Analysis: Stendevad delivers portfolio redesign
With the raft of changes ATP has been making to its investment strategy now almost complete, it is clear the Danish pension fund has been at pains to take in the big picture – as well as the minutiae of the changed financial world it finds itself in.
This sense that chief executive Carsten Stendevad and his team have been zooming in and zooming out comes from his comments at the IPE Conference and Awards in Barcelona, and ATP’s data about its two-year strategy overhaul, due to be announced officially in its 2015 annual report.
On the one hand, he has talked about the recent drop in global market liquidity and the difficulties in achieving diversification using traditional portfolio management methods, and on the other he has revealed that ATP intends to put pricing and the precise risk/return profiles of every single asset under the microscope.
ATP’s DKK770bn (€103.2bn) of overall assets are divided into two portfolios. The largest is the hedging portfolio that has traditionally consisted of long-dated bonds, designed to back the pension guarantees of the ATP Lifelong Pension.
The rest of the fund’s assets – around DKK100bn – form the bonus or free reserves and are invested in a separate portfolio with the aim of funding pension increases, in order to maintain its purchasing power in real terms.
Given the size difference between the hedging and investment portfolios, it is no surprise that the former, along with the pension guarantees it supports, was the first to be reformed.
In the autumn of 2013, ATP adopted a new discount yield curve to value its existing pension liabilities. This reduced the interest-rate sensitivity of existing guarantees by 25%.
The following summer, the fund made changes to the nature of the guarantee it would provide, redesigning the product – essentially shortening each guarantee period to 15 years – to increase its investment flexibility.
Stendevad has illustrated the dramatic drop in liquidity in the fixed income markets that has happened over the last 13 years, which he says has had a profound effect on ATP.
In 2002, when ATP established its hedging programme, the fund was able to do single trades in the $1bn (€920m) range.
By 2013, the average trade size for its pension guarantee hedging programme had dropped to around $200m – today, it can only do about $50m per trade. And this is in German Bunds, not some exotic security.
The decrease in bond market liquidity has posed challenges for both its portfolios, and it is the changes to the investment portfolio that the pension fund is now rolling out.
The most obvious change is the culling of two of the five categories within the portfolio structure.
The new strategy groups assets into “risk factors” rather than “risk classes”. This suggests a shift in focus towards the forces affecting an investment and away from assumptions that particular types of asset are tied to particular types of risk.
Under the changes, which ATP says went live in the late summer, the investment portfolio is now separated into “interest rate factor”, “inflation factor”, “equity factor” and “other factors” groupings. Since 2006, it had used the system of five risk classes – commodities, credit, inflation, equity and interest rates.
With this shift, ATP has departed from portfolio construction approaches that revolve around traditional asset classes – which it fears overestimate the amount of diversification actually achieved – and is now thinking intensively about risk factors, Stendevad says.
He says that every individual investment has been decanted into these four risk factors.
Questions have been asked at ATP, for example, about the common risk factors real estate and infrastructure are exposed to, and whether these two asset types are actually different.
Commodities, it has been decided, should not be grouped on their own but seen relative to the inflation risk from which they are inseparable.
Other asset types are allowed to straddle groupings, such as unlisted equities, which, though largely included in the equity factor group, also feature in other factors.
Similarly, index-linked bonds belong to the interest rate and the inflation groups, while corporate bonds fall within the interest rate factor group, as well as the equity factor group.
This other factors group combines alternative risk premia, long-short strategies, momentum, low volatility and the pure form of illiquidity premiums, Stendevad says.
He says ATP’s investment team made “significant steps” towards identifying the true risk/return nature of different assets, and how these compare. This was then done at a macro level.
The big difference now, says Stendevad, is that the pension fund is doing it at a micro level with every decision, with all its risk systems geared towards identifying the true risk characteristics.
This shift in perspective also seems apparent in the tightening focus on costs and reducing ATP’s use of external funds. Even though ATP does not have the scale to invest 100% in-house, it has been considering how much value it gets from its external mandates. It has reduced the amount of assets it has invested via funds by almost €1bn from the middle of 2013 to €7.5bn in the middle of 2015, and this divestment will continue.
Within real estate, ATP does have some fund investments, but Stendevad says, as soon as contractually possible, these will be replaced with direct investment strategies. All other things being equal, ATP far prefers to be in liquid assets, he says.
But again, drilling down to the detail, the pension fund is scrutinising whether its liquid investments are outperforming the potential in illiquid markets, through its process of decomposing holdings and potential holdings into its new set of risk factors. For ATP, it takes more than the fact that an investment is liquid to give it the edge over an illiquid one.