Managing Equity Risk in the Dutch Pension Transition

The stakes are high. For many funds, the coverage ratio at the moment of transition towards defined contribution-like structures (personal pension pots) will be a key determinant of participant outcomes. A significant fall in equity markets shortly before the change could materially reduce starting capital for participants, affecting confidence and complicating governance. Moreover, it is an unfortunate characteristic of markets that drawdowns tend to be sharper and more abrupt than rallies. Some sort of action to reduce exposure to large equity market losses through this critical period could well be sensible.

Yet this discussion is not only about protecting the balance sheet: it is about maintaining evenwichtigheid, or the fair balance between the interests of different participant groups. Stronger protection against an equity market fall in this crucial period is particularly beneficial for older members, whose equity exposure will decline after transition and who would have less time to recover from a market decline. Conversely, for the younger generation (whose equity exposure will rise in the new system), capital growth remains the key priority and risk mitigation measures for one or two years could result not only in potential missed gains but in the loss of compounded returns that those gains would have subsequently delivered over time. This could be a very significant price to pay, especially when it is primarily for the benefit of other individuals.

Now is the moment to ask: is some form of (temporary) equity risk mitigation appropriate?

Should this take the form of a more straightforward ‘linear’ approach, such as selling equities or shorting futures, or might an option structure—to protect against severe drawdowns while retaining upside—be more appropriate and fairer for the different member cohorts?

To add urgency, there is a relatively short period of time remaining for pension funds to assess this risk and take meaningful steps. It is widely assumed that the transition deadline may be January 1st 2028, although the date will not be confirmed until the legislation is ratified. There are also a limited number of governance ‘windows’ for each pension fund over the coming months – occasions when investment committees meet and decisions could be taken. Furthermore, some Dutch pension funds may not be ready to implement more complex protective measures—such as dynamic equity risk hedging—since (unlike interest rate hedging) equity overlays are not commonplace in this market. If these are found to be attractive, it can take months to enact the various legal agreements, programme parameters, account openings, collateral arrangements and other operational processes required. The time required for third-party provider selection should also be factored in, since a fund’s existing fiduciary manager may not be well equipped to offer the most attractive solution in a cost-effective manner.

1. Consider all potential tools in the toolkit

This unusual situation calls for a review of all potential equity risk mitigation techniques – including those that may have previously been deemed inappropriate or, for whatever reason, have not yet been seriously examined. The objective should not be to eliminate equity risk entirely but to protect, temporarily, against severe market dislocations that could derail carefully laid plans during the one-to-two years before transition.

Various potential strategies are noted in the table below. Each brings advantages and disadvantages: there is no ‘silver bullet’. Linear solutions, such as selling equities or shorting futures, are straightforward and inexpensive but remove all upside potential, opening questions of intergenerational unfairness when applied in this context. Options-based strategies can give protection while retaining upside potential, but the parameters need to be very carefully considered, and pricing is sensitive to volatility. There is also an embedded ‘cost of carry’ to hold options protection, also known as theta bleed. Indeed, if the deadline is changed, a pension fund could find itself having to ‘roll’ protection at a time when it has become prohibitively expensive (‘roll risk’).

Source: bfinance.

Different funds can weigh the pros and cons of each measure—or a combination of measures—depending on their specific priorities and circumstances, such as current coverage ratios and the age profile of their members.

2. Separate ‘decision to prepare’ from ‘decision to execute’

It can be pragmatic to separate the decision to prepare from the decision to execute. Most pension funds in this market are not operationally ready to implement appropriate strategies and laying the groundwork can take several months. This is particularly true when using options, though even a more straightforward linear approach such as shorting futures can involve operational complexity when executed in a way that requires external counterparties, trading agreements or credit facilities, and new account structures or collateral management.

With a ‘decision to prepare,’ providers can be assessed, parameters and triggers can be defined, legal agreements can be put in place and operational process can be established. The ‘decision to execute’ can then wait until market conditions are attractive, pre-defined thresholds are reached, or decision-makers conclude that the risk environment justifies action.

As well as being helpful from a governance perspective, the separation into two clearly distinct decisions also helps pension funds address the sensitive subject of timing. Market conditions are inherently unpredictable. Reducing equity risk reactively when volatility is already elevated can lead to prohibitively high cost and/or (in some cases) limit access to the most effective structures. The ability to act swiftly—without being forced into rushed decisions—is a strategic advantage.

Preparing early allows for swift implementation when the decision to go is taken, but it also means you have an expert eye (the manager) looking at the markets and deciding when to go on your behalf. Managers will be closer to the market than most investors and should be expected to make better decisions on implementation timing.

3. Review providers beyond the fiduciary relationship

In many cases, a pension fund’s existing fiduciary manager may offer an in-house solution. Although this may appear convenient, it can also come with limitations, such as less transparency on pricing and structure, as well as potential conflicts of interest since overlay mandates may contribute to internal revenue generation.

It may, therefore, be sensible to consider other providers, potentially through a selection process in which the fiduciary manager can (if appropriate) participate. Recent years have seen a broader range of providers enter the field of equity overlay provision, beyond the small group of global institutions that had historically dominated the sector, giving scope for genuine competitive pressure.

Firms vying for such appointments at present include asset managers with overlay desks, specialist risk managers focusing on volatility-based strategies, and boutique quantitative firms offering signal-driven approaches. Several of them show strong awareness of the regulatory context and governance dynamics of funds preparing for the WTP. An open provider selection process allows for a truly independent design of the mandate, stronger pricing discipline, clearer documentation, and the appointment of a provider with strong specialist expertise in execution.

The ability to compare costs effectively through such a process can be particularly compelling. While overlay management is potentially highly cost-effective, price transparency in the Dutch market is limited since such mandates remain relatively uncommon outside of the LDI (interest rate hedging) context. In a recent bfinance engagement for a tail risk overlay mandate (€2–5 billion), the client was quoted a management fee of 8bps p.a. by their incumbent manager, but a competitive process revealed a market median of 5bps p.a. and an alternative provider was ultimately appointed at 3.8bps p.a. including options and triggers.

Fees for tail risk overlays

Source: bfinance, ased on a review of 22 global providers in 2025.

Time to act?

For Dutch pension funds approaching transition under the Wet Toekomst Pensioenen, the question is not whether an unfortunately timed equity market drawdown will occur, but rather how to manage the asymmetric risk profile associated with this scenario. With coverage ratios under scrutiny and a fixed transition horizon, managing equity risk is emerging as a strategic priority. The current regime has been typified by the more frequent occurrence of drawdowns (and sharper corrections) than seen historically, meaning a potentially greater likelihood of encountering a drawdown that could result in an undesirable path-dependent outcome.

More straightforward linear approaches for reducing equity risk pose problems for intergenerational fairness. More complex options-based strategies, particularly dynamic overlays, can address this challenge without inappropriate imposition on younger members for the sake of protecting their older peers.

Pension funds can consider: have these risks been quantified and addressed appropriately? Have all potentially relevant strategies for addressing this challenge been considered? Are we confident that a solution available from the existing fiduciary manager would reflect best practice on various aspects, including transparency, execution expertise and cost? There is no simple singular answer to the challenge. One thing is clear: now is the time to address it.