sectorbrief uitbesteding vermogensbeheer engels_tcm51-227343

Supervision of Pension Funds and Investment Firms Small and medium-sized pension funds P.O. Box 98 1000 AB Amsterdam Confidential

Date

16 January 2013

Our reference

2013/11989

Encl(s):

1

Subject

Supervisory Theme Outsourcing of Portfolio Management

This is an informal English translation of the “Sectorbrief Themaonderzoek Uitbesteding

Vermogensbeheer” dated 16 January 2013 in Dutch which can be found on www.dnb.nl.1

This translation is provided to you for your convenience. The Dutch version of the “Sectorbrief

Themaonderzoek Uitbesteding Vermogensbeheer” is leading under any and all circumstances.

Dear members of the board of trustees,

Within the scope of thematic supervision De Nederlandsche Bank (hereafter DNB) currently

examines the outsourcing of portfolio management by a number of pension funds in supervision

class T22 (hereafter Supervisory Theme). DNB is looking primarily at the structure of investment

mandates.

The Supervisory Theme is on-going. In the meantime, we wish to provide you by means of the

annex to this letter with a number of tools which you can use to analyse and evaluate your

investment management agreements. Note that this supervisory theme shall also be conducted

with respect to (a selection of) pension funds in supervision class T3 in 2013.

Notes

In its letter of 26 April 2011 (ref. no. 2011/237247), DNB informed the sector of the results of the

DNB investment surveys 2010. The annex to this letter covered a number of points of attention

1 http://www.toezicht.dnb.nl/binaries/Sectorbrief%20Themaonderzoek%20Uitbesteding%20Vermogensbeheer_tcm50-227343.pdf 2 DNB has grouped supervised institutions into supervision classes in accordance with the new supervisory approach FOCUS!

Date 16 January 2013 Our reference 2013/11989

regarding the investment policies of pension funds, including the structure of investment

mandates. The findings available at that time have been the reason for DNB to start a supervisory

theme with respect to outsourcing of portfolio management.

Within the scope of the Supervisory Theme DNB examines several aspects, including whether

investment management agreements contain such limitations with respect to the investment

policy that result in a sufficiently unambiguous and effectively limited instruction for the

portfolio manager. That is required for pension funds to guarantee control and integrity in

business operations (beheerste en integere bedrijfsvoering), also with regard to the outsourcing of

portfolio management.

The annex contains notes on four topics and an accompanying list of relevant questions:

1. Translation of the strategic investment policy into the instruction for the portfolio

manager

2. Effective limitations (to this instruction)

3. Insight into the investment portfolio

4. Legal structure of the investment management agreement

We hope that you find the list of questions in the annex useful and that it helps you to analyse

your investment management agreement(s) and take suitable action where necessary.

Should you have any questions or queries concerning this letter, pleases contact the Examining

Officer (toezichthouder) or the contact person of your pension fund.

Yours sincerely,

De Nederlandsche Bank NV

Prof. O.C.H.M. Sleijpen

Director of the Supervision of Pension Funds and Investment Firms division

Date 16 January 2013 Page 2 Our reference 2013/11989

ANNEX – OUTSOURCING OF PORTFOLIO MANAGEMENT

This annex contains notes and a list of relevant questions for each of the topics identified in the

DNB letter to the pension funds (sectorbrief) dated 16 January 2013. This list of questions is not

exhaustive. Its aim is to provide guidance by indicating potential shortcomings, thus enabling you

to take suitable action.

There are four topics which are in any event important in the case of outsourcing of portfolio

management:

1. Translation of the strategic investment policy into the instruction for the portfolio

manager

2. Effective limitations (to this instruction)



The instruction for the portfolio manager is usually set out in an investment management

agreement, with the portfolio manager's investment mandate attached. This annex refers to the

investment mandate. If you have issued instructions to the portfolio manager in another way,

please refer to that instead.

Should you have any questions concerning this annex, please contact the Examining Officer

(toezichthouder) or the contact person of your pension fund.

1. Translating the strategic investment policy into the instruction for the portfolio manager

It is important the instruction given by the pension fund to the portfolio manager corresponds

with the pension fund’s strategic investment policy to prevent additional risks arising from the

manner in which the portfolio manager carries out the instruction, and which are not envisaged

and/or predicted by the pension fund.

