DMFCO: Allocation to mortgages can even increase under the Wtp
This interview was originally written in Dutch. This is an English translation.
Over the past 10 years, Dutch mortgages have become an important cornerstone of the investment portfolios of Dutch pension funds. However, with the new pension system, the funds may have to revise their allocation strategy. According to Evelien van Hilten, Head of Portfolio Management at DMFCO, the allocation to mortgages may increase. There are still some challenges to overcome.
By Harry Geels
How has the market for investing in Dutch mortgages developed over the past 10 years?
'The non-bank mortgage market has grown rapidly over the past decade. In 2014, when we started, institutional investors had a choice of two mortgage funds. Now there is much more choice. Not only in terms of the types of funds, but also in terms of the forms of mandate. Pension funds, most of which now allocate between 5% and 10% to mortgages, have become a dominant player in the Dutch mortgage market. In the space of 10 years, mortgages have developed from an exotic to a traditional investment category. Part of that growth can be explained by the fact that banks initially withdrew somewhat from the mortgage market, but that is no longer the case. The market now seems to have stabilized in terms of non-bank and bank mortgages. The only change we are seeing now is that insurers are reducing their interest in mortgages somewhat. Of all investors, they had the largest allocation to mortgages and are now reducing it somewhat. We are now the largest non-bank provider of mortgage investments and, through our label MUNT Hypotheken, we provide over €4 billion a year in mortgages through independent mortgage advisors.'
The entry of pension funds into the mortgage market has increased competition for the banks.
What are the main reasons for Dutch pension funds to invest in Dutch mortgages?
'Initially, mortgages were seen as a nice diversifying addition to the LDI portfolio because they have a high correlation with the swap rate. In addition, they offer an attractive spread above government bonds, with a low risk, due to the good payment morale of the average Dutch person. Foreign investors sometimes cannot believe how low the default rate on Dutch mortgages is. We have only had to write off 0.01 basis points on our entire portfolio over the past 10 years.
Of course, the spread has slowly decreased somewhat over the past 10 years due to the increased popularity of the investment category, but it has been stable and interesting for some time now. The spread level is often about 150 to 200 basis points above government bonds. The spread consists of roughly three parts: a credit risk, which as mentioned is limited by our payment morals, interest rate risk, in the sense that early repayment is possible, and a compensation for illiquidity.
In recent years, we have noticed that sustainability has become an even more important theme for pension funds. Mortgages fit well within these new requirements. A mortgage can be used to make a house more sustainable. But there is also a social component, namely that a mortgage enables people to buy a house. What also plays a role for pension funds is that a mortgage holder can also be a participant in the pension fund, which creates an interesting dynamic in which there is more focus on the interests of the consumer. Within our platform, we are therefore well able, in consultation with investors, to pursue a social policy in which mortgage customers are not immediately evicted if they are unable to pay the interest and repayments due to a setback in life.
The entry of pension funds into the mortgage market has also created more competition for banks. Mortgage conditions for consumers have therefore improved. In the past, for example, interest rates were not adjusted downwards if the risk profile of the mortgage improved. MUNT has introduced this and included it as a standard condition. Fortunately, this is also increasingly happening at competitors, because it is seen as a fair condition.'
Do you foresee a change in the demand for Dutch mortgages from Dutch pension funds in the context of the new pension system?
'The general expectation is that mortgages will continue to play the same role in the new system as they did in the old one. It is possible that allocations will even be increased somewhat. For example, by including more mortgages in the protection portfolio and selling government loans, additional returns can be added, which will benefit young participants. This can be done without a significant increase in the risk profile. There are various approaches, depending on the willingness to accept noise in the short-term return, which arises from deviations in the return on mortgages compared to the swap.
If this tolerance is low, we see mortgages being included in the return portfolio. However, mortgages are also a good fit here because they add diversification and returns with little impact on the risk budget. In our discussions with pension funds, we generally hear that allocations to mortgages are staying the same or increasing. Mortgages made sense before the Wtp. So why would they not make sense after the transition?'
What issues do Dutch pension funds need to consider in the context of the new pension system?
