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“In 2022, the first step in reducing the risks has already been taken on the basis of the plan”

Leon Verboon

Transition or vain hope?

For investors, 2022 was a year to be quickly forgotten. The swift recovery of the global economy in 2021, after two tough corona years, led to rising inflation by the end of that year. This devaluation of money was supposed to be temporary, as was the opinion of the US Fed's central bankers, to give an example. But this "transitory nature" of inflation turned out to be wishful thinking. 

Inflation and interest rates rising rapidly
With US inflation already heading towards 8% in March, the Fed raised interest rates for the first time. That was the trigger for a series of sharp rate hikes: US policy rates rose from 0.25% to 4.5% in seven increments. The European Central Bank (ECB) followed in July with a first interest rate hike of 0.5%, followed by three more policy rate hikes. The ECB's policy rate stood at 2.5% at the end of the year.

The effects of rapidly rising inflation and interest rates were far-reaching, as share and bond markets worldwide recorded heavy losses in 2022. When interest rates rise, this generally has a negative effect on stock markets, as investing in bonds then becomes relatively more attractive. Especially in a sector like technology, share prices of big techs like: Amazon, Meta, Alphabet and Microsoft (after years of increases) went down by double-digits percentages. Partly because rising interest rates reduce the value of the tech companies' future profits and investors calculate those profits back to present value today. Consequently, the US technology index Nasdaq posted a negative result of more than 33% (in local currency) over 2022, while the broader S&P 500 fell more than 19% (in local currency). At that, the AEX's loss of close to 14% was not too bad. "Moreover, investors were increasingly spooked by fears of a downturn. Which makes sense, as rising interest rates make it more expensive for companies and consumers to borrow money. Then, when prices also rise sharply, energy prices in particular, economic activity falls over time. And before you know it, you land in a recession", Leon observes.

From late February 2022, after Russia's invasion of neighbouring Ukraine, inflation only accelerated. The war caused energy prices, especially in Europe, to keep rising during the year, followed by huge price increases in food and other products. In the Netherlands, for example, the consumer price index (CPI), CBS' inflation barometer, rose 12.1% in October (compared with October 2021). Over the whole year, inflation in the Netherlands reached 9.6%. In the eurozone, inflation over 2022 was 9.2%, in the US it was 6.5%.

"It's been a rough year for equity markets because of the sharp rise in interest rates, the war in Ukraine, high energy prices and fears of recession, among other things"

Farewell to Russian investments
Besides affecting financial markets in general, the war in Ukraine also had a more direct impact on SSPF's investment portfolio. A small part of the pension capital had been invested in Russian shares and bonds. After the invasion of Ukraine, the board decided to divest the Russian investments. As this affected only a limited part of the investment portfolio, the impact was minimal.

Weak bonds and a strong dollar
Bond markets also fell sharply in 2022. With interest rates rising, investors can indeed buy newly issued bonds with higher interest rates, thus reducing the value bonds currently in their portfolios. Long-term bonds are particularly affected by this phenomenon. Less credit-worthy interest-bearing securities such as low-rated corporate bonds were relatively less affected by higher interest rates, but their returns were mainly hit by the increased credit risk premium. Leon also points to the increased strength of the dollar: "We saw a sharp rise in the value of the dollar versus the euro. On the one hand due to sharp US interest rate hikes, on the other hand because the dollar is seen as a safe haven in times of high instability. In early 2022, for instance, a euro still fetched $1.13; in the autumn, that went to parity, so then the euro was worth as much as the dollar. That was inconceivable for a long time; the last time we saw that was in 2002."

Leon mentions a few other, perplexing disruptions in the global economy that characterise this reporting year: "China's zero-tolerance corona policy caused its growth to fall sharply in 2022. This policy also meant that China, as the world's export motor, was far less able to supply Western countries with goods and semi-finished products. In addition, industries such as the car industry were severely affected by global chip shortages. And don't forget British former prime minister Liz Truss whose economic plans caused worldwide consternation, resulting in much economic uncertainty especially in the UK."

