European Pensions Nordics roundtable
PANEL
Chair: Dorothee Gnaedinger, International Benefit Consultant, Mercer
Eric Bateman, European Business Development, Kleinworth Benson Investors
Billyana Kuncheva, Director of Fixed Income for the Nordic region, M&G Investments
Matti Leppälä, Secretary General, CEO, Pensions Europe
Sirkka Lindén, Associate, Mercer
Chair: To set the scene, could you please tell us what your perspectives are about the Nordic pensions market and what you see as the main challenges within it?
Leppälä: I would say that the Nordic market differs from many others. It is more insurance dominated and in some countries even the pension fund framework has more similarities with the insurance framework with its solvency rules. Funding levels are also comparatively high and so it doesn’t have the same underfunding issues as, for example, the Irish or the UK funds are at the moment faced with. I think one of the major issues is the volatility of the liabilities and how they’re dealing with that. I think there are solutions to that. Looking at the solvency frameworks of different countries, the details are different but basically Nordic countries’ solvency situations are better than most. And then that relates to the development at European level with Solvency II and the pension fund IORP Directive and debates about the solvency requirements for pension funds.
Chair: What about from a wider regulatory perspective, what kind of challenges are you seeing in particular Sirkka (Lindén)?
Lindén: There is pressure to increase the retirement age and it’s just a matter of time when we going there. Each country faces this and it is due to economic issues but in my personal opinion, I feel quite confident that for example here in Finland, even though the debate is quite hard, that it doesn’t actually make sense for us to do that. But it will go there absolutely. On the other hand regulatory issues are putting employers in a position where they’re trying to think how we could invest in people in a way to attract and perhaps give some additional pension, but that has been quite difficult and of course it always costs lots of money, but that’s what we face every day.
Chair: Does that have anything to do with the general agenda of the Nordics (and other countries) to move from DB to DC?
Lindén: For historic reasons and due to the very strong statutory pension system it has been a very long transition from DB to DC. We started with DC in the late 1990s, and other countries have been doing that very much earlier. DC plans is the direction absolutely that we are moving towards, but we still have to take care of all those old DB plans because they are equally important for their owners and beneficiaries.
Leppälä: The change from DB to DC has been strong also in the Nordics. The Finnish employment pensions are still DB from the employees’ point of view. But from the employer’s point of view, it is a DC plan. So you pay the contributions and you have no other obligations, and as a consequence the volatility in the market does not affect your balance sheet. So that is a hybrid scheme if one looks at it from a wider perspective, but from the beneficiary’s point of view it is a DB plan.
Bateman: I think from the investment side it’s a different type of pressure. One thing that is absolutely clear is the cost pressure within not just Nordic pension schemes but European pension schemes at the moment. For people like us the pressure to actually deliver is greater than it ever was before. If you’re an active manager you absolutely have to be seen to be adding alpha or adding value and the time horizon for not delivering that is growing shorter and shorter. I think the other pressure is actually the cost that European or global pension schemes are paying to people like us. They are increasingly under the microscope and I would suggest they probably won’t increase going forward so I think it’s a tougher environment for people like us.
Leppälä: That is definitely true. Talking with our members it’s a theme that is present for all of them.
Kuncheva: When we discuss costs, we should look into both investment costs and pension administration costs. In general the investment costs in Finland are relatively low. The results of an independent survey of the Finnish pension system were published in the beginning of 2013. The overall conclusion was that costs are pretty reasonable on the investment side. I think that the administrative costs are one reason why we are seeing a consolidation trend in countries like Finland and Denmark. On the other hand, even though from the outside the Nordics is often thought of as a homogenous market, every country has a different pensions system. For example, Finland’s peculiarity is that there is no ceiling for the national pension. This means that these additional pensions and private saving products are not really very common here.
Chair: So what does an additional pension look like here in Finland in comparison to the other Nordic countries, is there a difference?
Leppälä: In Sweden or in Denmark you have a great variety of additional occupational pensions and private savings products, in addition to the long tradition of investing in mutual funds by private persons. It is very different with the Finnish supplementary occupational pensions coverage, which is very low. There was a big increase in the third pillar personal pension products some years ago but then taxation and other rules have been continuously changed and it is very difficult to sell these products at the moment. It seems that the Finnish government thinks that it would undermine the statutory earnings related pension scheme if people were to have additional savings. They are perhaps afraid that people might go to earlier retirement if they have additional savings. In fact there is evidence showing that people who have actually saved more tend to stay longer in working life with that security. This debate has been going on in Finland for many years but at the moment the situation is not very good for the personal pensions.
Chair: That’s really interesting. It sounds as if the government is discouraging supplementary pension provision; a measure that’s contradictory to pretty much anywhere else in the world.
Leppälä: It is true because at the moment at European level many authorities are really focusing on personal pensions. Many different parts of the European Commission as well as EIOPA, are interested in personal pensions. It seems that from the European level there is an increasing push for a take up in personal pensions and building a European framework for personal pensions but in Finland that is not the case at the moment.
