Pension funds test asset limits
The Danish system of pension investment limits is under pressure from an unusual quarter.
A 30% rise in the value of the Copenhagen Stock Exchange has created problems for two of the largest public sector pensions funds. ATP (Arbejdsmarkedet Tillaegspension) and LD (Lomodtagernes Dyrtidsfond) have found themselves close to the statutory limits that allow them to hold up to 35% of their assets in equities.
ATP requested in April that the ceiling be lifted to 40% in line with the life insurance and private pensions funds,” says ATP information manager Claus Brask. The fund, with around Dkr190bn($128bn) of funds under management, is very close to the 35% limit .
Whether the fund goes over the ceiling will depend on the financial markets, he says. “We don’t have to sell shares as a result of the rising market, but we have to if we want to buy new shares at current levels.”
Within the labour market pension funds, however, there does not appear to be much pressure building up for removal of the 40% limit on equity investment.
Torben Moger Pedersen, director of PensionSelskaberne in Copenhagen, which runs the blue collar workers’ scheme, with 304,000 members and assets of Dkr8.5bn, says: “None of the labour market funds have hit the 40% ceiling. They have plenty of air up to this.” In fact, best estimates put the average Danish fund’s holding of equities at around the 20% level.
Where PensionSelskaberne is feeling the pressure is on the overseas holdings limit, which is 20% of pension liabilities plus free reserves. “We have almost reached our limits and we cannot increase our share of non-Danish assets in the portfolio,” he says. He sees a danger that the fund could be carried over the limit by sheer market rise. “We will not be in a forced-to-sell situation, but we will not be able to invest as much of our new funds in foreign equities as we would like.”
A very forthright line on the limitations is taken by Frank Andersen of Unilever Danmark, who chairs the Association of Company Pension Schemes. These are mainly defined benefit schemes and form a much smaller part of the pensions market. “We are trying to get these rules changed because we want freedom of investment. The 40% and the 20% rules hamper our possibilities.”
With the lowering of returns on bonds, member schemes are switching increasingly to equities and will face problems from the 40% ceiling. Andersen feels there are serious problems because of the restrictions on international exposure, particularly from the point of view of spreading risk and reducing volatility. “If you can only put 20% into foreign currency investment, there is a risk because of the relatively small size of the Danish equity market.”
A spokesman for one of the country’s largest asset managers says that so far the group has not had any queries from clients concerned about the investment limits. “But we do expect them to come up”.
On the limits in foreign currency investments, he points out that the Danish authorities will accept investments beyond 20%, provided the currency risk is hedged. “So if you do this systematically, you have the possibility of investing more outside Denmark.” This, however, is protection only against currency and not against market movements so if the the equity markets rise, overseas portfolios will have to be reduced.
The advent of Emu could help unravel the situation, even though Denmark is not committed to join the system. Should the country go in, the general belief is that all euro-denominated investments would be acceptable to match pension and insurance liabilities. At the Danish Insurance Association (DIA), which looks after labour market pension schemes, they are cautious about such views. The association’s Jens Tranberg says it would depend on “how the EC regulates the life directives as a result”.
But should the Danes decide to stay outside Emu, there is another intriguing possibility. As Moger Pedersen of the PensionsSelskaberne points out: “At the moment, you are allowed to invest in Ecu-denominated assets up to 50% of total assets. We expect that this limit will apply to euro-based investments. In that case you can see a substantial rise in the possibility of using foreign assets in your portfolios.”
DIA’s Tranberg says that “this is a big question”. But he agrees it could mean a 50% limit immediately for euro investments. “But we do not know the position, as we do not know how the EC is going to handle these questions on matching of assets.”
Nor does the association believe that matters are sufficiently pressing on the overall investment limits to push for changes for the labour market schemes at present. If the limits were abolished, something else would have to be put in their place, says Tranberg.
This is a view firmly rejected by Andersen at the much smaller company pensions association. He not only wants the limits to go, but also complete freedom to invest and reliance on the prudence of the sponsor. His association will continue to lobby for these changes. “I believe that the government is becoming more positive towards a change.”
But he is conscious that there could be a sting in the tail - the danger of equity dividends being taxed, as bonds are now. “Schemes are saying that as we are not up to the 40% limit, we do not want it increased, because the government may say: ‘We will increase beyond the 40%, but we will also take it as a total package and tax revenue from equities’.” His response is that pension schemes should be free of all taxes to encourage savings for old age.”