Low Carbon Fuels
“China's zero-tolerance corona policy caused its growth to fall sharply in 2022"

Substantial increase in funding ratio
How did SSPF perform in this turbulent year? The pension fund achieved a return of almost -19%, but also saw its nominal funding ratio rise significantly from 130.6% to around 138%. Even more important is the increase in the real funding ratio, Leon points out: "It went up from 84% at the end of 2021 to around 88% at the end of 2022. Since last year, we have been focusing less on the usual nominal funding ratio and more and more on the actual funding ratio. We took this decision after an extensive ALM study in 2021. We aim for an actual funding ratio above 100." The objective is that the pension fund can not only meet current pension obligations, but also has sufficient financial resources in place to increase pensions now and in the future in line with price increases. Which leads to a real value guaranteed pension for all participants. Leon: "In our Journey Management Plan, we have defined that once the actual funding ratio reaches certain levels, we start derisking, or, in other words, reducing risk. In 2022, based on this Plan, we already took the first step in risk reduction: we reduced the percentage of Return-Seeking Assets - such as shares and private equity - from 50% to 40%. At the same time, we further increased our interest rate hedging, from 30% to 50%. By reducing risks at high funding ratios, we are creating a more stable and robust financial position on the one hand, while at the same time safeguarding that the likelihood of reaching the danger zone is reduced.

"It's been a rough year for equity markets because of the sharp rise in interest rates, the war in Ukraine, high energy prices and fears of recession, among other things"

Invested assets by subportfolio
SSPF's invested assets fell from around €33 billion at the end of 2021 to €26.1 billion by the end of 2022. Purely seen from an investor's point of view, falling assets are not a good thing to see, but there is an important note to be added to this drop, Leon points out: "You should always see pension fund returns in relation to pension liabilities. Indeed, due to our investment strategy, SSPF's assets move to some extent with our pension liabilities. The fall in those pension liabilities, as a result of a sharp rise in interest rates, therefore largely explains the fall in invested assets. On balance, the financial position of the pension fund has not worsened, but actually improved!"

The pension fund pays a lot of attention to creating a robust portfolio, Leon continued. "For instance, we had a return of -9.3% with our Return-Seeking Assets this year, while broad stock markets recorded -14%. We create a robust portfolio by diversifying and investing in a spread. For instance, in addition to shares, which did worst overall, we also invest in other investment categories. These did considerably better this reporting year, including private equity with a slightly negative performance of -1%, hedge funds with a plus of around 2% and real estate with a return of +9%. The latter is easily explained: the rental income of offices, shops and houses is generally increased yearly by the inflation rate, so that makes real estate a highly sought-after investment category." And government bonds? "Those performed downright miserably due to the historic rise in interest rates. This has by far been one of the worst years for government bond investments."

Objective subportfolio
SSPF's investments are divided into three subportfolio. The already mentioned Return-Seeking Assets subportfolio (40% of total invested assets) includes a wide variety of, among others: shares, high risk bonds, private equity investments, real estate and hedge funds. This subportfolio aims to deliver optimum returns, with, at the same time, a strong focus on risk diversification. The other two subportfolios, adding up to 60 per cent of our total invested assets, are: matching assets (including interest rate derivatives and government bonds) and liquidity & investment grade assets (including short-term government and corporate bonds and mortgages). The matching assets aim to maximise the capacity to meet liabilities; this subportfolio therefore focuses on matching the interest rate sensitivity of future pension benefits as best as possible. The liquidity & investment grade assets are designed to provide liquidity, track liabilities to some extent and aim for modest returns with limited risk.

The Return-Seeking Assets portfolio scored an investment return of -9.3% in 2022, the matching assets and liquidity & investment grade assets portfolio also gave negative returns of -28.3% and -9.6%.