RIJSWIJK, The Netherlands -- For Holland's Shell Pension Fund, the euro is here.
Four years ago, Shell pension officials projected European economies would converge with the expected adoption of European monetary union.
As a result, fund officials made strategic changes both in the fund's benchmarks and its European equity and bond strategies. The upshot: While most European pension funds are now struggling to come to grips with the advent of the euro, which starts Jan. 1, the Shell fund is years ahead.
"EMU will not alter our allocation," explained Kees van Rees, managing director of Shell Pensioenfonds Beheer B.V., which manages the 24.2 billion guilder ($11.8 billion) Shell fund. The fund is more than 90% internally managed.
That farsightedness is just one example of how fund officials have achieved a reputation for innovation and sophistication in the Dutch pension market, which is viewed by many as Europe's most advanced. It also has enabled the fund to generate returns that outpace most other Dutch pension funds.
The fund has been in the vanguard in areas ranging from asset-liability modeling, performance measurement, global tactical asset allocation and currency overlays.
The pension fund "always has been seen as a kind of a profit center" for Shell, explained Lou ten Cate, vice president at Wilshire Associates, Amsterdam, and a Shell pension official in the early 1980s.
Shell pension fund officials' views on the integration of European economies have led to changes in asset allocation and European securities portfolios that are miles ahead of the pack.
"We have considered Europe as our home market for quite a while," said Mr. van Rees. The fund has 55% of its assets invested in countries participating in the European exchange rate mechanism.
That outlook also led officials at the Dutch fund to remodel their European equity and bond portfolios early on.
In 1994, the fund created a sector-based pan-European equity portfolio, shedding traditional top-down country allocation views. Fund officials later melded their other European portfolios into a single pan-European approach. That bottom-up style now is being emulated by virtually every European money manager, as they see a broader and deeper European equity market emerging.
But the fund's "most spectacular success," said one source, has been its early bet on high-yielding European bonds.
Under then fixed-income chief Sijb Bartlema, who now oversees all of the fund's investments, fund officials figured EMU would result in convergence of bond yields. In addition, the underlying cheapness of various European currencies justified a shift into high-yielding European bonds on fundamental grounds.
Altering the bond benchmark to include other European countries, the fund put a huge bet on high-yielding European bonds, particularly in the southern European countries of Italy and Spain. In Italy, the convergence theme has narrowed spreads with German bunds to as little as 31 basis points from a 1995 peak of roughly 650.
Mr. Bartlema also created an arbitrage capability, enabling the fund to take advantage of pricing differences in the bond market.
Combined with a rising allocation to stocks -- now at a 66% -- the result has been superior performance for the fund, which is run from an industrial office park in Rijswijk, just outside The Hague.
Although 1997 performance data will not be released until April, observers expect a second consecutive year of dazzling returns, powered by the large equity allocation -- which is twice the level of the typical Dutch pension fund -- and stellar bond returns.
In 1996, when the high-yielding bond bet kicked in, the fund chalked up a total return of 22.7%, far above the Dutch pension fund industry median return of 15.2%, as measured by The WM Co., Amsterdam. Observers said bonds alone provided a nearly 20% return, more than double the fixed-income return of the typical Dutch fund, and should come in close to that level for 1997.
Observers trace the Shell fund's innovator status back to the early to mid-1980s, when officials decided to professionalize the fund's investment management operations.
Shortly thereafter, personal computers were introduced, placing vast amounts of information at portfolio managers' fingertips. Previously, for example, graphs had to be updated by pencil every day, or run through the mainframe computer.
During the late 1980s, the Shell pension fund adopted a team approach to investments. Emerging from separate fiefdoms for stocks and bonds, this ensemble approach enabled fund officials to make large tactical bets in the asset allocation. Now commonplace among big, internally managed pension funds, this type of short-term shifting -- involving changes in asset class, region, portfolio duration, currency exposure and stock selection -- previously only had been performed by big investment banks.
Another area in which the Shell fund pioneered was the development of weekly performance measurement. These ready-fire analyses also supported fund officials' abilities to make tactical bets.
But perhaps the most critical move Shell pension officials made was to adopt asset-liability modeling. One of the first Dutch funds to adopt such studies, that move provided the intellectual firepower to push the fund much more heavily into equities.
The studies also supported a heavy move into international equities, given Dutch stocks' tiny proportion of global equity market capitalization.
Throughout the 1990s, asset-liability studies called for increasing the overall equity allocation. Stock investments grew to 52% of assets by the end of 1993 from 36% at the end of 1989, according to the pension fund's annual reports.
Unfortunately, as the Shell fund increased its stock ownership, securities markets sometimes teetered. In 1990, Dutch stocks fell 17.4%, as measured by Morgan Stanley Capital International; the MSCI World index plunged 28% in guilder terms.
Again, in 1994, rising interest rates, volatile bond and currency markets unsettled stock markets. The fund's stocks and convertibles fell 3.7%, following a 41% rise in 1993. (Fixed-income investments, however, slipped even more, losing 8.3%.)
While markets didn't always cooperate, in the long run equity allocations swung heavily in the Shell fund's favor.
In late 1996, the equity target allocation was raised again to 60%, and, a year later, to 65%.
Another key change in the fund's benchmark stemmed from a 1996 asset-liability study. By placing a 100% hedge on U.S. dollar and yen exposure, fund officials were able to dampen volatility in the total fund, Mr. van Rees explained. In addition, external portfolio managers tend to manage more closely against their benchmark, he added.
The shift also enabled fund officials to nudge up the policy exposure to equities, to 65% from 60%. In effect, they are able to obtain a higher return with the same level of risk.
