As a pension investor, APG manages a long-term investment portfolio on behalf of its pension fund clients. However, this doesn't mean a pension investor is immune to societal changes, such as population aging. Due in part to the steadily aging population, the Netherlands will also introduce a renewed pension system in 2025. What does this mean for the asset mix of a major pension investor like APG? Jan Fokkens (Senior Strategist) and Thijs Knaap (Chief Economist) discuss the importance of a patient asset mix.
Published on:
17 September 2024
In a nutshell
• Due to the aging population, the focus of pension investors’ portfolios is increasingly shifting towards interest rate protection and less towards equities.
• In recent years, some Dutch pension funds have been paying out more in pensions than they receive in contributions.
• A pension investor like APG is and will remain well-equipped to acquire and manage ‘patient capital’ on behalf of its pension fund clients.
At the start of this year, 20.5% of the Dutch population was over 65 years old, compared to 12.8% in 1990. The Netherlands is aging, and it is no exception in Europe. BlackRock CEO Larry Fink even warned of a global pension crisis due to the growing aging population. Fokkens confirms that an aging population can influence the investment mix. “Older people tend to be more risk averse. Above all, they want a stable pension payout, preferably compensated for inflation. As a result, pension funds are likely to invest more in fixed-income securities for them and less in equities or real estate. But aging is a gradual process, so it doesn’t lead to a sudden shift in the portfolio. That’s the potential danger: it’s so gradual that you might miss the point where adjustments are needed.”
Drawing board
This brings Fokkens to the renewed pension system, which Dutch pension funds will transition to from 2025 onwards. “In this renewed system, the risk of missing such changes is much smaller because an explicit investment mix is established for different age cohorts. This follows the lifecycle theory, where more risk is taken for younger participants since they have less need for protection against interest rate movements and have more time to recover from potential investment losses. As individuals age, their profile shifts towards more protection against interest fluctuations and less exposure to equities.”
Since the overall investment policy is an aggregate of all age cohorts within a pension fund, the aging population will naturally place more weight on the older cohorts, Fokkens continues. “This automatically shifts the focus of the investment portfolio more toward interest rate protection and less toward equities. The fact that such a shift occurs implicitly, without needing to constantly revisit the drawing board, is one of the positives of the renewed system.”
Patience
APG benefits from a certain level of patience, Knaap explains. “We can stay invested in an asset for many years, which is necessary for certain assets, such as private equity. With private equity, you know it won’t generate returns for several years. A bank, on the other hand, risks clients withdrawing their money, forcing the bank to sell its stake prematurely, potentially incurring losses. We don’t face that risk, which makes us particularly well-suited for long-term investments. An additional advantage is that few parties are in a similar position, and long-term investments tend to deliver solid returns.”
Since most pension wealth is held by older individuals, the investment portfolio becomes less risky
Similar to the current pension system, Knaap expects that in the renewed system relatively few pension fund participants will transfer their accumulated wealth to another pension investor, keeping long-term investments attractive for APG. Participants might have the option to withdraw up to 10% of their pension savings upon retirement; however, Fokkens notes that these are amounts that can be easily freed up month by month, so they won't affect the investment mix. “There’s also the possibility of collective value transfers, but that’s unlikely. Many employers are subject to mandatory participation, meaning they can’t easily switch pension funds.”
Automatic Mechanism
In recent years, some Dutch pension funds have been paying out more in pensions than they receive in contributions for current participants, Fokkens explains. “But even then, the net outflow only amounts to about 10 to 20 basis points relative to the total amount of pension investments. Within our investment portfolio, so much cash flow is generated that we generally don’t need to sell illiquid investments to free up funds.” Due to aging, monthly cash outflows will gradually increase. “But again, this happens so gradually that it won’t trigger the need to proactively sell illiquid assets. Additionally, there’s an automatic mechanism at play. Since most pension wealth is held by older individuals, the investment portfolio becomes less risky, and the importance of illiquid investments in the portfolio automatically decreases over time.”
Secure Living
Aging does have consequences for pension funds and their investments managed by APG, Knaap notes. Most Dutch pension funds were established around World War II. Until the late 20th century, they could balance out benefit fluctuations with relatively modest contributions from active participants, allowing retirees to live comfortably. Since then, the proportion of retirees has steadily increased. “Raising pension benefits now has serious consequences for a pension fund. It can’t be covered by just slightly increasing contributions anymore. In recent decades, when investment results faltered and interest rates declined, pensions were not fully indexed every year. While we’ve moved past that phase, the number of retirees will continue to grow relative to the number of workers. Having retirees shoulder part of the risk forces us to consider the desired level of risk for different age cohorts. One of the positive aspects of the renewed pension system is that it allows pension funds to take enough risks for younger participants, while keeping the risk relatively low for older participants, especially compared to the current system.”
Scale and Expertise
Knaap emphasizes that a pension investor like APG is exceptionally well-equipped to acquire and manage “patient capital”. “In the stock market, the price of a share is determined by a large group of buyers and sellers. As a result, you can assume that the price you pay is not too high or too low. But when investing in private equity, for instance, it’s harder to assess whether the investment is worth it. To get a clear picture, you need to analyze what the company will be worth in five years. That’s much more complex than simply buying equity and is also the reason why not many parties can do what we do.” This requires both scale and expertise. “At APG, we are fortunate to be large enough, and there’s no risk that our pension fund clients will need to withdraw their invested capital tomorrow, so to speak. It’s a good thing that we can continue doing this in the future, and we won’t need to drastically adjust our investment strategy or asset mix due to developments like aging or the renewed pension system.”