AF Advisors: How do institutional investors’ portfolios differ?
This column was originally written in Dutch. This is an English translation.
Many Dutch people invest. If not through their own investment account, then as part of a mortgage, an insurance policy or a pension scheme. Yet few invest for the sheer pleasure of it. Those who speak passionately about their returns are more likely to be speculating, with a bit of luck, than actually investing.
By Jasper Haak, Managing Partner, AF Advisors
However, the objective shared by almost all investments is that they are geared towards providing for retirement. Investments made as part of a pension fund or life insurance policy are, naturally, focused on this, but many retail investors also use their money for retirement, or at least as a supplement to it.
In the past, it was difficult to compare pension fund portfolios with retail portfolios. The investment policy of a pension fund aimed to achieve the best possible pension, given the ambitions and obligations arising from the membership base. This meant investing in a collective portfolio with a collective investment policy.
Consequences of the pension reform
The pension reform is changing this to some extent. Investments are still made collectively, but no longer under a single collective investment policy. This varies per member or per group of members. Under the flexible contribution scheme, this is done via an explicit lifecycle, and under the solidarity-based contribution scheme via a de facto lifecycle with an investment policy per age group. The risk is reduced as the member approaches retirement. All this means that it is now easier to compare pension investment policies across investments via pension funds, insurers and banks.
Although there are now more similarities, differences remain. Pension funds still share the longevity risk and have a number of options to make pension payments somewhat more stable. Banks will have to take into account their customers’ need to withdraw the money earlier for other purposes.
Investment mix
What do banking, insurance and pension portfolios have in common? In all three, risk is reduced over time. In pension funds with a defined-contribution scheme and in banks, this is often done through a stepped structure, whilst insurers and pension funds can generally do this more gradually with a flexible contribution scheme.
A clear difference lies in the investment mix for members well before their retirement. In banking portfolios, the risk profile is determined by the client, advised by the private banker. With pension products from insurers and defined contribution schemes from pension funds, there is often a choice between different risk profiles. The client makes this choice independently based on a choice architecture. In the case of defined-contribution schemes offered by pension funds, there is no choice and the investment mix is determined by the participant’s age. What all three types of investment portfolios have in common is that, for younger participants, relatively little risk is generally taken.
Investment categories
All three types of portfolios feature well-diversified investments. However, the degree of diversification varies. In addition to shares and bonds, pension funds also invest in private markets. For banks and insurers, this is not the norm. Insurers now invest in Dutch mortgages within their pension products, but investing in other private market categories is more of an exception. Private markets play no role in most of the banks’ managed portfolios. In advisory portfolios, however, private markets such as property, private equity, infrastructure and private debt are increasingly being included.
Investment reports
Banks are accustomed to providing their clients with insight into the composition and returns of the investment portfolio. This is primarily done through their own reports. This is something that is relatively new for pension funds. Many pension funds provide members with limited insight into the investment portfolio via the annual report, possibly supplemented by periodic updates on the pension fund’s website. Insurers’ pension products fall somewhere in between. There too, information about the investments is often brief.
Outlook
The future will tell whether the differences between these portfolios will narrow. Will banks also start working more with lifecycle approaches for their clients? Will banks and insurers invest more in private markets on behalf of their clients? Will insurers and pension funds produce better reports for their members? Now that there is increasing competition between second-pillar and third-pillar pension products, they will look to each other more often. And that often means that portfolios will start to resemble one another more closely: lifecycle investing, partly in private markets and with good reporting.