If bond yields were to rise as fast in the Netherlands as they did in the UK in the past few weeks, this would be “a challenge” for Dutch pension funds, according to pension regulator DNB.
The “situation in the UK”, as DNB euphemistically described the volatility on the UK Gilt market sparked by former chancellor of the exchequer Kwasi Kwarteng’s doomed mini budget, once more has proven “the importance of adequate liquidity management by pension funds”, DNB said in a written reply to questions from IPE.
Echoing DNB’s comments, BlackRock’s Jens van Egmond said the turbulence in the UK is a “useful warning” for Dutch schemes. “It shows why you really need to be able to quickly access liquidity as a pension fund.”
Stress tests
Dutch pension funds regularly conduct stress tests to see whether they are able to access sufficient liquidity to deal with market shocks. “But this [the UK volatility] can be a reason for funds to adjust these stress tests, for example by simulating a stronger interest rate shock that up until now was perhaps seen as very unlikely to occur,” said Max Verheijen from liability-driven investment (LDI) consultancy Cardano.
APG, which is in charge of LDI management for its pension fund clients which include the country’s largest scheme ABP, is now reviewing its own stress test, according to the firm’s head of trading and treasury Jan Mark van Mill.
“What happened in the UK is a new scenario, so we are adjusting our stress test to this,” he said.
APG conducts stress tests to determine whether its pension fund clients can generate sufficient liquidity to meet collateral calls in certain interest rate scenarios.
Collateral
Whereas UK pension funds need to raise cash to meet collateral calls, many Dutch pension funds can also still use bonds for now, pending an obligation for central clearing for new derivatives contracts that’s set to come into force next year.
This makes its less likely Dutch pension funds will run into trouble, though the UK market turmoil has proven the importance for pension schemes to “have diversified sources of collateral”, according to Verheijen, for example by further diversifying their government bond portfolios.
Pension funds could also look at their maximum interest rate hedge and the percentage of illiquid investments they can have in certain stress scenarios without running into liquidity problems, said Justus van Halewijn, delegated chief investment officer at Columbia Threadneedle Investments.
“For one pension fund client, we have for example introduced a 15% cap for illiquid investments,” he said. However, pension funds should avoid getting into a situation where operational constraints compromise their investment policies, he added.
LDI funds
Dutch pension funds are, however, unlikely to run into similar trouble as UK pension funds did, even when yields rise fast. Dutch funds tend to have lower interest rate hedges than their UK counterparts, even though some funds have increased their hedging ratios as interest rates have come down and as some funds have taken risk off the table in anticipation of the pension transition.
“Besides, Dutch pension funds are less dominant on the local (euro) market than UK funds are on the Gilt market. UK funds’ exposure is also concentrated on the long end of the curve,” said Van Egmond.
Last but not least, most Dutch pension funds have bespoke LDI mandates with lower leverage and don’t use LDI funds. “This all makes UK funds relatively vulnerable [compare to Dutch schemes,” he said.
However, some Dutch pension funds do invest in LDI funds. Aegon AM runs such a pooled fund on behalf of five pension funds.
“We indeed have had to raise collateral several times this year for our customers as the interest rate swaps in these funds had considerably decreased in value this year because of falling interest rates,” said Gosse Alserda, an investment strategist at the firm.
The interest rate rises have prompted Aegon AM to sell government bonds to raise collateral, Alserda said. “As a result we have had to rebalance portfolios too, because the weightings of the matching portfolio had come down too far.”
He said, however, that a situation as in the UK can “practically not occur” in The Netherlands because of more stringent buffer requirements. “Our customers need to hold €0.53 in liquid investments per euro invested in the LDI fund. In practice these liquid investments are mostly government bonds.”
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