Still lighting the way?
Written by Marek Handzel
April 2013
Nordic pension funds continue to lead the industry with bold investment strategies to counteract regulatory changes and dysfunctional financial markets, but Marek Handzel finds out whether outside forces are dampening their enthusiasm for risk
Spot the odd one out from this list of Nordic supposed truisms: original Eurovision song contest entries; cutting edge crime thriller novels; a creative approach to pension scheme asset investments. Not difficult is it?
When it comes to their innovation, Nordic institutional investors are rightly renowned as world leaders. But, in contrast to the musical and literary fame they enjoy, their celebrity in financial circles is based on fact, rather than personal taste.
And given the challenges facing Nordic pension funds, their status as investors that are always ‘one step ahead of the game’ does not look set to disappear any time soon.
In fact, they are being forced to push the boundaries in some ways. Issues such as a focus on investment fee cost transparency (following the hidden fees scandal in Denmark), the transfer from guaranteed pension products to market rate ones (in Denmark and Sweden), pressures to consolidate due to administrative costs (Finland), and the shadow of a Solvency II-type regime have not allowed the Nordics to rest on their laurels.
These dynamics are pushing pension managers in the region - following the lead set by the ATP funds in Denmark and the AP funds in Sweden - to look at securing higher long-term returns and better risk diversification across their entire portfolios.
This is exactly why Unipension, the investor in Denmark that runs assets worth DKK 80 billion ($13.9 billion) for the Danish Architects’ pension fund among others, announced a change of real estate strategy in March. It sold its Danish allocation in home property to divert capital into foreign markets, through indirect funds. Unipension explained the change by stating that it wanted to follow its equity and bond strategies of looking for better returns while better protecting its investments.
The outer limits
In the equity space, finding a similar balance had proved to be too difficult for many funds in Europe, hence the steady decline in general equity holdings across the continent. But the Nordics are tackling this predicament in two main ways.
Firstly, many funds in the region have a more significant allocation in truly global equities and have embraced concepts such as risk-efficient indexing and smart beta in their passive strategies. Secondly, they have taken on more private equity, as a natural partner to traditional equities.
Managing director of Parametric Portfolio Associates, a US-based equity manager, Paul Bouche, says that this expansive method to equity allocation has its roots in the aftermath of the bursting of the dot.com bubble.
“After the global tech boom and bust a lot of investment consultants and fund staff reconsidered cap-weighted indexing,” says Bouche, whose company was recently appointed by the Danish teachers pension fund, Laerernes Pension, to manage a $200 million (DKK 1.2bn) emerging markets mandate.
“People thought that this stock process of just drifting with market sentiment wasn’t enough risk-management for a portfolio and have asked if there was a way to structure the portfolio so that it’s a little more intelligent.”
Added to that, says Old Mutual Asset Management head of non-US distribution Olivier Lebleu, is a willingness to explore the unknown.
“There are tenders out there at the moment from the larger pension funds for frontier and African equity markets,” says Lebleu.
As he points out, the larger BRIC countries and other emerging markets are much more integrated with global markets than they used to be. So if you want higher potential growth and diversification, then you have to go to the edge of the capital markets.
“It’s one area that may benefit from rising income levels and a potentially strong growth story.”
And Nordic funds are in a great position to be able to tap into any substantial growth, says Lebleu. Not only are they early entrants, but they are walking into the market hand-in-hand with the best managers. “[General Nordic] investment returns have been substantially above their target returns as a result of their sophistication,” he says. “So the world’s best asset managers come to their doors - they have the pick of the litter.”
In terms of private equity, Adveq CEO Sven Liden says that investment in the asset class has emerged as a leading trend – in collaboration with equities.
Liden has seen an increase in private equity allocation and he says there has been a recognition that over the last five years private equity has outperformed other asset classes, whereas hedge funds mostly have not. The latter still suffer somewhat from a battered image post-Madoff and the stripping of their ‘non-correlated’ facade in the past few years. So much so that strict in-house due diligence within pension funds has prevented a new surge in take-up. In some ways, private equity is now seen as a safer option.
“If you think logically then private equity and equity are the same. The only difference is liquidity,” says Liden.
Working within a limited framework
But further moves into areas such as private equity are easier said than done, says BlackRock head of the Nordic region Peter Nielsen.
The reality is that Solvency II is playing a major role [in asset allocation] and will continue to do so.” he says.
“People cannot invest as much as they would like to into private equity or other non-liquid asset classes. They really need to think hard if they want to invest in it and whether or not they can they afford to take that higher capital charge.”
New capital requirements from Brussels are leaving some funds in a Catch-22 situation however, he says. With Northern European bonds predominantly giving close to zero or even sub-zero yields at times, investors are being ‘forced to think outside the box’ in their fixed income allocations yet they are still expected to satisfy Solvency-II type safety buffers.
“The party is over when it comes to extra yield in government bonds,” says Nielsen. “So there is a demand for a substitute and people are going further up the curve, in areas such as emerging market corporate and government debt, but there’s volatility there. Others are looking at substitutes such as investment grade or high yield infrastructure debt rather than traditional high yield.”
Other areas include mezzanine and bank loans, he adds. “As a lot of pension funds at the moment are very worried about duration, bank loans are a good place to be because of their low duration.”
Finding a middle way
Despite still being innovators, Nordic pension funds are no longer prepared, nor in some areas permitted, to take big bets, hence the adoption of smart beta strategies and a lessening of active investment in markets closer to home.
“The conversations we are having are very much around the notion of transparency or risk parity,”
says AMG’s director of business development for the Nordic region Michael Moth-Greve.
Pension funds are, in his view, far more focused now on their risk exposures in context with potential outcomes in the financial markets. “So they’re not just thinking about the risk in a portfolio, but also how they could be positioned in the many different areas that you can dream up,” he says.
This could also be a reflection of the fact that some Nordic funds are keen not to spread themselves too thinly by pushing the boundaries.
“While it may be true that alpha is scarce,” says Moth-Greve, “there are good active managers out there and are high conviction managers that have the ability to deliver alpha”.
Nevertheless, he says, two camps are emerging. One, generally made up of the big funds, retains this belief in alpha and so seeks to pick high conviction managers. The other sits in the middle ground between active and passive strategies, trying to pick the ‘low hanging fruits’ that are available in various markets.
Moth-Greve is sure however, that with the right set-up and managers who have the appropriate foresight, the latter approach can still be a rewarding one.
This suggests that even with risk at the forefront of funds’ thinking, they can still find space to innovate.
Marek Handzel is a freelance journalist
