Local authority fund with broad horizons
Akershus Fylkeskommunale Pensjonskasse was founded in 1952 to provide pensions for the employees of the municipality adjacent to the north and west of Oslo. The fund has 19,406 members.
Two years ago the hospitals in this region were taken over by the Norwegian state. The hospital employees’ pension arrangements which have been with the Akershus fund since its inception may, following the transfer, be transferred to a separate fund. The hospital employees account for three quarters of the total fund membership.
The scheme provides 66% of final salary and benefits are adjusted in line with inflation. The employee pays 2% and the employer will pay from 8 to 16% depending on the individual member’s salary.
At the end of March the fund had a total of NOK4.4bn (E550m) in pension assets, around 48% higher than the figure at the end of 2000.
Funding levels have improved dramatically of late. At the end of March coverage of liabilities stood at 117% compared with 114% at the end of last year, which was up sharply from 107% at the end of 2002.
The stock market recovery has been the basis for this improvement. The fund returned 13.4% for the calendar year 2003, which was up from just 0.1% at the end of 2002 and 1.5% the year before. In the first three months of this year the fund returned 3.7%.
The stock market upturn resulted in a significant move into equities. By the end of March they accounted for 18.4% of total assets compared with 8.3% at the end of 2002. Eide notes that when the stock market was performing particularly well at the end of the 1990s the allocation to equities was close to its legal limit of 35%.
The equities portfolio is 40% Norwegian and 60% foreign. Foreign equities are preferred because the Norwegian equities market is small in relation to its counterparts in many other parts of the world and therefore it tends to be too volatile. The exchange risk resulting from the portfolio of foreign equities is not hedged, as Eide explains, “because it diversifies the risk of the equities investment”.
Benchmarks are used, which for the Norwegian portfolio is the Oslo mutual fund index, the OSEFX, while the international equities portfolio is benchmarked on the MSCI world index.
Eide’s approach to risk is clear. “When we take on risk we do stress testing this means that we try to see that we have enough risk capital to meet any possible reduction in market value,” says Eide. “We are also implementing value at risk.”
The main shift to equities has been at the expense of bonds, as not only has stock market performance improved but interest rates fell dramatically from around 7% at the end of 2002 to 1.75% at the end of last year. At the end of March, bonds accounted for 52% of total assets compared with 69.3% at the end of 2002.
In terms of the bond portfolio, the part invested in government certificates is what Eide terms the risk free part of the portfolio.
The fund also invests in foreign government bonds which are sourced from area A of the OECD, which consists of the 25 most industrialised countries. The portfolio of foreign government bonds is hedged back to Norwegian Kronor to eliminate the currency risk.
As far as other bond investments are concerned, Eide notes that “investing in municipal and financial debt gives us a credit spread versus government bond”. He adds: “The fund uses a government bond index as the benchmark and adds 25 basis points. A credit benchmark is not available.”
As for corporate bonds, Eide explains that “Norwegian corporate debt carries a high yield but is a risky asset class and we therefore seldom invest in it”.
Foreign corporate bonds are also sourced from area A of the OECD. “We invest in an international defensive high yield fund consisting of BBB- and BB-rated companies with exposure to the corporate bond market in the US,” says Eide.
He adds: “We don’t take credit risk in this portfolio so the investment in corporate bonds is very small.”
As far as the bond portfolio is concerned Eide focuses on interest risk. “I adjust the duration of the portfolio depending on the interest,” he says. “The fund uses low duration bonds when the interest rate is increasing high duration bonds when the interest is decreasing.”
Just under 20% of total pension assets are held in ‘hold-to-maturity’ bonds.
The law stipulates that pension funds can only have 3% of the portfolio invested in any one bond issuer.
The fund also consists of employee mortgage loans which accounted for 7.7% of pension assets at the end of March. Meanwhile real estate has never accounted for more than 0.2% of assets. “We do not intend to use real estate funds,” says Eide. “Real estate can generate a high return, but the liquidity risk is too high.”
As for alternative investments, private equity is not used because it is not considered sufficiently liquid for Eide’s investment purposes.
On the other hand, hedge funds were used for the first time last year in the form of fund of funds which suited the fund, as Eide explains, “because of its high Sharpe ratio”.
The proportion of cash in the portfolio has increased sharply of late, up from 4.6% at the end of last year to 7.3% by the end of March. “Cash is king,” says Eide, referring to its usefulness for tactical movements.
As for management of the fund, Norwegian bonds are managed internally. Foreign bonds are managed through funds and active mandates. Just over 19% of the portfolio is managed externally. Of the 19.2%, passive management accounts for 3.6%, active 14.9% and SRI 0.7%.
“We try to get external managers that have a Sharpe ratio,” says Eide. “We try to find firms that are excellent stock pickers.”
Eide has not yet done an ALM study for the fund. He expects that the hospital employees will be moved to the Norwegian state’s own pension fund and will wait until the outcome is certain in this regard before commissioning the ALM study.
The internally managed bond portfolio is Eide’s responsibility. In the case of equities Eide makes proposals to the director of the fund. “It is my advice she goes on,” says Eide. However, it is the board of the fund that decides about the selection of a new fund manager.