OP Banking Group’s investment strategy has evolved steadily over the years, although not always in the most conventional manner.
It manages two entities: a fund of E690m and a foundation of E570m. The fund is one of the smaller pension insurance companies. Like its much larger,E20bn-counterparts, Varma and Ilmarinen, it manages the pension arrangements of a group of companies, but the difference is that the companies in question are all in the same group, and consist of 242 local cooperative banks which joined together to form the OP Banking Group and decided to set up a communal pension arrangement.
The foundation was closed in 1991. “The banks chose not to keep the scheme as the pension needs could be taken care of in the pension fund as well, thanks to policy changes,” says Magnus Backström, CIO of the OP Bank Group Pension Fund.
Last year the fund returned around 8% compared with -2% in the previous year. In 2001 the return was around 3%. The figures for the foundation are very similar.
On a very broad level asset allocation is very similar. The big difference is that the foundation has more in cash because it is paying out more than it is getting in new money. Cash and deposits account for around 11% of assets compared with about 2% in the pension fund. The similarity lies in the fact that total cash and fixed income in both is identical at 45%. Likewise the level of risky investments does not differ.
A further 10% is allocated to alternatives and 30% to real estate. Of the alternatives allocation about 3% is private equity which has remained fairly stable over the years. The remaining 7% is hedge funds where the first investment was made in 1999.
“The main message going through our activities is diversification,” says Backström. “In general we aim for diversification over yield.”
An example of this can be found the recent change in allocation. The investment in equities in the fund, which stands at 15%, is down from 20% a year earlier, and that compares with around 25% in 2000. The reason for the shift is a move into hedge funds to diversify the portfolio.
Of the fixed income portion government bonds represent roughly 60% with the balance being corporate bonds at investment grade, a minimum of triple-B. The government bond allocation includes inflation-linked bonds which account for 5% of the total portfolio, while the corporate allocation includes high yield which represents 2% of the total.
The fund has a very high proportion allocated to real estate. This is because the allocation consists in part of the bank’s own branches. This seems like a high proportion of the portfolio to allocate to an illiquid asset. “We have been happy with such a large part in real estate and we have no plan to decrease it,” says Backström. “It will give some protection if inflation picks up some day. We don't have to worry about liquidity of the total portfolio. The foundation has 10% in money market but liquidity is not such an issue for the pension fund.”
Backström has clear views about the taxation of real estate funds. “Definitely we would like it to disappear,” he says. “If there is an entity that receives rental income and pays it out as a dividend or interest it should be taxed only once.”
The solvency capital issue is a problem for the industry and OP Banking Group is no exception. “The solvency regulations limit our ability to add new asset classes,” says Backström. “That is a reason why there haven't been more major shifts in the portfolio. The regulator puts new asset classes into the riskiest asset class until people understand them. So you can only afford to be innovative if you have solvency capital.”
Backstrom claims to have no solvency problems, although it is clear that the allocation to equities is way below that found in the LGPI.
As elsewhere in Finland, the main problem is the treatment of hedge funds. “Hedge funds are perceived incorrectly so as being as risky as private equity and more risky than quoted equity,” says Backström. “Our experience has shown that hedge funds have a vastly superior risk return ratio to private equity. Unfortunately we are not in agreement with the regulator in this respect.”
OP Banking Group manages most of the fixed income portfolio in-house, drawing on the bank’s expertise in the field. Everything else: high yield bonds, equities and hedge funds are all managed through funds or fund of funds.
Specialised mandates are preferred for reasons of control. Furthermore, as Backström explains, “balanced mandates are not active enough. You end up paying a higher fee for an activity but not implemented”.
The approach might be described as traditional. “With equities we work with country mandates: Finland Europe, UK, US and Japan,” says Backström. “We realise that the correlation between geographical areas can be very high, while the correlation between sectors is lower, but we still work with geographical areas because that is where the funds exist. We are thinking of moving to a sectoral view and we try to take that into consideration when we chose our mandates.”