Exploiting Market Mispricings: Dutch Pension Reform and Arbitrage Opportunities in German Bonds

The Dutch pension system's transition from a defined benefit (DB) to a collective defined contribution (DC) model is reshaping institutional investor behavior across Europe, creating fertile ground for relative-value strategies. As pension funds recalibrate their portfolios to align with the new framework, the demand for long-term government bonds is collapsing, while arbitrageurs are capitalizing on divergences in the German bond-swap market. This structural shift, driven by regulatory changes and evolving liability profiles, has sparked a wave of strategic reallocation, volatility, and novel opportunities for market participants.

Structural Shifts in Pension Allocations

The 2025 Dutch pension reform marks a seismic departure from the DB model, which historically required pension funds to hedge long-term interest rate risk through deep holdings in government bonds. Under the new DC system, younger workers' pensions are increasingly allocated to equities and other growth-oriented assets, reducing the need for long-dated hedging instrumentsDutch pension reforms : 4 things to watch^[1]. For instance, the ABP pension fund—a cornerstone of the Dutch system—has announced a strategic shift away from government bonds, with an estimated €25 billion reduction in its holdings. Extrapolating this trend, European government bond demand could decline by up to €100 billionDutch pension reforms : 4 things to watch^[1].

BlackRock has advised pension funds to cut government bonds in liability-driven investment (LDI) portfolios by at least 10 percentage points, favoring alternatives like mortgages, short-duration corporate bonds, and private debtDutch pension funds should slash government bonds, says BlackRock^[4]. This shift is further accelerated by the elimination of preferential risk-weighting for government bonds under the new pension framework, which allows for greater flexibility in portfolio constructionDutch pension reforms : 4 things to watch^[1]. The result is a structural decline in demand for long-end euro duration assets, with cascading effects on swap curves and bond yields.

Relative-Value Opportunities and Barnegat's Case Study

Amid this reallocation, arbitrageurs are exploiting mispricings in the German bond market. Barnegat Fund Management, a hedge fund known for its relative-value strategies, has positioned itself to benefit from the divergence between long- and short-term interest rates. The fund has taken a long position in 30-year German bonds via futures while shorting comparable swaps, betting that long bonds are undervalued relative to swaps. Conversely, it has shorted five-year notes, which it views as overvaluedDutch pension reforms : 4 things to watch^[1].

This trade is rooted in the Dutch pension reform's impact on long-dated assets. As pension funds unwind their long-term hedges—particularly those with 20-year and longer maturities—the demand for long-end bonds is expected to weaken, pushing yields higher. Barnegat's founder, Bob Treue, attributes part of the divergence between bond yields and swap rates, which began around 2022, to these pension-driven flowsDutch pension reforms : 4 things to watch^[1]. The fund's performance underscores the viability of such strategies: it returned 5.4% in 2024 and 7.9% through August 2025, with an annualized return of 13% since its 2001 launchDutch pension reforms : 4 things to watch^[1].

German Bond-Swap Divergence and Market Dynamics

The German bond-swap curve has steepened significantly in 2025, with 30-year yields rising to levels not seen since 2011Bund Curve Steepening Could Extend as ECB Cycle Bottoms^[2]. The 10s30s spread currently stands at 55 basis points, approaching 2021 levels but still below historical peaks when the ECB rate cycle bottomedBund Curve Steepening Could Extend as ECB Cycle Bottoms^[2]. This steepening reflects a confluence of factors: the Dutch pension reform's impact on long-end demand, German fiscal expansion, and broader macroeconomic uncertainty.

The transition of Dutch pension funds is expected to exacerbate this divergence. As institutional demand for long-dated bonds wanes, liquidity in the 30-year segment is likely to tighten, increasing transaction costs and volatilityLDI Market Update – March 2025, the new Dutch pension ...^[3]. The Dutch central bank has expressed concerns about potential financial stability risks during the unwinding of hedging positions, particularly in low-liquidity environmentsLDI Market Update – March 2025, the new Dutch pension ...^[3]. However, a one-year grace period has been granted to allow for a more orderly transitionLDI Market Update – March 2025, the new Dutch pension ...^[3].

Risks and the Path Forward

While the arbitrage opportunities are compelling, they are not without risks. The unwinding of long-term hedges could create sharp volatility in the 20s30s swap curve and beyond, where liquidity is already thin. Additionally, the success of Barnegat's trade hinges on the persistence of the current yield curve structure, which could be disrupted by unexpected ECB policy shifts or fiscal developments in GermanyBund Curve Steepening Could Extend as ECB Cycle Bottoms^[2].

For institutional investors, the key lies in balancing exposure to these opportunities with robust risk management. The Dutch pension reform is not merely a one-off event but a structural reorientation of capital markets. As pension funds pivot toward higher-return assets and away from long-term duration, the implications for bond markets—and the arbitrageurs who navigate them—will be profound.