The €1.5bn De Eendragt Pensioen NV, the Dutch pension fund-turned- insurance company, continues to grab the headlines, with the recent announcement of a 17.2% net return on its investments in 2011. This highly respectable return came despite the fact that De Eendragt, as an insurance company, already complies with the rigours of Solvency II. (De Eendragt changed its status from a pension fund to an insurance company in 2006, due to a change in Dutch pension regulation).

De Eendragt CEO and CIO, Philip Menco, regrets the fact that Solvency II punishes insurers for taking investment risk, which he says makes the Directive’s effect very unbalanced. “Solvency II requires an enormous amount of company equity. It’s five times a safety belt,” he says.

Menco points the finger of blame for Solvency II at central bank supervisors wishing to limit their own risk. “If you are so limited that you can’t invest in anything other than Government bonds, you will get hardly any return longer term. The effect of this in the Netherlands is that we are seeing a move away from the hard [pension] guarantees we have to give. If Solvency II is applied to pension funds, it won’t be possible to make returns.”

Looking forward, the CIO wants to grow De Eendragt’s client base from the current 50 Dutch pension schemes worth €1.5bn to €2-3bn, saying that although De Eendragt is a not for profit company, it needs greater economies of scale. All profits, apart from those needed for solvency, are returned to its insureds via lower premiums. Whatever the future holds for De Eendragt, Menco’s mantra “let risk lead in your investment process, not return,” will remain the guiding force.

De Eendragt’s 17.2% return in 2011, in what was a difficult year for most investors, was in large part due to the company’s matching portfolio which invested heavily in triple A-rated French, Dutch and German government bonds, at a time when the yields on triple AAA-rated sovereign debt plummeted to historic lows, sending bond values soaring.

Menco explains: “We split the investment policy between a matching portfolio which matches the liabilities 100%, and a return portfolio for the free reserves which consists of everything except regular fixed income products. To discount our future liabilities, we use the ECB triple A curve, instead of the swap curve and the bond portfolio is built in such a way that there’s a matching of the interest rate liabilities with the ECB AAA euro government bond index.”

In August 2011, De Eendragt sold all its French government bonds and replaced them with long duration German bonds which contributed to the 20.5% return on the matching portfolio and also to the 17.2% overall return. To gain exposure to 50 year bonds, De Eendragt buys additional 30 year bonds with a total return swap, using bank lending, so that the fund is borrowing short and investing long.
“We have to do it this way as there is a limited supply of 50 year government bonds, and these are mainly issued by the French government,” he says.

As for the much smaller €250m return portfolio, Menco says: “We maximise returns longer term by using risk budgeting as a starting point in nearly all market circumstances, by ensuring that the potential loss is very limited and by using a combination of different asset classes and non market cap weighted equities.”

As a counterbalance of equity risk, the return portfolio uses two CTAs, which employ hedge fund-type strategies using momentum in the markets to go long/short in a whole range of different asset classes. One of the mandates is very short term and the other longer term oriented. Both have been successful since their appointment 18 months ago.

There is also a Global Tactical Asset Allocation (GTA) mandate consisting of a hedge fund strategy allowing the manager to make decisions on a systematic basis. Although Menco professes to disliking hedge funds, he says that the quant model used by this particular manager is completely transparent and that he can understand the process.

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