HEERLEN, The Netherlands -- ABP is beefing up its internal investment capabilities.
At a time when many large pension funds have outsourced most of their assets, Stichting Pensioenfonds ABP -- the world's largest pension fund, with 290 billion guilders ($145 billion) in assets as of June 30 -- is building its in-house management capability in equity, fixed income and real estate.
External management, now between 12% and 15% of assets, is expected to increase somewhat over the next few years as ABP continues to diversify its assets, but then gradually decrease to less than 10%.
Virtually all of the fund's 168 billion guilder bond portfolio is managed in-house, while 80% of its 78 billion guilder equity portfolio is in various internally managed index strategies.
This doesn't mean ABP officials are dropping their external managers en masse, although a number have seen their contracts terminated in the past year. (ABP officials decline to discuss their manager arrangements.)
It does, however, mean ABP officials think they can create investment strategies better suited to their needs at a cheaper price in some areas. And ABP will stick with external managers in places where the fund lacks internal expertise, such as Asian and specialized asset classes, said Chief Investment Officer Jean Frijns.
The giant pension fund for Dutch civil servants hasn't stopped there. Officials have taken a number of key steps in recent months affecting the fund's development:
* Boosted its target equity allocation to 40% from 30% for 2000, up from 27% now and only 21% at year-end 1997. (That compares with 14% at the end of 1995.)
* Shifted global fixed-income chief Paul Spijkers and three other staffers to ABP's New York office, where they will rummage through U.S. corporate and credit-related debt markets. ABP's U.S. fixed-income exposure of 7 billion guilders is projected to grow substantially during the next few years.
* Expanded a small representative office at Amsterdam's Schiophol Airport to manage the fund's structured investments, focusing on long-term investments in real estate, private equity and structured finance. Allocation to the three areas is being upped to 20% by 2000 from 15% now.
Mr. Frijns also has enabled the fund to make tactical shifts in its asset mix. "We realize we are in a dynamic world, that the fundamental equilibrium is shifting and unstable," he said.
ABP's newfound flexibility becomes apparent, for example, with its recent board approval to use its 10% real estate allocation as a swing factor. If market conditions warrant, fund officials can "borrow" a piece of the real estate allocation to raise equity exposure.
The fund also is taking a more flexible view on how it builds its equity allocation. In the past, ABP officials had set monthly targets for raising its equity stake. Strong domestic equity returns had caused the fund to exceed its allocation to Dutch stocks, causing ABP officials to sell domestic stocks.
Now, ABP officials are adjusting the targets to the market.
"If market conditions remain as favorable as (they have been) over the past 18 months, we certainly would reach the 40% benchmark in two to two-and-a-half years," Mr. Frijns said.
"But should market conditions deteriorate, we would considerably slow down our expansion."
Mr. Frijns remains optimistic, explaining: "The resilience of the world economy is such that it can overcome the crisis in Southeast Asia."
Overall, ABP will reduce its allocation to Dutch stocks from more than 50% of total equities to about one-third by 2000; it already has fallen below 40%.
Pan-European stocks are becoming the domestic equity benchmark for the fund, even though that includes noneuro countries such as the United Kingdom and Switzerland. That shouldn't be a problem, Mr. Frijns said: The fund hedges roughly 50% of its noneuro equity exposure.
With the integration of companies across Europe, sector has become the most important factor in the European stock portfolio, although country factors still are considered, Mr. Frijns said.
The result is a matrix approach. "We could underweight all stocks in Germany but overweight all stocks in banking," he added. The fund also uses risk controls such as sector weights and country weights in its models.
Mr. Frijns also has been persuaded that the massive reallocation of assets by institutional investors could result in money being funneled into European blue-chip stocks, as investors move into the biggest and most liquid stocks.
"The relative overvaluation of large-cap over small-cap could persist over quite a few years," he said.
If all pension funds shifted to a pan-European approach, it would cause a massive reallocation, although insurance companies might provide a countervailing force, he said.
Officials at Goldman Sachs International, London, estimate that continental European pension funds and insurance companies will need to rebalance $76 billion in European equities, not counting new money flows and shifts from bonds to stocks. About half of the rebalancing is expected to occur in 1999.
ABP officials will maintain an exposure to European small-cap stocks, as they do to all markets.
Mr. Frijns also hopes to speed ABP's movement into emerging market stocks, which the fund has entered more recently. Now, however, activities are nearly at a standstill, an ABP spokesman said.
