Leo Lueb is taking the giant Dutch pension fund PGGM into a new world of managing alpha and beta, using three basic building blocks to carry out his mission.
Leo Lueb started his business life in the hotel industry, but soon shifted his focus to economics. Now, as chief investment officer at the €77 billion ($98 billion) Stichting Pensioenfonds PGGM, he's shifting the fund's focus. Earlier this year he restructured the plan's investment process to manage assets along lines of alpha and beta. PGGM, based in Zeist — a commercial city in the Netherlands' industrial heartland — is one of the first European pension plans to separate the management of alpha and beta and apply it across its entire policy portfolio. In a recent interview, Mr. Lueb spoke about the impact this will have for the giant Dutch plan.
How does it work? The policy portfolio owns (considerable investments in) a number of very large liquid benchmarks. There are three processes. One is effectively and efficiently implementing the liquid part of the portfolio, which is what we are doing with the beta side. The second element is to see if we can generate outperformance from the financial markets through alpha. The third is to see if we can have a more absolute return focus on parts of our portfolio and for that we go for enhanced beta. So those are the three building blocks or basic processes that we distinguish in our portfolio.
What proportion of the investment portfolio is in these different processes? In beta, there is around €62 billion and in enhanced beta about €15 billion. It's hard to say how much is in alpha because we look at it in terms of value at risk. That's one of the benefits of being able to decouple (alpha and beta), because you don't necessarily need underlying assets to generate alpha. On the alpha side we expanded the universe significantly, as it used to be very much limited to components of our policy portfolio. With the separation of alpha and beta, we have significantly broadened the scope of the universe for alpha generation.
What sorts of strategies does that allow you to enter? Basically all strategies that give us a true, consistent alpha. They should be able to deliver that in a meaningful way and … together, provide a well-diversified portfolio of alpha strategies.
So the world is your oyster here; you could shoot the lights out if you wanted to? We always want to find a balance between the risk we take in the overall portfolio. So in that sense, shooting the lights out is something we are not aiming for. We are aiming for a solid balance between risk and return. You could be setting things on fire each time you shoot the lights out; that is not something we want to do.
Is there anything particular to the Dutch market or your position at PGGM that made you do this? It's not necessarily the strategic return assumptions, it's just that we see the financial markets changing. As a pension fund you want to continue to add value to your pensioners, you have to make sure that you are able to do that going forward. We felt that sticking with the traditional organization would not, in the long run, be effective. Financial engineering has given rise to a whole load of new instruments; pension funds need to keep pace with that. Opportunities are increasingly being financially engineered and those opportunities do not necessarily fit the traditional mold.
Key to this is that you have in-house resources? Key to this is that we decided not to outsource the important decisions, that we decided to focus on where we can add value ourselves and second, obviously, is also the size of the pension fund. If you would have a fund that is significantly smaller, you would have to follow a different strategy for organizing yourself effectively.
What are the target returns of the three processes? Now it gets a little more complicated because what we say is we have to organize our investment process along the (alpha and beta) processes, but the asset-liability model policy portfolio is organized along traditional assets. So there the return expectations are still based on the individual return expectations we have for the individual asset classes.
Should the way that pension plans conduct asset-liability modeling change? I think developments in the financial markets are a definite challenge for traditional asset-liability modeling. ALM needs to take into account those new opportunities when they arise.
Are you changing your ALM process? I think in general ALM processes will change going forward. With the increase in different instruments and the arrival of new risk factors, ALM processes will have to, in some way, take those into account ... And that is a serious challenge because many of these products are new and have little history to them. The ALM process in itself is a process that is not carved in stone for PGGM and I don't think for anybody else. We continuously scrutinize our ALM process to take into account the new economic reality.
What does this mean for your existing external managers? It means they have a counterparty that is open to doing more opportunities with them in terms of expanding and opening up products. It means the focus will be more on the pure added value of their products. The focus will definitely be on where the added value is for a particular manager.
Have you had to restructure, issue new mandates? We started out with the existing set of managers, and we have been able to internally make that portable process. We are structuring our own processes just to make sure that the alpha manager is left with his alpha results. Which makes it very obvious where the added value is. It gives you an entirely different perspective on your external managers because it really focuses on what the drivers of the outperformance are.
Does that mean you are going to change managers where you see managers are not finding alpha in the way that you would expect them to? If you decouple your alpha sources from the strategic mix you start with one step and that is risk and considering what the broad sources of alpha are. The first step that we are taking is to rebalance that source of alpha. If you have 50% of your money invested in equities then you automatically end up with a fairly large chunk of your alpha coming from equity-oriented strategies. So the decoupling of alpha and beta enables us first of all to get that balance, between the different sources of alpha in the portfolio, in better shape. We are looking at the alpha component much more critically. We are scrutinizing the external managers more closely.
Can managers expect some restructuring of their mandates in the next year? Well, I think the managers will see that there is more competition in terms of the alpha. There will be more competition in terms of alpha-generating opportunities that we will be able to address or to take advantage of. So in that sense the competition will increase.
You started your career at hotel school? Well, my parents came from a hotel background. What I liked about it was that it was beautifully practical and very interactive, so I decided that would be a very good start. After having done that for three and a half years, I decided that I knew a little about a lot of things but I didn't know a lot about a little. So from then on I studied economics. I started off at Credit Lyonnais, from there I moved to Deutsche Bank, where I was mostly involved in fixed income and at some stage in the European money markets. From there I moved to NIB Capital where I was head of the securities brokerage division. From there I moved to PGGM, where over the past five years the challenges of pension fund investing have made sure that I have never had a dull moment.
