The Nordics: trends in investor demands

Richard Tyszkiewicz, director of European business development at Bfinance, explores the ever increasing sophistication of Nordic investors, and asks how this is influencing manager selection processes

Due to the European continent being incredibly varied, people have a tendency to divide it up into convenient chunks. Thus, we have the Nordic Region, ranging from Finland in the East all the way to Iceland in the West. But as a service provider to the institutional investor community, how safe is it to generalise on this basis? While the various countries definitely share certain common traits, it is also important to take the time to understand and appreciate the differences in approach within areas such as fund manager selection.

One common characteristic that is indeed displayed throughout the region is the high calibre of the investment teams within the Nordic pension funds. They tend to be staffed by comparatively youthful and highly qualified individuals,
with a healthy degree of scepticism with regard to both fund managers and consultants. This emphasis on building up in-house expertise has meant that reliance on traditional external investment advice has been less widespread than in other European countries. The individuals and teams responsible for selecting external asset managers generally benefit from a high degree of autonomy and, typically lean organisations make for a quick decision-making process.

The end result is that there is a far greater diversity of approaches to asset liability modelling than in more intermediated markets such as the UK. Many Nordic investors are very much following their own path and are therefore particularly keen to be actively involved in the finer details of the search and selection process. There is an understandable resistance to the outsourcing of key investment decisions or the acceptance of one-size-fits-all’ solutions.

Nevertheless, trends in the region and the wider market have presented Nordic pension funds with tough new challenges in recent years. Deregulation has facilitated and encouraged portfolio diversification, with a continuing shift away from fixed income. At the same time, the asset management industry has experienced a dramatic fragmentation, evidenced by the proliferation of specialist providers across all asset classes. Nordic investors are especially eager to identify and analyse products not simply from the familiar large multinational asset management houses, but also from highly specialised, but less well-known and sometimes geographically isolated boutiques.

Many of these smaller asset managers struggle to get their story across to such a widespread region. While they may have excellent teams and products, they might not be in a position to maintain a large regional sales force or open representative offices. The result is that Nordic investment professionals wishing to conduct a truly exhaustive search of the market on their own face a considerable challenge to their time and resources.

In response to this need for diversification, the different Nordic countries have come up with a variety of approaches to external asset manager selection. Certain Danish pension funds, for instance, have a strong history of close
co-operation in this field, pooling their resources and approaching the market as a group.

But while yielding potential economies of scale, this practice can prove problematic, particularly at the latter stages of a search when unforeseen differences in requirements between investors become apparent. This means that while informal co-operation certainly continues, such joint searches are becoming fewer and far between.

The loss of any eventual economies of scale can be more than compensated for by the downward pressure on prices resulting from the use of a competitive tendering process. Among the Nordic countries, Sweden has seen the widest presence of both domestic and international investment consultants, with local investors having often tried a variety of third party manager selection methods over the years. Certain pension funds such as the State buffer fund AP1 have since taken the decision to create fully-fledged in-house teams dedicated to manager selection, whereas others, such as AP7, prefer to co-operate with external partners on a mandate by mandate basis.

In contrast to Sweden, the Finnish market has seen little consultant involvement over the years. In some cases this gap has been filled by local asset managers, but the potential conflicts of interest are one of the reasons that new channels are being explored by many local investors.

The situation is somewhat similar in Iceland, where the country’s geographical isolation and booming domestic market have contributed to a limiting of pension funds’ exposure to the wider asset management community until fairly recently. A marked trend towards consolidation has seen an increase in the average size of Icelandic pension funds, and the largest ones are now faced with the need to appoint multiple managers in order to meet risk diversification requirements.

Norway’s highly concentrated market is dominated by the enormous Government Pension Fund, which has a truly global reach through offices in New York and London. However, legislative changes are expected to lead to
a gradual increase in equity allocations among small to mid-size funds, which should also lead to increased manager search activity in Norway as specialist mandates become more viable.

In addition to portfolio diversification and the growth in the sheer number of managers, selection procedures in the Nordic region are also being influenced by the need for transparency. Public and private sector funds come under high degrees of scrutiny from the government, regulators, trade unions and members. They must be able to demonstrate that best practice is being followed, and that investment decisions are being made in the most efficient and objective manner possible. The provision of a written audit trail of all decisions taken is increasingly considered an essential part of the fund manager selection process. It can provide evidence of the inclusion of the widest possible cross-section of providers in the market at the time of the search, as well as clear fact-based selection criteria. Nordic countries are also often at the forefront of efforts to put environmental, social and governance (ESG) issues at the top of the investment industry agenda. Institutional investors are coming under increased pressure in the region to incorporate ESG within their investment policies. This translates into a broad range of approaches from reactive portfolio monitoring and negative screening through to the appointment of pure ESG focused asset managers.

While the increasing number of mainstream ESG equity products available will facilitate searches in that field, many Nordic schemes find it almost impossible to ensure full compliance with their ESG policy when considering other asset classes such as funds of hedge funds.

One recent trend that shows no signs of abating is the move towards non-domestic real estate. The greatest demand is for unlisted property vehicles, the search and selection of which present a significant challenge. The universe of specialised managers is often unfamiliar and there is a veritable smörgåsbord of different structures and investment styles available. A systematic like-for-like comparison is hard to achieve. In characteristic Danish style, some of the largest pension funds responded to this challenge by pooling their resources as the so-called Real Estate Club. Others are following their own particular path, and we have seen a noticeable wave of European, Global and Far Eastern property fund searches on behalf of Nordic investors. These have required the creation of bespoke methodologies and appraisal techniques to help identify the strongest providers in this highly specialised field.

Notwithstanding their common characteristics of expertise, independent thought and pragmatism, working with Nordic pension funds is a rewarding experience due to the sheer variety of strategies and styles displayed not just from country to country, but also from fund to fund. The legislative and competitive environment is in a steady process of change, which means that things look likely to remain very busy in the field of fund manager selection as Nordic investors implement their strategies for the future.