Martin Steward speaks to Cecila Thomasson Blomquist at PP Pension, whose DB business relies on dynamic asset allocation around a solid real estate core, and whose DC business is undergoing major changes
Fans of the dark and violent Millennium novels might wonder whether any Swedish journalists stay alive long enough to retire. But most do, of course, and many save for that eventuality with media industry pensions provider PP Pension. Not only is the way the former Pressens Pensionskassa does business going through a big plot reversal (see Loss of ITP 1 premiums means new business focus), it has also never lacked the conviction to make dynamic asset-allocation changes.
The company’s defined benefit ITP 2 scheme was steered through the financial crisis intact – enabling Cecilia Thomasson Blomquist, who joined as CIO in August 2009, to consolidate and deliver a 4.2% five-year annualised return for 2008-12, inclusive.
Coming into 2008 with equities already reduced to 31%, that was slashed by half again before that tumultuous year was out, with the proceeds kept in cash ready to deploy into the rebound of 2009. By the time Blomquist was onboard, equities were back up to more than 30%, before settling back down to about 22% at the end of last year.
“It was my opinion that we were running a low-risk portfolio in a market that was good for taking risk,” says Blomquist. “But in summer 2012, when things got really shaky in the euro-zone, we really did have to start considering the worst-case scenario. Nonetheless, I’m happy that we retained our belief in equities and didn’t give in to the temptation to think that everything was collapsing.”
This hints at the very clear view that Blomquist has of the fund’s risk budget. While many European pension funds have made big moves into credit as imperatives to reduce equity risk have run up against the reality of rock-bottom risk-free rates, PP Pension has maintained its allocation to government and mortgage bonds while adding only a small amount of high-rated Swedish corporate bonds.
“In credit you take commercial risks and we just think that you are better-paid for that risk, in the long run, by holding equity,” Blomquist reasons. “Particularly when your starting point is an environment of such low rates.”
The same concern for clarity of risk budgeting is evident in the approach to hedge funds, where PP Pension works with fewer than 10 Nordic managers and prefers the most liquid strategies. Firstly, both the home bias and the liquidity preference reflect a concern to limit operational and fraud-risk exposure. Secondly, this is about avoiding doubling up on market risks.
“We like liquid strategies because we look for hedge fund managers who genuinely bring trading skill, rather than simply investing in market-risk premiums,” says Blomquist.
“This type of manager tends to have good returns when equity markets are not doing well. Having said that, the starting point must always be a belief in the expected return – and, indeed, I think it’s very dangerous to rely on these strategies to provide portfolio protection.”
And thirdly, like the lack of investment in private equity, the bias towards liquid hedge funds reflects the fact that PP Pension likes to focus its illiquidity risk in real estate.
Despite coming down by almost three percentage points during 2012, the fund still came into this year with more than 27% in bricks and mortar.
“We have a very high percentage in real estate compared to our peers, and it is a very specific strategy,” says Blomquist. “We are very careful not to take the risk of high vacancy levels, and being a small fund, we are able to put that money to work and the portfolio doesn’t become unmanageable.”
PP Pension owns 32 properties. Its commercial exposure focuses on office space around Stockholm’s central business district (including PP Pension’s own HQ in Norrmalm), avoiding cyclical retail sectors. Residential properties are split about 80% Stockholm and 20% Malmö and Lund, areas chosen for their growing popularity with young professional families. Both ITP 1 and ITP 2 members can join the waiting list for one of its sought-after apartments.
So much for the assets. As far as Blomquist is concerned, it’s the liabilities that have caused most consternation.
“Really low interest rates have combined with marked-to-market liabilities since 2006, so while we have achieved positive investment returns throughout this volatile post-crisis period, liabilities have just continued to grow across the entire industry,” she says.
Help has come from both inside and outside of PP Pension. Collective-agreement negotiations in 2012 led to a modification of the premium-setting model in its ITP 2 business that should make liabilities less interest-rate sensitive and its investment strategy more counter-cyclical.
“Before, no matter what happened we could never change the premiums, which is just changing the price of the risks associated with your liabilities,” Blomquist explains. “The collective partners decided that if there are reasons to change the premiums in the future, we can do so.”
She sees this as a big step towards making PP Pension’s products genuinely sustainable, and likes the fact that it charts a middle way between DB and pure DC.
“The new system is also much fairer, because under the old system you could change the premiums for new customers but not for existing customers,” she adds.
From outside, the Financial Supervisory Authority also relented in 2012 and allowed pension providers to treat the long-term interest rate on 31 May that year as a ‘floor’ should yields fall any further. The IORP solvency framework will be adopted when – or if – it is implemented.
“The direction of travel still suggests that anything that isn’t fixed income will carry a very high capital cost,” says Blomquist. “I don’t think there is anything wrong with the basic idea of a solvency regime, but we must be careful not to manage too much for liability-matching risk when interest rates are at such low levels. In the end, investment returns pay pension promises, and the biggest risk for society is that we no longer have long-term investors able to commit capital.”
Blomquist would prefer to see regulation that acknowledges the visibility that pension providers have into their future cash flows: “Something that allocates certain investments to certain cash-flow buckets through time, and pushes investors to take less risk only as the relevant cash flows come closer,” she suggests.
That model would reflect Blomquist’s own approach to managing risk, of course. Will she get it? It’s unlikely. But that efficient risk-budgeting philosophy will always ensure that PP Pension can squeeze as much risk as possible out of whatever regulatory or market framework it finds itself in.