Market shocks could see individual pot valuations rise and fall by 50 per cent under the upcoming new Dutch pension system, Northern Trust and True Capital Partners have warned.

Their joint white paper, Navigating the road ahead: Tackling investment risks in the Dutch pension transition, said it is expected that most funds will be adopting a ‘lifecycle’ approach to investing under the new system, where younger participants take on more capital risk due to their longer term investment horizon before gradually transitioning their portfolios towards lower-risk investments as they approach retirement.

As a result, “at a system-wide level in the Netherlands we expect to see an overall transfer from longer-dated fixed income to equities. We believe that investment risks should be a ‘top of mind’ topic for pension funds and stakeholders as they plan for the transition”, the paper stated.

Currently, of the €1.5trn of Dutch pension assets, €380bn are invested in equities (26 per cent allocation), with an additional €98bn in private equity (7 per cent allocation).

The white paper analysed a ‘typical industry-wide pension scheme’ adopting a lifecycle approach post-transition, investing on equities, bonds and, for hedging purposes only, interest-rate swaps.

It applied ‘familiar market shocks’ and their effect on the funding ratio, using what happened to assets and liabilities during historical market shocks, such as in 2008 and 2020. It also looked at the percentage change in value of assets per age cohort after applying stress scenarios, assuming distribution by present value of liabilities.

“With participants effectively transitioning to a starting asset level to invest in a different asset mix on a DC basis, [there] are very large variations in potential outcomes,” the paper found.

“The value of an individual’s pension pot could fall or rise by close to 50 per cent relative to its current level, simply by assuming what happens in the past happens again – and recall some of these [historical] market moves only took one to three months,” it added.

Looking at an individual level, the paper revealed that “there can be dramatic’ moves”.

Giving the example of a 52-year-old, who has therefore already accrued most of their pension entitlement, and “yet is still seeing scenarios with a loss of almost 30 per cent of asset value”. Those nearing retirement (age 62) were also found to be losing in asset terms in all [market shock] scenarios.

However, “if such outcomes seem uncomfortable, the good news is that there are ways to mitigate these risks”, the paper added.

This may involve reducing interest rate hedges reducing the duration of bond portfolios, and changes in their underlying portfolios to shift towards risk assets, it suggested, but that “it will be important to think about managing transaction costs and risk profile adjustments involved in such changes”.

Post-transition, “there is also a potential argument for hedging tail outcomes, despite the long-term horizons of most pension funds”, the paper suggested.

“In the early years following the transition, where participants are becoming accustomed to the new system, large swings in value could be worrying. Where protection is priced attractively and valuations relatively high, we believe there is also a case for using hedges that allow participants to participate in equity upside while limiting the prospect of large losses,” it added.

The implementation deadline for the new pension system, which will see the Dutch model shift focus from DB pensions to DC pensions, was initially set at 1 January 2028. According to the whitepaper, a collective DC model is the targeted format, where a contribution framework is paired with continued centralised management.

Pension funds in the Netherlands need to decide on what their new scheme will look like, its contribution levels, whether accrued pensions will be transferred to the new scheme, or whether they will transition to the new system at all or wind up and consolidate.

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