Within the last two years, Jean Frijns, chief investment officer, ABP Investments, has revamped the investment management of Stichting Pensioenfonds ABP, Europe's largest pension plan. But in 2003 he faces one of the toughest years of his career as he attempts to engineer a significant turnaround in the plan's investment returns. At the end of last year, officials announced ABP's funding position was so weak they had to submit a reserve recovery plan to the Dutch pensions regulator. Beatrix Payne asks how the investment management has changed and how Mr. Frijns plans to improve the fortunes of this titanic pension plan.
Q What is the proportion of actively managed assets vs. passive?
A I would say about two years ago we decided to define us more as an active manager and not as a passive manager. Within the equity platform, what we were running passively is now run actively. The percentage purely passive in equity indices is about 20% to 30% … down from 60% about two years ago.
The emotional reason was that the passive investment philosophy felt like a straitjacket during the IT bubble when people were forced to stay close to the index. I am not entirely happy with index strategies, because then you are the prisoner of the market.
So we set up in-house resources and built up an in-house fundamental stock-picking team. We set up a group of quantitative equity strategists and a sectoral team, and by combining different strategies which are not highly correlated, we run an overall strategy where the active risk is diversified away a bit.
Q Which asset classes were brought in-house?
A In the equity portfolio, I would say roughly 60% is now managed in-house and 90% of that is in active strategies.
In equities, all the developed countries mandates were brought in-house. We still keep State Street Global Advisers and Barclays Global Investors as index managers. But the core active management takes place in-house. Satellite active specialist strategies and emerging markets are managed externally.
Almost everything for fixed income is now managed actively in-house. Only very specialist mandates, such as emerging market debt, are managed by outside specialists.
Real estate is now all managed in-house.
We have set up a new group in New York, which is an in-house fund of hedge funds manager. They also hire external fund of hedge funds managers, who manage about two-thirds of the assets. That proportion will shift to around two-thirds run in-house and one-third given to external managers.
Q You once had trouble recruiting because you couldn't offer competitive salaries. Has that changed?
A We still don't pay salary levels that are comparable with those paid in the London. What we did was set up a bonus pool that gives more flexibility to pay an incentive, so it makes it possible to attract real talent. That's new, since the beginning of this year. We introduced the same system in the U.S. a few years ago.
Q Have you completed your asset-liability modeling study?
A We are in the stage of discussing the results with our board of trustees, the regulators and the sponsors. Our growth expectations are much lower than they used to be at the last ALM study in 2000.
The most important difference is the lower interest rate, which makes trying to find a balance between assets and liabilities much more difficult. So if you want the same kind of return you have to take on more risk.
The second thing is that the financial position of ABP has gone down considerably.
The third issue is that there are now stricter solvency constraints by the regulator. Given the much stricter constraints … we have an even bigger problem.
What we hope is to define an integrated contribution, investment and indexation strategy which results in steady recovery of solvency rate, a stable but not much higher contribution rate and indexation of benefits to inflation, which is in most years almost 100%.
Given the environmental factors, the results (of the study) are not that bad. They don't make me very sad. It's possible to define a feasible, sustainable policy for ABP pension fund and you can do that with an investment mix which is roughly 40% equities or perhaps a bit less, 40% fixed income and 20% alternatives.
Q That's not much of a change.
A No. But we need equities. Under the assumptions we have made with respect for future market conditions, we are not very optimistic. We are making cautious assumptions. So we have shown for fixed income that we can expect a return of about 4.5% per year, a bit less even. Inflation is assumed to be 2.5% per year, so it's a 2% real return for fixed income. That makes it fairly clear that you need equities. If you don't have equities, the return will just be too low and the contribution rate will have to be too high. We expect an overall return of about 6.2% on the total portfolio. We have alternatives not so much to increase the overall return, but to diversify the risk.
Q How long will it take you to get to a more comfortable funding level?
A Well, our aim is certainly full 100% funding at marked to market valuation (the plan is 86% funded, using an interest rate of 2.5%). If you look at full market value and do not assume a change in the real interest rate, or perhaps a slight increase, I would say between 10 and 15 years. We hope that we will be faster than 15 years in getting fully funded. We hope it will be more 10 than 15 years.
Q What is your view of the equity risk premium?
A We were never very optimistic about the risk premium of equities vs. bonds.
We currently expect an equity premium relative to bonds of about 2.5%.
In our strategic investment plan of 2000, we adopted an equity risk premium of 2% to 3% for the next five years. We were not pessimistic about economic growth. We were cautious about the high price-earnings ratios, but we thought it was sustainable in the light of the growth.
But the world has changed.
If you look at the current situation, dividend yields are much higher. In Europe, dividend yields are about 3%; in the U.K., they are about 4%. So in order to achieve a 3% equity premium, you need a much lower earnings growth figure. What has changed, relative to 2000, is that dividend yield is about 2% higher and expected earnings growth is about 2% lower. We are now much less optimistic about economic growth and earnings growth.
On the other hand, I am more optimistic about the capital efficiency of companies. What is helping us is this new lean-and-mean drive in companies; they are restructuring balance sheets and looking at the bottom line. Companies are not built on expected growth but on delivering earnings.
Q What are you doing to ensure the reserves don't fall any lower?
A We do not buy insurance such as derivatives. That is more or less futile given the size of our fund. We have increased our hedge ratio relative to the dollar, which has an enormous impact on our results. We hedge all the fixed income and about 30% to 40% of our equity portfolio.
Our equity exposure is about 31%. We have also increased our duration policy, and all these things help in reducing the overall risk.