Chair: So, it’s an exciting time for personal and occupational pension providers in all of Europe. Eric (Bateman), what is your perspective of the provider market in the Nordics, with particular focus on the fee pressure that you mentioned earlier?
Bateman: It’s very difficult to respond to it. I think it’s really a pressure on providers to deliver. The period of grace that a provider has is shorter than it was before, I think because the funds are under pressure in terms of what they’re paying to people. The results are us being under greater pressure to deliver, so it’s not so much a transparency angle that we’re coming from, but I know that’s been an issue in some of the Nordic markets and indeed in other European markets as well, but I think just in terms of the overall pressure of an active manager. I think you have to be active and really deliver alpha. I think the pressure has never been greater and conversely there’s a greater pressure on fees than there was even two or three years ago. I think it actually means doing what you say you’re going to do. The phrase creating alpha tends to be linked with sensationally strong performance but I think what managers are being asked to do now is what they say they will do. So if you are in a particular space don’t drift from your style but also deliver what you say you’re going to deliver.
Kuncheva: I think it’s more to investment manager relationships than investment performance expectations. The matter of trust, predictability and transparency, in addition to performance, is also very important. In addition, institutional investors including pension funds are increasingly looking for sparring partners to discuss ideas with. Unlike in some other countries, in the Nordic region the decision-making organisations are very professional, they are not too dependent on intermediaries and consultants and are usually very much aware of new investment ideas and trends. They are very well serviced by the sell-side community, so managers need to offer market insights and new solutions. And that’s in addition to delivering investment performance, that’s another service that they expect in return for the fees.
Leppälä: And one peculiarity about the Finnish system is it is still a legal requirement in the Finnish pension system that the majority of the investments in pension insurance companies have to be done in-house. That is why you cannot outsource to the same extent as many do in some other countries. This legal requirement has enabled the pension insurance companies to build in-house teams who actually do have expertise.
Chair: So, the relationship between providers and pension funds in the Nordics can be described as a form of partnership – with high expectations for delivery. Does that also mean investors are willing to take a bit more risks in order to achieve these relatively high expected returns and performance? Do they look at alternative options? Where do you find new ideas?
Kuncheva: Meeting a certain level of return in the current economic environment – for example 4 per cent annual return over the long term – these days is getting harder and harder without taking unwarranted risks. So you need to work harder for your returns and that puts demands on both internal organisations and external counterparts.
Leppälä: But the big difference is how the liabilities are discounted in Finland. There is an administrative discount rate of 4 per cent and because within the same scheme you have both the funded part and the pay-as-you-go part you don’t have to be as rigorous mark-to-market liabilities as they are e.g. in Sweden or in Denmark. These kind of differences make comparisons between countries very difficult. But as a result you don’t deal with the same kind of solvency volatility issues in Finland as you do e.g. in Sweden because in Finland only assets are marked-to-market, but not liabilities.
Chair: Have you seen different investment strategies that have been of interest or that clients have been asking for?
Bateman: I think where we are seeing demand is on the equity side. Dividend-based strategies are still proving quite popular. Environmental strategies also remain of interest to investors in this part of the world. We have also started to see real interest in emerging markets again and going back 20 odd years when I first started doing this, emerging markets was a fairly revolutionary story. It felt like they’ve really become out of favour and there was a lot of cynicism about emerging markets but it feels like people are now looking and maybe seeing them as an entry point to revisit again.
Kuncheva: That corresponds to our observations as well. Yield, whether it is in dividend form or coupon paying instruments, is really a driving force. But we need to remember that while everybody is running after the yield, the value in some yielding assets is already becoming a bit questionable. So I think the larger institutions are beginning to be aware of the risks becoming asymmetrical with very little upside. It is good that investors are becoming more value aware, price aware and are looking for ideas where there is still adequate return for the risk taken. We found them mostly in markets, where there are assets that are under-researched or hated or complex or illiquid. For the investors that can afford illiquidity and that can afford and feel comfortable with the complexity, these themes are of interest. Of course the mainstream large allocations remain as they were, but not so much in government bonds but in corporate credit. We haven’t seen this great rotation that everybody is talking about from equities to fixed income. I think its more on headline level than on practical level, people are still comfortable with relative safety in terms of volatility that corporate bonds offer. In the big picture, tactical asset allocation bets are becoming more common, especially in Finland. Other pension investors have taken a different route and have invested in illiquid and alternative assets to escape market volatility. These paths are quite different so it’s interesting to see which would pay out better in the long term.
Chair: What about multi asset credit?
Kuncheva: That has been a big topic for us. We’re lucky to have a strategy that has been proven to deliver over the credit cycle and has attracted a lot of interest. So for investors who do not have the resources to take a tactical view in credit or within that to analyse specialist credits that requires a lot of intensive research, we have seen a lot of interest in giving us the mandate to do that for them – even if it is only an overlay or a diversifier to their existing credit exposure.
Chair: Nordic pension schemes are quite well known in the world for their environmental, social, governance (ESG) agenda when investing. Eric (Bateman) you mentioned this before. Would you like to elaborate on this point?
