Dutch pension fund ABP says passive investing is now the preferable approach for its liquid assets.
Dutch pension fund ABP seems to have had a change of heart about its approach to active investing, stating it now looks at passive investing as a starting point for any liquid investments, where historically it has been mainly an active investor.
ABP cited the growing size of its investment portfolio and rising investment management costs as key drivers for a revision of its investment beliefs and said the fund was regularly questioned about the justification for the level of management costs it has paid.
“Partly due to the size of the investment portfolio, the asset management costs are high in absolute terms. This regularly raises questions regarding the usefulness or necessity of these costs,” the fund stated in the Dutch version of its 2022 annual report, published on 28 April.
“Investments in liquid asset classes have a lower cost level than in illiquid investments, especially if the liquid asset classes are invested passively. Based on our revised investment beliefs, a passive approach is preferable.”
The English version of the annual report wasn’t available on ABP’s website at the time of writing, but the fund did revise the English-language version of its investment beliefs statement.
In this document, ABP says that, based on academic research, the majority of returns of a portfolio can be attributed to asset allocation, not active management.
“The added value of active investing within an asset class is limited and occurs mainly in illiquid asset classes. For liquid asset classes, index investing with low costs is the starting point,” it said.
“We can add forms of active investing if we have sufficient prior evidence that, after the deduction of costs, this will structurally contribute more to achieving our ambition at ABP than index investing.”
In 2022, ABP spent €2.5 billion (A$4 billion) on asset management fees, including €797 million (A$1.3 billion) on performance fees.
However, the year before the fund spent €5 billion (A$8 billion) on asset management, largely due to higher performance fees, which totalled €3.4 billion (A$5.6 billion) that year.
ABP said that for illiquid assets, active management was still the preferred approach.
“For illiquid asset classes (mostly private investments), there is no possibility for index investing and we actively manage portfolios,” it said.
Investment Cost Review
The change in investment beliefs comes following the completion of asset consultant Mercer’s review of ABP’s asset management costs incurred in 2021.
The review was finalised in early 2023 and ABP summarised the findings of this review in its annual report.
Mercer said the level of asset management costs paid to wholly-owned asset manager APG was in line with the market for both liquid and illiquid assets.
But the asset consultant did note the performance fee structure for ABP’s liquid investments in developed markets, emerging markets and emerging market debt was somewhat unusual and more often found in mandates for illiquid assets.
Although Mercer acknowledged that the basic management fee was lower than the market average, it also said that if markets had performed in line with expectations that year, then the total cost would have risen above market averages.
But because markets performed poorly, it did not.
For illiquid assets, ABP paid asset management and performance fees that were in line with the market average, while for private equity investments they were even a bit below average.
ABP said it will assess what the review’s findings mean for each asset class during the remainder of 2023.
Against the Grain?
The pivot towards passive investment comes as many institutional investors in Australia seem to be going in the opposite direction.
The outlook for lower investment returns and greater volatility, brought on by a return of inflation, rising interest rates, more international conflict and deglobalisation, warrants a greater role for active strategies, they say.
For example, Raphael Arndt, Chief Executive Officer for the Future Fund, said in a recent speech that alpha-seeking strategies in listed markets are starting to look more attractive after years of lacklustre performance.
“Around six years ago we pivoted our listed equities approach away from active managers. At that time markets were being driven by central bank policies and our view was that it was nigh on impossible for active equities managers to consistently add value over and above their fees,” Arndt said in an address to The Australian Financial Review’s Alpha Live Conference in Sydney in April.
“Conditions have changed.
“Economies are diverging and companies can better distinguish themselves in a more challenging environment. As a result, active alpha-seeking strategies in our $65 billion listed equities program are increasingly attractive, provided that we can be confident that returns are driven by skill and not luck.”
He illustrated his point by stating that the Future Fund had recently started investing in Australian small-cap stocks for the first time in the history of the fund.
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