Daily monitoring: less unnecessary rebalancing, better alignment with the target portfolio and interest rate risk position

For Dutch pension funds transitioning to the Solidarity Defined Contribution Scheme (SPR), the ability to monitor portfolios on a daily basis becomes a logical next step in maintaining controlled execution. Under the SPR, assets are invested collectively, while protection returns and excess returns are periodically allocated to age cohorts according to predefined rules. It is precisely this combination of collective asset management and cohort-specific allocation that makes the desired target portfolio and interest rate risk position non-static, requiring continuous reassessment and thereby creating a need for more frequent rebalancing.¹

In addition, the process under the SPR involves more operational steps. First, actuarial changes must be processed, then returns must be determined and allocated to cohorts, and only afterwards can the new benchmark or target portfolio and interest rate risk position for the collective be established. This chain of events creates a delay between the moment the target portfolio and interest rate risk position change from an economic perspective and the moment the actual portfolio is adjusted accordingly.

This delay is not merely an operational inconvenience, but also an investment and execution risk. Delayed rebalancing does not change the expected ex ante return, but it does increase the dispersion of outcomes. Moreover, the mismatches that arise as a result ultimately affect the excess return. This particularly impacts younger participants relatively more heavily, as they generally have greater exposure to excess return.

This immediately highlights the importance of daily monitoring. Funds that only monitor monthly discover too late that the actual portfolio has drifted away from the target portfolio. By contrast, funds that monitor actual positions, market movements and derived target weights on a daily basis can determine much more accurately whether a bandwidth breach truly requires action. This also aligns with the supervisory expectations of the Dutch Central Bank (DNB). DNB requires pension administrators to substantiate and monitor the design of interest rate risk protection and to take measures when limits are exceeded (see dnb.nl). The daily figures will generally be an approximation of the officially audited figures, as the latter will only be available once per month.

If a fund determines at month-end that the asset allocation and/or interest rate risk position falls outside the agreed bandwidth(s), daily monitoring enables two possible actions:

• Intervene immediately based on non-audited figures and adjust the portfolio,
  or
• Wait for the audited figures and assess one month later whether the portfolio still falls outside the bandwidth, taking into account returns generated during the intervening month.

Waiting can reduce transaction costs. If execution takes place one month later, additional returns will have been generated during that period. As a result, the allocation may already have moved back within the bandwidth without requiring rebalancing at the beginning of the month.

Daily monitoring makes it possible to manage the target portfolio more precisely by ensuring that rebalancing follows the allocation of returns with minimal delay. If rebalancing is based solely on audited figures, delays still occur. In that case, daily monitoring provides the opportunity to determine at the moment of delayed rebalancing whether rebalancing is still necessary, given recent market returns. Analyses show that this can reduce the number of transactions by 25% to 45%.² This results in lower transaction costs. Under the SPR, this is even more important than under the FTK framework, because the target portfolio itself is dynamic.

Daily insight requires a new connecting function between the pension administrator, custodian and asset manager: the “middle office function.” This link gathers new information on a daily basis and translates it into an up-to-date composition of the target portfolio and interest rate risk position. This requires daily monitoring of portfolio positions, automation of rebalancing calculations, an early warning system for significant deviations, real-time data links with custodians and daily position reconciliation.

² Depending on volatility in the equity and interest rate markets.

From a governance perspective, daily monitoring offers another advantage: it makes the rebalancing policy easier to explain. A board can demonstrably show that it does not act purely mechanically on a monthly valuation date, but instead assesses on the basis of current information whether a transaction is still required. This aligns well with controlled execution under the SPR, where not only the lifecycle and allocation rules must be correct, but also the operational translation into the investment portfolio and interest rate risk position. Especially when bandwidths are used, the distinction between “a measured breach” and “a breach still present at the time of trading” becomes policy-relevant.

As a result, the key question regarding rebalancing shifts from:

“when do we rebalance?”
to
“based on which information do we decide whether rebalancing is necessary?”

Daily monitoring provides the flexibility to use this second question as a policy instrument. It reduces the likelihood that funds act on outdated month-end data, limits unnecessary transactions and helps keep the actual portfolio and interest rate risk position closer to the intended target portfolio and interest rate risk position. This is not only more efficient, but also better aligned with the nature of the SPR, in which monthly cohort allocation and dynamic target portfolios and interest rate risk positions are inextricably linked (see dnb.nl).

Conclusion
For a Dutch pension fund operating under the SPR, daily monitoring is valuable for two reasons. First, it provides faster insight into the dynamic target portfolio and interest rate risk position, thereby offering the possibility to limit the mismatch between actual and intended portfolios caused by delays in the rebalancing process. If rebalancing is only permitted on the basis of officially audited figures, delays will still occur. This creates a second advantage of daily monitoring: it enables the inclusion of the most recent returns, making it possible to determine whether an earlier bandwidth breach has already corrected itself naturally. Precisely because of this, the number of rebalancing moments can be reduced without compromising control over risk and target weights.

Daily monitoring enables savings on transaction costs and improves portfolio management.

Want to know more? Contact Max Verheijen from BasisPoint | m.verheijen@basispoint.nl | +31 6 2491 3687