Firstly, this requires a pension fund to draw up its investment policy adequately. After all, if the

investment policy is in any respect still unclear to the pension fund, it is almost impossible to set

out this policy in a clear and simple instruction for the portfolio manager. Secondly, a coherent


and complete set of agreements between the pension fund and the portfolio manager is required to

determine the limits of the instruction. When drawing up the investment mandate, it is essential to

include, for example, further details of investment categories (such as regional spread) and the

restrictions of the investment universe (i.e. the manner in which it is permitted to take exposure).

Questions about the further details of the investment categories:

• Establish

o Has every investment category been sufficiently specified in the investment

mandate? An investment category can be defined in different ways. For

example: by regional or sector division, by investment method (single funds or

fund of funds) or by the strategy within investment categories (e.g. within hedge

funds).

• Using a benchmark:

o Does the investment mandate include the objective(s) of this benchmark? These

objectives may be, for instance, to compare estimated returns with the actual

returns or to provide a guideline for how the portfolio manager should invest or a

combination of both.

o Is the benchmark appropriate for the category in which the investment is made,

the objective of the benchmark (see above) and the specification of the

investment category?

• Using investment funds:

o Does the investment policy that you incorporated into the investment mandate

correspond with the investment policy of the underlying investment funds being

invested into? For example, are investment restrictions in the investment funds in

line with your asset allocation?

Questions on the investment world:

• Establish

o Does the investment mandate state the exposure that the portfolio manager may

take in each of the various investment categories? For example, only directly or


also through derivatives? What are the conditions?3

o Which products may be used to take exposure?

• Aligning with risk management

o Is the (potential) risk profile of the products in your portfolio adequately aligned

with the risk management of your pension fund? You may decide, for example,

that your investment portfolio can contain products with a non-linear risk profile.

Can your risk management capture such a non-linear risk profile?

• When using investment funds:

o Does the investment universe that you incorporated into the investment mandate

correspond with the investment universe in the underlying investment funds in

which you have invested? For example, do the non-permitted or permitted

products in the investment mandate and in the underlying investment funds

correspond with each other?

2. Effective limitations to the instruction for the portfolio manager

It is important that the pension fund’s aim regarding the limitation of the various risks and the

subsequent specification in the investment mandate correspond with each other. This means that

effective limitations on all relevant risks are formulated in the investment mandate or that the

pension fund consciously decides not to limit a risk. In doing so, the extent and degree of freedom

that the portfolio manager is given regarding the various risks are determined. This is also

important for appropriate risk management.

Questions on clear and effective limitations:

• Establish

o Have limitations been agreed for all applicable risks in your portfolio?

For instance, interest rate, currency, credit and active risk but also for risks in

connection with the use of leverage, concentration risk and liquidity risk.

o Does the limitation correspond with the objective that you intend to achieve with

3 Please see for further details on derivatives section 13 of the Decree financial assessment framework pension funds. This section

states, among other things, that derivatives are permitted insofar they help mitigate the risk profile or facilitate effective portfolio

management.


the limitation? For example, you wish to hedge interest rate risk, including curve

risk. However, you impose a limitation on duration that takes into account only

the risk of the level of the interest rates and not the curve risk. In this case, the

objective and the limitation do not correspond.

o Can there be a difference of interpretation between the portfolio manager and the

pension fund? For example, because the chosen wording can be interpreted in

various ways?

o Are the limitations suitable for the complexity of the (possible) risk

characteristics of the products being invested in? Less liquid products and a non-

linear risk profile require, for example, other limitations than liquid products with

a linear risk profile.

• Evaluation

o Is it clear how often limitations should be evaluated by the pension fund and

portfolio manager? Consider, for example, the interest rate risk that is dependent

on pension liabilities. Is the limitation evaluated when pension liabilities are

reassessed?

o Has the way in which this evaluation should be conducted been documented?

o Has it been agreed in advance if and how limitations are amended because of the

evaluation?

• When using investment funds:

o Are the limitations documented in the investment mandate in line with the

restrictions used by the underlying investment funds? For example, do the

limitations on the use of leverage in investment funds correspond with the

limitations stated in the investment mandate?


In addition to specifying clearly the instruction for the portfolio manager, it is essential that you,

as a pension fund, remain 'ín control’ by having sufficient insight into your investments. This

means, for example, that you are informed of what is happening in your investment portfolio,

what the risks are and what the total costs of the portfolio management are. The required insight

can be realised through reports and (insight into) fees, etc. The questions below relate to the


reporting requirements as stipulated between the pension fund and its portfolio manager.

Questions on reporting requirements:

• Insight

o Do you have a good understanding of the (possible) risk profile of your

investment portfolio? Do you understand the risk exposure per risk driver?

o Can you see whether your investment portfolio is an adequate translation of your

strategic investment policy?

o Your portfolio risk is expressed as various measures per risk driver. Do the

reports you receive, contain measures suitable for the complexity of your

investments?

