, with modest expectations of returns on capital markets. In this scenario, PDN assumed that interest rates were reaching the bottom and would not fall much further. However, interest rates did fall further, which is why PDN has profited less from the fall in interest rates than pension funds with a higher interest rate hedge.
2. PDN is a grey fund
PDN’s membership is relatively old, and is therefore referred to as a ‘grey’ fund. ‘Green’ funds have a young membership and can afford to take more investment risks. They select investments with a stronger focus on achieving returns in the long term. The expected return on investments is therefore structurally higher than for a relatively ‘grey’ pension fund.
‘Grey’ pension funds take a relatively risk-averse investment approach for the entire membership and the expected return on investments is structurally lower. Moreover, the obligation term of ‘grey’ funds is relatively short term. They benefit less from a fall in interest rates than ‘green’ funds. PDN cannot influence this aspect and this is largely independent of its chosen investment policy.
3. The investment composition
PDN has opted for a certain investment distribution based on the risk appetite. We use what is known as a matching portfolio and a return portfolio for this. A matching portfolio focuses on taking limited risks, while a return portfolio focuses on realizing returns and excess returns. A return portfolio involves higher risk investments.
A continued fall in interest rates and higher returns on high risk investments have resulted in relatively high returns in recent years. The size of PDN’s return portfolio has been somewhat lower than other Dutch pension funds over the past seven years. This means that PDN’s returns lagged behind other funds that opted for a different interpretation within the return portfolio.