Sweden’s public sector AP3 scheme, one of the Swedish government’s four state buffer funds, has had a bit of a rough ride recently. After achieving the lofty heights of 17.7% returns for what it must have considered a stable portfolio at the time, last year’s 9.5% has led to a rethink that has seen AP3 once again walk away with a couple of IPE’s renowned European pensions awards - not least the one featured here as Sweden’s best scheme.

So how does a scheme that has seen its returns fall rather dramatically end up winning an award? It is the measure of its determination and carefully planned reconstruction of its investment portfolios that impressed the judges enough to win AP3 the 2007 award for Sweden.


Not content to rest on its laurels or implement tactical changes in the hope of restoring its good fortunes, the €22.8bn scheme went back to the drawing board to review its investments and devise a carefully thought-out long-term plan that would ensure the scheme’s success in the future. It began by asking itself some very basic questions about its objectives and how any changes to its portfolios would best reflect this.

“A few years ago we sat down at the fund and started to look at basic rationale of our business,” says the scheme. “This led to the scheme setting out three central principles that are designed to drive how the scheme’s investments develop.”

First is the concept of long-term forecasting. AP3 firmly believes that it is possible to predict how the investment markets will perform and evolve, and therefore the impact on investments, over very long periods of time. As pension funds themselves operate in long time horizons, AP3 sees no problem in trying to anticipate investment returns from 30 years or more in the future.

The next principle concerns the way investments and securities are priced. Values change constantly but AP3 believes it can occasionally identify assets that are not priced at the right level in the medium-term spanning one to five years. This will help it ‘price’ its investments in the future to give it a clearer picture of the returns it can expect.
Finally, the age-old question of passive or active management. Research over the years has suggested that active management fares no better than passive managementon average. But AP3 is adamant that active management can add value in some cases and it will continue to pursue a strategy that calls for active management of some of its investments.

AP3 likes doing things in threes, it seems. The three principles are supported by three practical solutions, although there is not a solution per principle as such.

The first solution introduces an innovative use of derivatives. Whereas other schemes use derivatives in the form of swaps as part of a liability matching strategy to unlock capital tied up in long-term assets each year, AP3 has been much cleverer and realised you can do a lot more with derivatives. It uses the increasingly popular alternative to separate its long-term liability-driven allocation from the medium-term value of the assets. This has resulted in a sophisticated portable beta overlay programme that AP3 claims allows it to implement its medium-term strategy effectively and confidently.

The next solution is all about finding that little bit more and using it wisely. Put another way, AP3 is keen to benefit from portable alpha. According to AP3, alpha - extra returns - can be generated from any of its investments, not just traditional long only investments. One means of achieving this has been the introduction of a long-only hedge fund to separate the passive index replicating element of the scheme’s long only investments from the actual stock picking element. The stock picking thus becomes a form of active management and the returns serve as alpha as they supplement returns from the passive indexed element. Aware of the risks involved, AP3 confirms that the risk budgets have been amended accordingly to ensure it has accounted for all the risk active management can pose in its risk return ratio calculations.

But that is not all. AP3 has also introduced stochastic modelling to complement the active management as this allows it to forecast dips in performance. “We know that some managers known to be good will fail at some point. Separating the stock picking from the benchmarked portion of the equity portfolios also gives us greater clarity in our objectives concerning the generation of alpha,” the scheme explains.
The third solution takes the scheme into the world of global tactical asset allocation, which is essentially another form of alpha. Financing the mandates used in the programme comes from the scheme’s treasury department which the AP3 says it has restructured somewhat for this purpose.


Reviewing the central principles that drive your scheme and implementing solutions to ensure they are workable is not a one-off exercise. Despite being an ongoing programme of reform, AP3 says it is already yielding positive results. The investment process has become more flexible and transparent and it expects to save money on its medium-term allocation strategy. It is not scared of derivatives, either, and the legal framework associated with introducing and running derivatives has not proved to be burdensome.

AP3 is no stranger to the international pension scheme world and its carefully planned and well-conceived changes to the way it runs its portfolios is impressive.

Starting from a philosophical standpoint, it has designed effective and sophisticated solutions to ensure it will grow in the most efficient way possible. Its use of derivatives is clever and its approach to active management and optimising the level of excess returns this can generate is highly commendable.

Confident it can get even more from its investments, AP3’s global tactical asset allocation programme is the perfect complement to the portable beta and alpha overlay strategies it has developed at the same time.