Finnish pension funds have posted above target level real returns of more than 7% for the last couple of years, according to Matti Leppälä, director responsible for international and legal affairs for the Finnish Pensions Alliance (TELA). But the industry is concerned that regulations put unnecessary limits on investments which in turn restrict returns. “So we are working towards the relaxation and reform of these rules,” he says.
The Finnish way is to advance through consensus and to this end for the past decade a voluntary negotiating committee, chaired by Ilmarinen CEO Kari Puro and including representatives of the social partners, has been preparing proposals for presentation to the authorities. Its latest recommendations, covering such areas as regulation and taxation, will be tabled by the end of September.
The proposals are well flagged and although the industry agrees that they are necessary they nonetheless add an element of uncertainty. “You don’t want to be in a position that when any of these proposals are approved you cannot change your portfolio,” says Jari Eskelinen, head of fixed income at Illmarinen. “There are different ways to respond, and the first is that if they come early enough you need to incorporate them into your next year’s investment plan. But it is not exactly clear whether they are going to be implemented some time during the next year, so you don’t want to put your portfolio in a position where is difficult to change some of the components during the year.”
Illmarinen’s investment allocation in 2004 differed little from 2003, with fixed income funds accounting for 49.6%, of which bonds were 46.9%, after 49% and 47.7% respectively; other money market instruments being 3%, up from 2.3%; equities 32.4% from 26.8%; real estate 11.3% from 14.8%; and premium loan receivables 6.3%, down from 8.8%.
“Last year we set up a new tactical allocation unit, looking at asset allocation in the medium-to-short term,” says Eskelinen. “We are trying to be more active than we used to be. Now there is a team that is only looking at shorter-term allocation and we also have a different asset liability team that looks at the way the assets should be on, say, a five-year horizon.”
The head of the new team is Mikael Simonsen, who notes that the tactical and strategic teams work well together. “The system is constructed in such a way that the strategists construct a strategic allocation plan from year to year and at the end of each year the board approves an investment plan for the next year that includes this new strategic allocation. And it is around this that our team is deviating. We don’t make any longer-term bets that could not be nullified by the investment plan for the next year.”
So what does Simonsen see on the horizon? “Tactically, we expect equities to continue to outperform bonds,” he says. “I’m not saying that any one of these will be very positive, but they will still be in positive territory. Our strategic allocation will be decided during the autumn and changes there may depend on possible alterations to the regulatory environment.”
Among the challenges that Simonsen identifies is “political news that could change the arena in a way that the latest London bombings did not manage to do”.
The fact that the current global geopolitical situation is likely to last for some time is among the potential problems identified by Hanna Hiidenpalo, director of investments at Tapiola Pension. “But the big picture is about low yields,” she says.
Last year roughly 70% of Tapiola’s investment portfolio was in cash and fixed income instruments, around 20% in equities or equity-related instruments, and 10% real estate.
In 2004 the return on investments rose to 7.2% from 7% the previous year. During the five-years 2000-2004 the average annual return on Tapiola Pension’s investment portfolio was 5.9%, the best in the industry, Hiidenpalo says.
“The best performing asset class was equities, where the total return was close to 14%,” she adds. “About 95% of the total assets are managed in-house, including almost 70% of the equity investments, and about one-third of the equities are listed on the domestic market. The return on direct equity investments was 17.5%, which can be compared with 12% for the European Stoxx 600 total return index. But the volatility has always been considerably below market levels.
“At the moment the breakdown is about the same - although we have increased equities,” Hiidenpalo says. “Solvency has remained strong and there is room for more risk in the portfolio. Equity performance appears to be very good, especially Nordic markets, and it appears that Finland is taking a different approach to the rest of Europe on equities, with an increased appetite for more investments in equities and related instruments over the coming years.”
To this end Hiidenpalo says that Tapiola is considering broadening its focus, adding some new structures or instruments to the portfolio. “We are considering real estate investments abroad on a larger scale and are assembling a team for such investments, but the timing is still open to question,” she says. “We haven’t been very active in hedge funds because our own investment process, which is tilted towards absolute return enhancement, has generated such good returns we haven’t needed to be in hedge funds and other instruments on any significant scale. Also in many cases the risk-return profile has not been attractive enough compared with our own portfolio. But we have some small stakes so we know what is happening on the market and we can follow and learn.
“In addition, we have a certain amount of commodities exposure indirectly through equities and debt in companies in the commodities sector and we have been looking at the sector. But we have not been convinced yet even though there have been great returns in some areas.”
Varma has been diversifying for a considerable time, says Petri Kuusisto, outgoing director of investments. “In the last six years the whole portfolio has diversified completely.”
At end-2004 bonds made up 52.9% of the portfolio, equities 25.8%, real estate 12.2%, loans to client companies 5.1%, and money-market instruments and deposits 3.9%.
“One of my focuses has been the investment reforms, so there are always changes in the portfolio,” says Kuusisto. “The alternatives part of the portfolio has been growing. We started hedge funds in 2002 and today they account for roughly €500m out of the €23bn total, and we have been doing private equity since the mid-1990s, but with aggressive growth in 2000/2002. Altogether alternatives make up just below 5% of the total portfolio and last year they showed a return of 14%.”
The 2004 investment result was 8%, with equities up 18%, outperforming the Stoxx 600 because of active stock picking helped by the holding in Sampo, which rose 45%, Kuusisto adds. The bond result was weak at 4.9% because of partially hedged interest rate risk.