Because of the leveraging policy, the fund has an effective allocation of 104%: 66% equities, 27% fixed income and 11% real estate. Basically, the fund borrows from other institutions at cash rates -- roughly 3% -- investing the extra money mostly in stocks that have generated 20%-plus annual returns.
In comparison, the average Dutch pension fund had a 31% equity allocation at the end of 1996, according to the most recently available data from The WM Co.
Shell officials made an equity allocation so out of line with the typical Dutch fund because they measure themselves against a tailor-made benchmark, and also because they compare themselves with pension funds of U.S.-based oil companies.
With equity allocations ranging from 60% to 75%, the Dutch Shell fund is "in the middle of the pack" of U.S. oil company funds, Mr. van Rees explained.
Meanwhile, the fund's international exposure also is far higher than that of the average Dutch fund. Shell has only about one-third of assets invested domestically, vs. more than twice that for the typical Dutch fund, said Mr. van Rees, who also serves as chairman of Stichting voor Ondernemingspensioenfondsen, the Dutch association for company pension funds, and the European Federation for Retirement Provision.
The fund's domestic equity exposure, just above 20% of total assets, makes up a good chunk of the total equity portfolio. But Mr. van Rees observed many of its holdings, such as Royal Dutch Petroleum, Unilever NV and ING Groep, have huge portions of their sales and profits stemming from abroad.
Adoption of the hedged benchmark in January 1997 also supported Shell's decision to expand its experimental currency management program.
To cover the dollar and yen exposure, Shell officials decided to apply a passive hedge on half the exposure and actively manage the other half.
Currency exposure stems almost entirely from the fund's equity and real estate investments, since 95% of bond investments are in Europe.
In contrast, one-third of the fund's equity allocation and nearly two-fifths of its real estate exposure were invested outside of Europe at the end of 1996, the most recent data available.
Shell internally manages the passive hedges as well as one active currency strategy. The fund also employs four external managers to manage hedges actively in three different styles: A.G. Bisset & Co., Rowayton, Conn.; Citibank Global Asset Management, London; Goldman Sachs Asset Management, London; and Pareto Partners, London.
On the whole, Shell officials remain wedded to internal management. "There's no doubt when you look at the figures that in-house management is cheaper . . . by quite a substantial margin," Mr. van Rees said.
While sharply rising pay for portfolio managers at management firms has made it difficult for many Dutch pension funds to attract and retain personnel, the Shell fund has experienced remarkably low turnover.
it's more than the money
Shell's stable of 10 portfolio managers are drawn to their jobs not just for money, but because they enjoy greater job security than in a New York or London-based organization, Mr. van Rees said.
What's more, "the general Shell approach" he said, "is to try to give people responsibility."
Top managers within Shell are rotated throughout the organization. While some experts think turning over managers is a drawback, others see its virtues.
"A lot of the brighter people in Shell are working at the pension fund," said Wilshire's Mr. ten Cate, who has consulted to the fund.
Shell also has started leveraging its internal expertise with other Shell-related funds. It has continued to manage the 750 million guilder Billiton pension fund, since the mining concern was sold to Gencor Ltd. in 1994.
And on Jan. 1, it started advising on the European equity and bond portion of a 1 billion deutsche mark ($557 million) pension fund recently set up by sister company Deutsche Shell AG. The European portfolio, comprising 60% of the total mandate, officially is managed by Deutsche Bank's DEGEF unit.
(Shell's London-based pension fund staff is advising on the 40% non-European passively managed portion of a similar 1 billion deutsche mark portfolio handed out to Dresdner Bank by Deutsche Shell.)
And there are prospects of using the Dutch Shell investment expertise elsewhere: Fund officials have agreed in principle to manage half of French Shell's 1.4 billion French franc ($223 million) pension fund.
While the vast majority of the fund is invested by internal staff, fund officials will hire specialists to cover distant markets, fill niches or to provide a basis of comparison.
Among the external managers, Shell last year hired Bankers Trust Co., New York, and GSAM to manage global tactical asset allocations.
Elsewhere, the fund has hired outside firms to handle U.S. and Japanese and emerging markets equity investments. Among the managers Shell has picked is ING Investment Management, Amsterdam, for Japanese equities. U.S. equity managers include David L. Babson Co., Fidelity Investments and State Street Global Advisors, all based in Boston.
In addition, the fund has made a significant investment in market-neutral strategies. Numeric Investors is one of Shell's market-neutral managers.
The Shell fund also employs external managers for emerging markets equity, including Capital International Ltd., London. The allocations are substantial: The fund has 1.8 billion gilders, 8% of total assets, invested in emerging market equities. The asset class offers longer-term growth and low correlations with developed markets, Mr. van Rees said.
Another 800 million gilders, 3% of assets, are invested in emerging markets debt.
The Dutch fund also has a variety of commitments to private equities, from which officials expect returns of 20 percentage points over public equities, Mr. van Rees said. The fund has a 1% allocation to the asset class "with substantial commitments" to increase that amount, he added.
In contrast, Shell officials have been shrinking their allocation to real estate because of a combination of mixed performance, officials' strategic outlook and liquidity reasons. The allocation has been reduced from its 1992 peak of 26% of assets to the current level of 10%.
What's more, the fund has been selling off its direct property investments, particularly in other European countries. Shell's primary bets are in Dutch and U.S. real estate, with American properties comprising 40% of the total real estate portfolio.
There is an ongoing debate whether to invest in securitized real estate. Mr. van Rees is skeptical about the liquidity available in public real estate investment trusts, saying it lags that available from publicly traded equities.
"What you have to be careful about is if you move from one illiquid asset to another illiquid asset," he said.