At the huge – over E45bn – PGGM pension fund for the health care and welfare sector in the Netherlands, they are busy completing their next asset liability modelling (ALM) study to be finalised in the first quarter of this year. But it is not just the actuarial department that is beavering away.
Niels Kortleve is director of investment strategy, and works with his eight-strong team at the fund’s headquarters in Zeist. “The investment policy of the fund is the responsibility of the strategy department, working jointly with the actuarial department,” he says. As a result of this the strategic benchmark will be derived, which is one of the strategy team’s main tasks.
Though it is very much a joint effort, Kortleve says the strategy contribution is distinct: “We have more insights into the nature of financial markets and asset classes, and the economic environment we expect in 30 to 50 years from now.” He is an econometrician by background, who joined PGGM over a year ago, after working in the asset management industry and in investment banking on fixed income and quant research and other areas.
“What we want to do is to get a real grip on the long-term performance we expect from asset classes. The main question is how much equities will generate relative to fixed income and how much real estate will generate,” he says. The different assumptions about the returns of the asset classes relative to one another will result not only in different asset mixes, but also in different contribution rates for the fund’s participants.
“The most important, but hardest thing we do, is to make predictions of future returns and risk premiums for various asset classes. To what extent will history repeat itself?” He gives as an example the lower returns on fixed income yields at around 4% nominal at the start of 1999. “With historical returns on fixed income at 6.5% approximately, was it logical to use the lower rates in an ALM study?” This question led his team to approach the modelling of fixed income in a different way. “We started with inflation, then put real rates in to get nominal yields; with the risk premium, you can get equity returns and so on. We think this is a better way to model how the economy and financial markets are behaving,” says Kortleve.
“When we started over a year ago, we put on our agenda those asset classes we thought might be of interest and relevant to PGGM. One of our tasks is to help decide what classes should be put in and what it makes sense to separate out,” he says. So, for example, under discussion is the question of dividing private equity from the exchange-traded equity since it behaves differently, and, of course, as PGGM probably has one of the highest commitments of all European institutional investors to the area.
The group has done some sensitivity analysis on private equity to ascertain the impact of higher volatility in returns than expected. “The assumed volatility of private equity is low, so you could run into problems if you cannot realise returns on the basis you expected. So we check, using sensitivity analysis, the assumptions that are being used.”
Another essential role for the strategy department is to look at the new asset classes and opportunities the fund is not looking at as yet. Commodities are being studied. “We want to look at the attractions of using commodities to provide some protection against inflation and we want to see if cash is an attractive asset class as it can bring down your risk relative to your liabilities, by providing a positive return should interest rates be hiked, while fixed income will result in capital losses.” Other areas being looked at are high yield (to be studied more extensively in the course of 2000), currencies, from hedging and asset class points of view. “We may include hedge funds in the future, but currently we do not want to.”
This means some number crunching to see whether such new asset classes would be beneficial from a strategic point of view. “For new asset classes, the lack of data is a real problem, as you have to say something about expected behaviour. So for areas such as reinsurance products, disaster bonds and others, when you look at these and the limited data available, it makes it very hard to predict the return profile of these classes.” Even with the more established classes, such as emerging markets, recent events meant learning some lessons, he adds.
Normally, the horizon the strategy team works to is a 35-year one, though there are questions as to whether this is too long. But there is a much shorter time frame to the department’s role, which is being extended – that of tactical strategy. “We put together a macro-economic environment for what we expect to happen in the next three to 12 months – for where the economy and the financial markets are heading in the US, Japan, Euroland, and to a lesser extent the UK.” The idea is to start giving sector advice to the internal equity department.
In addition, there is the more tactical asset allocation advice to the chief investment officer, by making proposals in relation to the balance between equities, fixed income, real estate or cash positions, when necessary. “If the CIO is not there, we take over the decision making and the implementation,” says Kortleve.
As the PGGM portfolio undergoes a number of changes including the managing of more of its money in-house, and moving to an international rather than domestic fixed income, including credits, this will inevitably, in Kortleve’s view, require more in-house research. He says: “This is to support them, but also to confront them with new ideas.”

Topics