Bateman: I think its becoming increasingly important, not just here in this part of the world where its always been important but across Europe it demonstrates a really clear logical, transparent and repeatable ESG process for a lot of clients. Some of what we do and some of our environmental products are by definition ESG compliant using any kind of measurement. So for example we have a water mandate and that universe is pretty much ESG compliant using any measurement. However, even in the rest of our business it’s something which we’re seeing lots more interest in, not just in the pension fund and institutional market but increasingly in the sub-advisory distribution market as well. So I think it’s only going to grow but it’s very important to be able to demonstrate that you do what you say you’re going to do with that and actually have a process in place, particularly for the smaller funds.
Kuncheva: In the Nordics it’s probably a theme that is more current than in the rest of Europe. I think once again we’re ahead of the curve on that particular front. The interesting thing is that there are still different interpretations on how to implement ESG or SRI factors. So what we tend to do is work with individual clients to meet their particular requests. On the investment side, we have found that this is definitely a factor that needs to be taken into consideration when we’re establishing the fundamental investment proposition. This is not a consideration that should be superimposed, but something that you incorporate already at credit analysis level. For us that’s an integral part of the investment decision-making process.
Chair: So do you think there is a trend in large Nordic pension funds to stimulate and direct the ESG trend?
Kuncheva: Different investors have different demands, so we need to respect the particular methodology clients are employing to implement change in the company they are investing in, be it as a bond investor or as an equity investor.
Leppälä: One of the features which is Nordic is the fact that the Swedish service providers who screen the investments are also used by some of the biggest Finnish pension institutions.
Chair: Do you think there’s a link between ESG investment and possibly de-risking?
Kuncheva: In this part of the world we have a lot of allocation to real estate where there are obvious benefits of owning a property with low electricity, heat and water consumption. Then we have the very active approach – the investments in infrastructure assets, in renewable energy that some of the larger Nordic pension funds have made, which is also another way of actively implementing ESG principles.
Chair: Are multinational employers looking more towards a streamlined approach to pension provision – for example from a governance perspective – with the aim to reduce investment risks?
Bateman: One of the obvious trends I have seen over the last few years, not just from Nordic institutional investors or pension funds, is the focus on long investments’ counterparty risk. With people like ourselves, if we went to a pension fund due diligence meeting, an onsite meeting five/six years ago, they tended to be 75 per cent focused on investment and maybe 25 per cent maximum focused on operational due diligence and that ratio has moved dramatically. I think things like operational risk within asset managers, investment risk management generally, is much more heavily focused on by pension funds than they were a few years ago, so it’s a different perspective.
Kuncheva: I do agree that after a few spectacular investment manager blow-ups, there is increased awareness of operational risk factors. I think investors are aware that little things like what are they doing with the collateral on securities lending, who owns it, who manages it, and administrative issues in terms of asset valuation, mark-to-market, who provides the pricing and so on and so forth. The quality of the counterparty is becoming an important investment criterion. In terms of investment risks, the trend is towards increased levels of transparency of the investment decision-making process and the underlying investment instruments.
Chair: What are the concerns that employers have when they come to you and ask for advice, do they come to discuss the new or old schemes?
Lindén: They mostly discuss old schemes and they are asking for advice about how to change their old schemes to DC plans and how to get to grips with the new DC plans they have. They are always very long projects because there are a lot of issues around it and lots of negotiations and its very slow work but always interesting.
Chair: Now perhaps we can make our final statements, summarise any kind of key message that you wanted to put to this table today.
Leppälä: A key message from my point of view is that the regulatory frameworks should enable pension funds to take risk and to manage that risk. That they are not too short-termistic, that the time horizon is not too short because of the volatility and because of this marked- to-market of assets and liabilities. The liabilities have a long duration, on average decades, but a solvency framework that just looks at e.g. one year makes often impossible to hold assets with more risk. That doesn’t make any sense and that is the major issue for DB pensions in Europe. This is not confronting Nordic countries as severely as some other countries but still it is an issue and we should deal with this also going forward in a very sensible way. In addition are the costs resulting from new regulation. New regulations and good supervision are important, as the financial crisis has been real and pension funds in the Nordic region also lost a lot, but there has to be a right balance of regulation and the costs.
Kuncheva: If I can sum it up in a couple of sentences, the Nordic pension systems are among the best in the world, run with a high level of professionalism. The internal investment teams are pretty good at meeting the challenges that financial markets throw at them. However, they also have to deal with the uncertainty of evolving regulation. This is not a challenge or a risk that can be analysed or hedged in any sensible manner. So I hope that the authorities are aware of the real impact new rules will have on the future pensions.
Bateman: I think looking back over the last 20 years from the investment perspective, Nordic pension funds have been real innovators, they’ve been very early into different asset classes, and they are dealing with the pressures that they are under in terms of their investment and manager selection. I hope that they can continue to maintain this innovation over the next 20 years because if they can then the prospects for the members of the underlying scheme should be pretty good.
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