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“We are more robust by investing in even more asset classes”

Leon Verboon

Inflation and interest rates are rising sharply

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. The 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: from late February, when Russia invaded neighboring Ukraine, inflation went up and up. 

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), inflation barometer of Statistics Netherlands (CBS) rose 14.5% in September (compared with September 2021); over the whole year, inflation in the Netherlands reached 9.6%. In the euro zone, inflation over 2022 was 9.2%, in the US 6.5%.

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 stock 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", Investment Analyst Leon Verboon observes.

“For stock markets, 2022 was a difficult year 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 the investment portfolio of the pension fund. A small portion of the pension capital had been invested in Russian shares and bonds through widely diversified investment funds. Following the invasion of Ukraine, in accordance with the wishes of the board and in line with EU sanctions, the positions in these investments were divested. As this affected only a limited part of the investment portfolio, the impact was minimal.

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“For stock markets, 2022 was a difficult year"

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."

"A 1% increase in interest rates leads to roughly 12% more pension being purchased with 1 euro of pension capital"

Negative returns are only one side of the story
The disappointing returns in both share and bond markets also had a negative effect on the SNPS investment results. "But for our participants, not an immediate negative result. Return is only one side of the coin. In fact, increased interest rates mean that the reserve to be held for pension entitlements of retired participants is lower and that purchasing pension, for those participants whose pensions have yet to be purchased, becomes cheaper. The latter is quite substantial: a 1% increase in interest rates means that with 1 euro of pension capital, you can buy roughly 12% more pension", according to Leon. The returns of the Life Cycle portfolios Return, Interest and Matching were negative over the reporting year, but it’s encouraging that SNPS performed slightly better than the relevant benchmarks.

The Collective Variable Pension - in which continued investment after the retirement date is facilitated - benefited from the increased interest rates (due to a decrease in pension entitlements), but at the same time faced a decrease in assets due to investment results. On balance, the result for the 2022 reporting year was negative. For the Collective Variable Pension, both negative and positive results are spread over a five-year period. "Because of this spread, we do not have to present participants who have opted for a variable pension with a reduction. In fact, thanks to the positive results achieved in previous years, most will see a small plus in their pension benefits", Leon observes.

Contract extension 
The contract with Achmea Investment Management (AIM), the fiduciary manager of SNPS, has been extended in 2022. "We are pleased with that, because they have been our partner since the founding of SNPS. We know perfectly well what we can expect from each other. We are satisfied with AIM and work well together. We see the relationship with AIM as a strategic partnership in which we cooperate to continuously take SNPS' proposition to an even higher level. They also like working with us because, in all modesty, we are an innovative forerunner that is already working more or less according to the basic principles of the new pension system."

Examining investment beliefs 
SNPS regularly reviews its strategic investment policy and its implementation. In 2022, Leon explains: "We started evaluating our investment beliefs, which form the basis of our investment policy. The outcome is that we have fine-tuned our existing beliefs and added new ones. For example, we are putting even more emphasis on ESG factors because, like diversification of investments, they can lead to improvement of the risk-return profile of our portfolios. Another investment belief is that we really believe in the value of active management as it allows you to add value because of some of the inefficiencies in the financial markets."