Danes like made to measure
With some 95% of employees covered by second pillar occupational schemes, Denmark can claim one of the strongest pension environments in Europe. But the Danish pension fund market is complicated by regulation, tax rules and the internal requirements of the pension schemes themselves.
Until regulatory changes in 2000, foreign asset managers suffered from a considerable disincentive to enter the Danish market. The picture has changed, but it is still the case that success for a foreign group may depend on partnership with a local company, or setting up a domestic Danish operation.
A normal pension fund has no problem from a tax point of view with an investment in a Luxembourg SICAV. But ethical rules within the pension fund, or regulatory restrictions on the percentage which it can hold in one stock, may prevent it from buying an off-the-shelf foreign mutual fund.
Rune Sanbeck, head of institutional clients at Danske Capital, says as a result “there is a strong trend towards tailor-made funds”. These are home-grown fund structures designed to meet the requirements of a single pension fund client, or of two or three acting jointly.
Nordea Invest chief executive Peter Hemme compares this phenomenon closely to German Spezialfonds.
A pension fund, or group of funds, chooses a management company which sets up a fund on its behalf: Nordea runs more than 70 funds of this sort. Each has an independent board of directors, with the management company in the place of chief executive. The fund itself has no employees.
The management company must act as fund manager, and must therefore take the decisions on investment transactions, but it can appoint advisers, including its own associate companies, and other asset managers, to recommend investments in specialist parts of the portfolio on a global basis. Other advisers are usually appointed according to the instructions of the client.
Pension funds like this sort of arrangement mainly because of its efficiency and cost-effectiveness. “Spezialfonds are bigger in Germany than mutual funds and it could be the same eventually in Denmark,” says Hemme.
Peter Preisler, head of European sales at T Rowe Price, agrees. A reason why the arrangement works so well is its low cost, but also the hassle reduction factor. “All pension funds use this fund construction for a small or large part of the portfolio, though it is most popular in sectors where there is a complicated back office aspect. High yield bonds, small cap and emerging markets – all these can be wrapped into a mutual fund. It’s more a matter of administration and packaging than anything else.”
As in any market, the decision to invest in mutual funds rather than segregated portfolios is partly dictated by size, says Bank Invest (BI) chief investment officer Daniel Broby. Smaller institutions may use funds to achieve diversification, while larger ones may choose a fund vehicle for small, specialist asset classes.
In the Danish smaller cap arena, says Broby, pension funds may feel they are “so close to the action that they prefer not to invest directly”. In other words, the pension scheme may feel its ability to actively influence the outcome of a corporate action may be compromised by scheme members’ interests.
BI’s Danish small cap Aktier fund is an example of this. The four founding pension schemes, DIP (the engineers’ scheme), JOEP (lawyers and economists), TRYG (Tryg-Baltica corporate fund) and Laegernes Pensionskasse (the doctors’ scheme) handed assets to BI to take advantage of the strong approach which is “part of BI’s style. We try to generate better returns by influencing companies,” says Broby.
The group sometimes combines its voting power with that of other investors, including ATP, the giant public scheme to which all employees are obliged to belong, in fighting issues which are often controversial: opposing diluted warrants, making sure incentive schemes are aligned with shareholder interests, and so on.
Tailor-made funds are likely to be attractive in the multi-manager sector, says Steven Tack of Russell. The group was awarded a US equity small cap mandate by Pensionskassernes Administration (PKA) in January. Tack says: “Pension schemes are recognising that if they want multiple managers it makes sense to be part of a larger pool. They may give up operational elements on the accounting side, but this is outweighed by the benefits of manager diversification. If anything, it simplifies accounting for the mandate.”
Russell expects to set up more such arrangements as time goes on. “The concept is new still, but we see opportunities in this area,” says Tack. Custom mandates of this sort will appeal to the larger pension scheme.
“At least a few hundred million
dollars or euros are needed to be able
to appoint several underlying
managers”, Tack. “Other funds
can obtain the same diversification benefits by using an existing multi-manager pooled fund,” he adds.
Among Danish pension funds equity exposure is still low, typically 15-30%, following the draconian ‘traffic lights’ monitoring system that has been imposed by the regulatory authorities in the last few years ensuring solvency.
Regarding current asset allocation trends, pension schemes are “re-looking at making active management successful. They want consistency of added value,” says Tack. Specialist equity markets, such as Thailand and Latin America, are of interest, as are specialist bond portfolios like high yield. T Rowe Price is about to launch an emerging markets debt fund as a Luxembourg SICAV, which gives the possibility of different share classes in order to offer special features for the client, such as currency hedging.
The umbrella structure of a SICAV could have a number of uses in the Danish market, but current regulations do not permit the establishment of mutual funds with separate sub-funds. “Danish tax legislation is perhaps acting as a trade barrier for foreign managers, and also preventing the industry from becoming more efficient. There will be a growing tendency among pension funds to look more and more towards Luxembourg SICAVs because of the greater efficiency,” says Preisler.
Hedge funds themselves have not attracted much enthusiasm hitherto among pension schemes, but that may be changing. Domestic market leader Danske Capital has launched two hedge funds: a e200m Luxembourg fund aimed at high-net-worth individuals and a domestic product, Danske Mortgage Hedge Fund, which is designed for institutional investors. The latter, with e50m under management, has a number of large Danish institutions among its investors, including leading pension provider PFA.
BI is in the process of launching a hedge fund under section 17 of the PAL legislation, which it says is attracting a lot of attention. (PAL funds are tax-advantaged pension funds comparable to UK personal equity plans, and used by both retail and institutional investors.)
Commitments to the new fund – BI Hedge Stabil (PAL) – from the coalition of financial institutions which owns BI, already run to DKr480m (e64.5bn); total subscriptions could reach billions, according to Broby.
Though the fund is initially aimed at retail investors, he reports a lot of interest from institutions. Brody conludes: “Attitudes to hedge funds have changed. The fact that we are launching has made a big slash in the Danish market. The whole playing field has been transformed.”