By 2000, Mr. Frijns said, the target asset mix for equities will be 40% Europe (including the Netherlands), 30% United States and 30% Asia and emerging markets.
That compares with the current mix of 40% Dutch stocks, 25% in the rest of Europe, 27% in North America, 6% Japan and 2% in emerging markets.
While the move into equities will come gradually, changes in the fund's fixed-income portfolio are much more dramatic. Traditionally invested in Dutch and German bonds, the portfolio now is being switched into European and U.S. debt, with a new focus on nongovernmental debt.
The introduction of the euro Jan. 1 has much to do with this. The euro will eliminate currency risk among the 11 countries adopting the single currency. Instead of playing the yield curve and differences in interest rates, European bond managers will focus on credit risk.
While investment experts predict the formation of a vast public credit market in Europe, ABP officials are taking their initial bets with U.S. instruments, where the market is far more mature.
"There's no reason to doubt that there will be a mature credit market (in Europe) but the path could be rougher than some investment bankers want us to believe," Mr. Frijns said.
market for debt
At the end of 1997, U.S. bond markets totalled $10.4 trillion, compared with $4 trillion for the 11 countries entering European economic and monetary union on Jan. 1 -- although European total debt actually is much bigger because of reliance on bank debt, said Clive Parry, fixed-income strategist for Morgan Stanley Dean Witter & Co., London.
In the United States, government and government-related issues comprise 47.1% of public debt, compared with 65.2% in Euroland.
Private bank debt was roughly the same -- 9.6% in the U.S. vs. 10.3% in Europe -- but U.S. industrials and utilities totaled 14.4% vs. 2% in Europe, and asset-backed and high-yield securities totalled 28.9%, compared with 22.5% in Europe (largely German Pfandbrief).
For the giant ABP, "it's impossible to buy" enough credit-related debt in Europe now, he said.
What's more, spreads between European government and corporate bonds have been much narrower than they are in the United States, given greater European confidence in bank-related debt.
Spread on a 10-year U.S. dollar bond swap was 82 basis points on Sept. 18, compared with 59 basis on a 10-year German bond swap.
The spreads in Europe are "disappointingly low," Mr. Frijns said.
That's why more than 30% of ABP's bond investments are going into credit-related U.S. debt. (The rest is invested in European sovereign and corporate debt, depending on market conditions.)
And it's also why ABP has moved a team headed by global fixed-income chief Paul Spijkers to New York. Right now, ABP's U.S. bonds are managed externally. Sometime next year, Mr. Spijkers' team will start running some bond money in-house.
ABP officials also plan to expand the New York staff to handle equities and structured investments.
Emerging market debt might be attractive for the fund, Mr. Frijns said, although this might not be the right time to enter the asset class.
Meanwhile, the Dutch plan has formed a new structured investment office in its Schiophol Airport office. Under the guidance of Managing Director Wim Borgdorff, formerly head of ABP's real estate division, the expanded unit will focus on less liquid long-term investments, including real estate, private equity and structured finance.
ABP started investing in private equity two years ago and has committed somewhere between 0.5% and 1% of total assets. That's under its target level of 2%, "but we are in no hurry," Mr. Frijns said.
ABP officials want the fund to account for no more than 2% to 5% of each private equity pool's commitments and are looking at funds investing in the United States, the United Kingdom and continental Europe.
In its structured finance deals, ABP takes European mortgage and corporate loan portfolios off the balance sheets of European banks and insurers, particularly Dutch institutions. ABP officials have done some deals through investment bankers, but they do most of them internally, Mr. Frijns said.
While ABP used to buy the mortgages lock, stock and barrel, it now purchases the rights to the cash flows instead, leaving the job of managing the portfolios to the loan originators.
Meanwhile, ABP has made a big shift from direct investment in real estate. It has placed its Dutch holdings into three pools totaling 11 billion guilders and is seeking co-investors for these funds.
Foreign direct real estate has been either sold or exchanged for participations in North American funds. ABP officials aim to have 50% of real estate holdings outside Holland by 2000, of which four-fifths will be in U.S. properties.
Overall, the changes are quite dramatic. For ABP, which was privatized in January 1996, the organization has become increasingly versatile -- although a $145 billion fund probably never can be described as nimble.
But ABP's newfound flexibility is enhancing the fund's ability to produce added value. "Five to six years ago, we were very much a cash flow-oriented investor," Mr. Frijns said. "Now, we are very much a portfolio-oriented investor."