Discussion of “Does Regulation Matter? Riskiness and Procyclicality of Pension Asset Allocation - Han van der Hoorn - OECD-APG Workshop on pension fund regulation and long-term investment
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Discussion of “Does Regulation Matter? Riskiness and Procyclicality of Pension Asset Allocation - Han van der Hoorn - OECD-APG Workshop on pension fund regulation and long-term investment

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This presentation by Han van der Hoorn, PGGM, was made at the OECD-APG Workshop on pension fund regulation and long-term investment held in Amsterdam on 7 April 2014. Discussions focused on:......

This presentation by Han van der Hoorn, PGGM, was made at the OECD-APG Workshop on pension fund regulation and long-term investment held in Amsterdam on 7 April 2014. Discussions focused on: long-term pension investment strategies under risk-based regulation; riskiness and procyclicality in pension asset allocation; and, regulatory challenges for long-term illiquid assets.

For more information, please visit:
http://www.oecd.org/daf/fin/private-pensions/OECD-APG-workshop-pension-fund-regulation-LTI.htm

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  • 1. Discussion of “Does Regulation Matter? Riskiness and Procyclicality of Pension Asset Allocation” OECD / APG / RiskLab Workshop 7 April 2014 Han van der Hoorn
  • 2. Relevance of the paper Procyclicality is hazardous to your health, and to your wealth • Procyclical behaviour can amplify shocks • Procyclical behaviour reduces investment horizons and, as a result, the supply of long-term financing, critical for economic growth • Procyclical behaviour is about market timing (avoiding temporary market dips); empirical evidence suggests that this is costly A proper (through-the-cycle) asset allocation is part of the solution 2  Similarilities, but also important differences Asset allocation Procyclicality Nature of problem Stock Flow Decision maker Asset owner Asset manager
  • 3. Procyclicality indicators Two benchmarks • Full rebalancing (FR): constant weights • Asset drift (AD): no transactions From a financial stability perspective, the most relevant benchmark is probably AD 3 FR AD 0 1 0 Neutral/ countercyclical “Partial rebalancing” 1 (Economic interpretation?) Procyclical
  • 4. If it ain’t Dutch … (1/2) FR Procyclicality Measure (Fig. 1): “Dutch pension funds […] were highly countercyclical during the latter period” (i.e., the crisis). AD Procyclicality Measure (Fig. 2) “Dutch pension funds are countercyclical.” 4  Can we conclude that Dutch pension funds were the “good guys” in the market?
  • 5. If it ain’t Dutch … (2/2) Countercyclical behaviour by Dutch pension funds is good news. However, • Pre-crisis, Dutch pension funds had higher allocations to illiquid alternatives that they couldn’t sell • Some procyclicality was happening inside asset classes and within trading limits • Substantial risk taking took place also in “safe” fixed income assets, as these • Had short maturities (mismatch with liabilities) • Were mostly nominal 5
  • 6. Explaining procyclicality – The challenge • “Perfect storm” (globally) • Low interest rates elevate NPV of liabilities • Financial crisis reduces asset values • Significant increase in life expectancy • Unconventional monetary policy, uncertain inflation outlook • At (around) the same time (in the Netherlands) • Introduction FTK • Change in contracts: from final-salary to average-salary DB • Consolidation of pension funds • Outsourcing of asset management, disentangling funds from service providers • Complex objectives and constraints (Netherlands) • Nominal liabilities, but with a real ambition • Solvency add-on for inflation-linked assets • Data limitations 6
  • 7. Results 7 • At the highest level of aggregation, very little explanatory power of potential drivers of procyclicality • Factors statistically different from 0 (at any significance level) at either FR or AD benchmark, show up with opposite sign (not significant) under alternative indicator, and/or with incorrect sign • Marginally better results at more granular levels, but still disappointing • Is there still scope for improvement? Expected sign Full rebalancing Asset drift Quantitative Investment Restrictions – 0.259 -0.534** Excess Liability Discount Rate ≈ 0.679*** -0.322 Liabilities Recognized in Sponsor’s Balance Sheet + -0.510** 0.190 Quantitative Risk-based Capital Requirements + -0.375 -1.030*
  • 8. Potential avenues for stronger results • Observed/observable variables • Instead of a weighted average of (standardised) market value and funding requirement, use distance between market value and funding requirement • Proportion of assets managed externally (principal–agent problems) • Unobserved variables • E.g., risk tolerance, incentive structures • Estimate model in first differences (i.e., make fuller use of panel data structure) • Use continuous instead of binary procyclicality indicator • E.g., 𝑃𝐶𝑖𝑡 (𝑙) = 𝑤𝑖𝑡 − 𝑤𝑖𝑡 𝑙 × 𝑟𝑡 𝑀𝑘𝑡 • Differentiate between bull and bear markets, and estimate model for two sub-periods 8
  • 9. Concluding remarks • Procyclicality matters; understanding its drivers is the first step to addressing the problem • As long-term investors, pension funds can (and should?) invest countercyclically, but do not fully exploit their potential, due to internal and external constraints • In line with our own experience, stricter regulation has triggered a de-risking of asset allocations, although not necessarily in a procyclical way • If we torture the data a little more, we may be able to uncover aspects of procyclical behaviour • Last but not least, I enjoyed reading the paper! 9