• When using investment funds (including fund of funds)

o Do you have insight into all investments, also the monies invested by means of

investment funds? Do the reports with respect to investment funds use the ‘look-

through’ principle?

• Analysis of the performance and the risk

o Can you gain a good picture of the ways by which the portfolio manager has

realised the performance or any negative results? Is the total return on your

investments broken down by cause of result? (Consider, for example, over- or

under-allocating to an investment category but also selection effects within an

investment category.)

o Can you gain a good picture where in your portfolio there is exposure to risk, and

how much risk? Has the overall risk exposure been broken down by risk

exposure per risk driver?

Questions on fees:

• Establish

o Have the investment management costs been documented, or has it been

documented upon which aspects they depend?

• Insight

o Do you know in advance what the cost of the total portfolio management is? You

may not know in advance what the total cost is because it depends on the choices


made by the portfolio manager (within the agreed restrictions). In which way

have you ascertained that you are still ‘in control’ of the cost of the total portfolio

management?

• Evaluation

o Do you understand sufficiently the costs of an investment category, so that you

can take them into account when evaluating that investment category? This to

ascertain whether the category has delivered, after costs, the added value you

expected.


The legal structure of the agreement between your pension fund and the portfolio manager is also

relevant. A pension fund should always invest in accordance with the prudent person rule and its

organisation be set up in such a way that it guarantees control and integrity of business operations

(beheerste en integer bedrijfsvoering). The latter means among other things ensuring the solidity

of a pension fund. In this context it is important that a pension fund has procedures in place to, for

example, control the financial risks and other risks that can erode the solidity of a pension fund.

Risks also include legal risk and operational risk. In addition, specific rules apply to outsourcing

agreements that a pension fund enters into. These rules are based on the Pension Act (or the

Mandatory Occupational Pension Scheme Act) and secondary legislation.

Questions on the contractual relationship with your portfolio manager:

Does the board devote sufficient time and attention to establishing an investment management

agreement? Consider, for example, the following:

• Liability

o How has the liability of the portfolio manager been arranged?

o Is this arrangement logical and reasonable?

• Ownership of the pension assets

o Have you made agreements with your portfolio manager that give you a clear

picture of any ownership risks and the control of these risks (whether in

conjunction with the asset management agreement or other documentation such

as relevant custody agreements and/or the documentation of investment funds)?


• Third parties services

o Is it desirable to allow the portfolio manager to use the services of third parties?

If it is, which third parties, for which services, when and under which terms and

conditions?

• Making withdrawals from the funds under investment management

o Can you, during the duration of the asset management agreement, make a

withdrawal from (a part of) the funds under management of the portfolio

manager, if necessary?

• Compliance with the rules of the Pension Act and the Mandatory Occupational Pension

Scheme Act

o Are adequate arrangements in place to ensure the portfolio manager complies

with the rules laid down in or pursuant to the Pension Act and the Mandatory

Occupational Pension Scheme Act?

• Requirements with respect to the outsourcing agreements

o Does the investment management agreement meet the other requirements with

respect to outsourcing agreements as laid down in the Pension Act (or the

Mandatory Occupational Pension Scheme Act) and secondary legislation? Does

the investment management agreement contain, for example, arrangements to

exchange information between your pension fund and the portfolio manager? Are

arrangements in place that, for example, enable your pension fund to change at

any time the way in which the outsourced activities are performed?

• Transfer of rights and obligations

o Is it desirable to allow the portfolio manager to transfer to another legal entity the

rights and obligations pursuant to the investment management agreement, and if

so, under what conditions? For example, have you agreed that your prior written

permission is required before rights and obligations are transferred (also in the

event that the portfolio manager wishes to transfer his rights and obligations to an

affiliated legal entity)? Have you also agreed that this permission is requested

when the portfolio manager wishes to make such a transfer?

• Termination of the agreement

o Have you made adequate arrangements with your portfolio manager regarding

the terms and conditions of termination and the rights and obligations of both


parties upon termination? For example, can you change your portfolio manager

in a relatively simple, controlled manner and within an acceptable period, should

such a change be required?

• In-house funds

o Have you made agreements with your portfolio manager that guarantee any in-

house fund selected for you offers at least the same added value as a comparable

fund with another manager?

• Governing law and jurisdiction

o Which law governs the investment management agreement?

o Which court has jurisdiction in case of a dispute with respect to the investment

management agreement?

***

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