EU bonds ideally suited for pension funds

At the end of January, the European Union (EU) will issue its first social bonds of 2021. In the last quarter of last year, the EU embarked on the wide scale issue of debt securities, in which PGGM has already invested 400 million euros for Pensioenfonds Zorg & Welzijn, the Dutch pension scheme for healthcare workers.

These new instruments provide an excellent investment opportunity for pension funds to hedge their interest rates, but the benefits extend further: the EU bonds also reflect the ambition of PFZW to generate social return, for example in the field of climate.

History shows that Europe is taking its biggest steps towards further integration in times of crisis, as has been demonstrated in this COVID-19 pandemic. In April 2020, the EU set up the SURE programme to provide financial support to mitigate the negative consequences of this crisis on employment in the EU.

In July 2020, a historic agreement followed on a financial recovery programme for the EU (Next Generation EU). One of the parts of this agreement is that the EU becomes an important player worldwide on the bond market. With an estimated annual issue of 200 billion euros, the EU will be the biggest issuer of new debt in Europe in the coming years.

Due to extra inbuilt safety measures, a bond issued by the EU has a better credit quality than a basket of national government bonds of the individual member states. Moody's has already awarded the EU an Aaa credit rating, but even S&P has raised the outlook of its AA rating from neutral to positive after the ground-breaking agreement on the European recovery fund.

In addition, EU bonds, particularly with their long average maturity, are excellent instruments for hedging the interest rate sensitivity of pension fund liabilities. At PGGM, we apply the concept of 'hedging volatility' to measure the effectiveness as a hedging instrument. The European institutions which issue bonds score better here than individual EU countries. In an optimisation portfolio, a mix of Aaa and Aa instruments also appears to give the lowest volatility in interest rate hedging.

Finally, supervisory authorities are putting increasing pressure on financial institutions to reveal the effects of climate change on their investments while pension funds simultaneously need to clearly show their participants how much of the pension investments contribute to tackling climate change.
From the NGEU, 30 percent will be funded by the issue of green bonds. The number of green bonds issued by European issuers will double and green bonds with an Aaa rating will even increase sixfold!

Besides standards, for example the EU taxonomy and Green Bond Standard, financial instruments from the EU will also further shape the leading role of Europe with respect to battling climate change. At the same time, these bonds offer pension funds the opportunity to achieve financial goals and social ambitions.

This blog is a summary of an article (in Dutch) that we wrote earlier in the winter edition of the VBA Journaal.