Dutch pension funds are increasingly moving to protect their listed equity portfolios against downside risk ahead of converting their defined benefit (DB) accruals to defined contribution (DC) capitals. Two pension funds that plan to move to DC on 1 July have already taken action.
Until now, pension funds have mainly protected their funding ratios by increasing their interest rate hedges. As a result, the interest rate hedge of the average Dutch pension fund now stands above 70%.
Reducing equity risk has been less common. Of the three frontrunner funds, only the staff pension fund of pension provider APG reduced its exposure to equity risk, by 35%. But this is changing.
“At almost all the 20 funds to which we provide fiduciary advice, reducing equity risk is being discussed,” says Twan van Erp, head of fiduciary advice at Achmea Investment Management.
In fact, two of these clients, that both want to move to DC on 1 July 2025, have already taken action.
The increased volatility in equity markets due to the capricious policies of US president Donald Trump, and a rapidly weakening economic growth in the US, make hedging equity risk all the more urgent.
Veterinarians
The professional pension fund for veterinarians already reduced its investments in equities from 24% to 14% of its portfolio last summer.
The professional fund for physiotherapists, another client of Achmea IM, has been protecting its portfolio of listed equities (23% of assets) against all price drops since autumn last year through a construction with put options.
“In this way, we protect the risk of declining assets for the young and guarantee a stable funding ratio for the elderly,” says Adam Barszczowski, a trustee at the fund responsible for investments, in an interview on Achmea IM’s website.
Other pension funds have decided not to reduce equity risk. Such as the pension fund for public libraries, which also wants to switch to DC on 1 July 2025.
“We judged last year that it was not necessary to hedge equity risk to protect our minimum desired funding ratio of 112%,” says trustee Walther Schapendonk.
The librarians’ pension fund currently has a funding ratio of over 130%. It invests about a third of its portfolio in equities, which means it could be at risk only in the event of extreme stock market movements.
Hospitality industry fund Horeca & Catering, which plans to move to DC on 1 January 2026, hasn’t hedged equity risk either. It cites “the high cost of such a protection strategy” as the reason.
Room for manoeuvre
With a funding ratio of around 116%, the pension funds for veterinarians and physiotherapists have much less room for manoeuvre.
“Indeed, the extent to which a pension fund fears falling below its desired minimum funding ratio is a key driver for looking at hedging equity risk,” notes Van Erp.
Arthur Stroij, director and LDI client portfolio manager at Columbia Threadneedle Investments, even speaks of a ‘sweet spot’ of funds that are not very far, but also not very close to their minimum funding ratio.
“Funds that need hedging the most usually cannot afford it. And funds with a very generous coverage ratio often do not find it necessary to buy protection,” he says.
Achmea has four other clients that want to move to DC on 1 January 2026. Neither of these have yet taken any additional protective measures for their equity portfolio.
“Funds that need hedging the most usually cannot afford it”
Arthur Stroij at Columbia Threadneedle Investments
The simplest and so far most common way to reduce equity risk is to sell part of the equity portfolio. However, most funds mainly look at options strategies.
“Funds often have very limited scope to sell equities because they have to stay within their strategic risk attitude,” explains Wilse Graveland, head of fiduciary management at Van Lanschot Kempen.
“Selling equities would also run counter to what most funds are going to do in the new system, which is to invest more in equities,” adds Stroij.
Put options
Fiduciary managers and pension consultants, therefore, favour put options.
“We see little added value in the structural use of options for long-term investors, but if there is ever a time to think about non-linear instruments it is now,” writes consultancy Sprenkels in a recent newsletter.
However, some funds are struggling with the high cost of implementing such a strategy. The prices of put options have risen due to increased volatility in equity markets in recent weeks.
According to Stroij, protection against a drop of 10% or more in the price of the S&P 500 currently costs 3% of the amount to be protected for a one-year maturity. Protection against a price drop of more than 20% costs 1.6%.
Collar
Those who find this too expensive can opt for a collar instead of a put option. This is a combination of a put option and a call option, where the investor buys protection and, in exchange, gives away any profits on their equity position above a certain level.
In this way, protection against a 10% or more fall in the share price combined with a 110% call option (giving away any price gains above that level) can even be bought for free.
“A disadvantage of his, however, is that you have to start depositing collateral the moment you get in-the-money (in the example, when stock prices have risen above 115%). This is perceived as complex,” says Stroij.
However, these costs go down as the time horizon towards switching to DC shortens.
“We think a number of funds will wait a little longer and rather take action six months before their transition date,” says Van Lanschot’s Graveland.
Van Erp of Achmea IM also expects an increase in activity, especially if funding ratios fall some more in the coming months.
“If that happens, the minimum desired funding ratio comes closer, which may prompt funds into action,’ says Stroij.
“We have already implemented a hedging strategy with put options for one client that will move to DC in 2026. Clients who transition later are also looking seriously at mitigating equity risk,” he notes.
Equity risk, he adds, has become a “more dominant balance sheet risk” due to the US geopolitical agenda and high valuations in US equity markets in particular.
This article was first published on Pensioen Pro, IPE’s Dutch sister publication.
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