'One of the issues is liquidity, or the possibilities for increasing or decreasing allocations more easily. The market has already made great strides in this area. For example, we are getting better and better at matching allocation changes from one investor with those of another, especially because more and more investors are active on our platform. Transaction costs have also fallen considerably.
Another theme is speed, not only of the allocation changes just discussed, but also of reports and market value determinations. We currently value on a monthly basis, but at the request of the pension funds, we will start valuing on a daily basis. This will enable us to carry out rebalancing processes faster than before, so that pension participants are better informed in the context of the new transparency requirements.
One of the goals of the WTP is to increase transparency for pension fund participants. Our experience is that they respond positively when they discover that investments are also made in Dutch mortgages. How wonderful would it be if they realized, for example, that through their portfolio they had helped to provide a mortgage for their own child.'
In what ways can DMFCO offer support to clients in light of the new pension legislation?
'In addition to daily valuations, we will communicate more directly with the custodians of the pension funds, rather than just with the fiduciary manager or the pension fund itself, so that the information is processed much faster. We are also working on an infrastructure to enable faster rebalancing. We also support our clients in the analyses that are carried out to determine whether mortgages are better suited to the protection portfolio or the return portfolio.
If clients feel the need to adjust their allocation as a result of their analyses, we try to get in touch as early as possible so that we can help them explore the various options.
In recent years, apart from the new pension legislation, we have started to expand our services with regard to reporting on socially responsible investment. This includes, for example, energy labels for homes and climate risks for our collateral, such as flood risks. Foundation risks are also currently being mapped. After all, these risks are not insurable. For the time being, the climate risks appear to be limited in the Netherlands, also because many mortgages are being paid off. This provides financial leeway to finance any future repair work. Flood risks are almost exclusively limited to the river regions because the Dutch government has extensive plans to prevent a doomsday scenario in which a substantial part of the Netherlands is flooded due to a rise in sea level. Nevertheless, it is good to have insight and to make scenario analyses because the future can of course be different.
In recent months, we have also gained access to aggregated data on the actual energy consumption of the homes in our portfolios. The energy labels that were once awarded are insufficient, because many renovations have been carried out since then and no new label has been requested. This offers investors the opportunity to report better, for example for SFDR purposes. We are seeing a significant increase in the data requirements among investors on this subject, so we expect to continue to put a lot of energy into this in the coming years.'
Mortgages made sense pre-Wtp. So why wouldn't they make sense after the transition?
What are the most important trends and developments you expect in the mortgage market that could influence the investment strategies of pension funds?
'The pension sector is under pressure from increasing regulation. Consider, for example, all kinds of reports on sustainability. But mortgage lenders, who fall under the supervision of the Netherlands Authority for the Financial Markets (AFM), also face increased supervision. The requirements of the pension sector and the AFM come together with the asset managers in the mortgage domain. In addition, a certain level of quality is demanded, which ultimately leads to increased costs. It is therefore expected that further consolidation will take place. This is already in full swing with pension funds, but we also expect that mortgage providers will merge. Smaller mortgage providers will not be able to continue to deliver the necessary quality and at the same time offer an attractive fee compared to the large platforms. This is not a trend that only concerns mortgage products, but all investment products. For mortgages specifically, it is important for investors to give this extra consideration. A commitment to an inactive platform can be difficult to transfer to another asset manager. In addition, mortgage customers will also receive less attention because insufficient investments are made in the platform. This often does not correspond with the social policy that pension funds pursue. It is therefore good to think about this carefully when selecting a new manager.’
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IN SHORT Dutch mortgages have become popular in pension fund portfolios over the past 10 years. Pension funds invest in mortgages because of their low risk and stable returns. Sustainability and social policy are becoming more important in mortgage investments. The new pension system will probably increase the allocation to mortgages. Liquidity and transparency are crucial in the new system. DMFCO offers support through fast reporting, analysis and socially responsible investment. Increased regulation is expected to lead to consolidation in the mortgage market. |
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Evelien van Hilten Evelien van Hilten is Head of Portfolio Management at DMFCO, the asset manager behind MUNT Hypotheken. Prior to that, she worked as an Investment Manager for Philips Pensioenfonds and as a Portfolio Manager for Mortgages and RMBS at NN Investment Partners. Van Hilten started her career as a Risk Manager after studying General Economics in Leuven. |
