Banking on the assets
Leif Hasager is an academic who has found his part time involvement with running the investments of one of Denmark’s oldest pension funds has become a full time occupation. “Now I handle everything in connection with the investment portfolio of Bank Pension, but any decision is taken by the fund’s managing director, Niels-Ole Ravn and myself, and we have to be in agreement before we proceed,” he says.
The Valby-based fund, with E1bn in assets, dates back to 1912, when it was formed as the Pension Fund for Danish Provincial Banks. It was run as part of the activities of the provincial banks’ union, looking after the interests of these banks’ staff. “It was separated from the union in 1988,” he points out.
“I became involved with the fund shortly afterwards, with the aim of developing a more professional approach to asset management.” One consequence of his background, is that the fund does its own ALM studies once a year. “I do it on a spread sheet, using eight different assets. We put in our constraints and the expected returns as well as estimates for volatilities and correlations. We then simulate different paths and see how the portfolio might perform. It’s quite instructive to see the circumstances in which you could go bankrupt in the future!”
Also, within the banking sector is the Finanssektoren fund, which has its origins within Denmark’s savings banks. “For many years we have had an agreement not to compete with each other and over the years we have talked extensivly about joining forces, but the decision is to continue as we are for the present at least.”
The structure of the membership representation, mainly composed of banks, means that each organisation sends a representative several times a year to discuss issues relevant to their 10,000 scheme members. “Over 40 representatives attend these meetings. This means we are very well informed about how our members look at the pension fund.”
Contrary to what might be expected, the fund has a net inflow of members due to the fact that the smaller banks are thriving and expanding operations, though some 60% of members come from Danske Bank and Jyske Bank, among the country’s largest commercial banks.
Under the Danish system, the first pillar ‘People’s pension’, provides a flat rate income of around E1,000 a month for a single person (E1,500 approximately for a couple), in addition this is supplemented by the ATP system providing another first pillar element, with the second pillar defined contribution element coming from Bank Pension and other employment-related arrangements. “The contribution to these funds have been rising and are now usually over 10% of earnings annually.” Normally, the employee pays in a third of this and the employer the balance, but this can vary locally. “But in the case of the older pension plans, contribution rates can be higher, with Bank Pension typically being 14% of pay. “The tendency at higher earning levels is to decide on the gross pay, and then leave the employee to decide how much to allocate to pension provision.”
The net inflow to the fund at this point is around E1.5m a month, but this can be boosted if another bank joins and supplementary schemes are absorbed. “We have had a substantial increase in membership in recent years, mainly at the younger age levels, which keeps the flows positive,” says Hasager.
Particularly in the past, members had additional pension arrangements elsewhere, with the fund providing just a limited proportion of their total provision. This also explains why the level of assets is not large considering the membership size and how long the fund has been going.
In the late1980s, the fund moved from defined benefits to defined contibution (DC), and currently gives a guaranteed rate of return of 3% annually for existing arrangements, but for future contributions this could be reduced to 2%. “We have decided to give people the option to invest a part of their contributions and savings themselves on an unguaranteed basis,” he points out.
But the fund is now looking at the whole issue of guarantees. “We consider that people should move away from unconditionally guaranteed pensions, as it does not make sense for pension funds to offer such guarantees. As what you are doing when you are giving guarantees is using their own money to buy protection, so you should really ask people if they are willing to pay the premium for that.” This is under discussion, though it has not yet been put to the board and no decisiion has been taken on this. “But in any event it would only be on voluntary basis,” he says, noting that members have a legal claim for the amount of their contributions and that cannot be taken from them, without their agreement. “Quite a few Danish funds are moving in this direction, as we are all feeling the strain, especially those funds with a 4.5% guarantee.”
Some years ago Bank Pension addressed the underlying issues after a number of studies as to what was needed by way of reserves. As a result the board decided it was acceptable to take a long term risk of over the next 25 years of having around a 10% chance of not being able to fulfill the fund’s promises in any one year. “According to that we calculated the reserves required of 20 to 25%, at the asset allocation we should have.” In the good market conditions of the time, fund was able to build up reserves in excess of these levels.
“The asset allocation we adopted then was very simple. As equities were untaxed and bonds taxed at a variable rate of between 30 and 50% and with a cap on equities of 50%, the decision was to invest as much as we could in equities.” In addition to a dedicated Danish portfolio of 10% of assets, the fund had a global equity portfolio amounting to 40% on a passively managed basis. “The balance was in Danish bonds, due to the small pick-up available.”
About two years ago, the fund started to diversify into alternative assets, particularly into both emerging markets bonds and equities, again on a passive basis, with a 1% allocation to each of a global fixed income and equity. “Later we added to these positions, taking a more regional view investing primarily in Russia and the Baltic states and most recently in China.”
All the investments are arranged through a variety of investment funds. “At one point we used to have in-house management, including passive management. I personally have run Danish equities and bonds for the fund. But you spend so much time doing trades and so on, we decided to do it externally.”
In choosing managers, the policy is to look first at what is available from the bank groups in the membership. “At least, they get the first shot at it, but they have to have competitive products. If they can’t provide the product of the right quality and at the right price, we go elsewhere. So we use Bank Invest, Dansk Invest and Jyske Invest.” Most of the portfolio is catered for in this way. Until some years ago, there were strong tax disincentives to using funds based abroad. “This has changed and we are using a wide range of managers such as T Rowe Price for high yield and US small cap, ABN AMRO for Europe small caps, PIMCO and ING for high yield, Oaktree for mezzanine and distressed debt; Firebird for ex-Soviet equities; ING Clarion for a fund of commercial bank real estate securities and MezzVest, Wilshire and Harbourvest for private equity.” Currently, 44% are in equities, of which of the specialists side, 4% is small cap, 6% is emerging markets, and 3% in private equity. On the fixed income side there 5% in emerging markets fixed income, 16% in high yield area, and the balance in general fixed income, probably mainly Danish, but to a large extent it is up to the fund managers to decide. Overall about two thirds of the portfolio is on an index oriented basis. But the private equity proportion of the portfolio is targeted to reach 7.5%, but to have this proportion invested all at once is hard to achieve, Hasager acknowledges.
He is pleased that the fund has been able to maintain its equity stance and even to add to it somewhat in the past 12 months, even when “things were looking very bad”, and that some E50m was added in European equities, amounting to some 6% of assets. “And if we had more reserves, we would have bought more,” he adds.
“We are working to a benchmark of 70% global and 30% Europe for our equity portfolio, which gives us an overall European exposure of 50%,” he reckons. This is discussed by the fund’s investment committee which meets four times a year. “We aim to arrive at a unanimous proposal that is put to the board.” Selection of fund groups is a process of gathering information about likely candidates from consultants and other funds and investors, and then meeting with and talking to the managements. “When we have seen enough people we make a shortlist and we go to visit them.” The list would in practice narrow down to three names, and the fund’s MD will meet at least the favourite candidate.”
Contrasted with investing through segregated accounts, Hasager reckons that there is a small added cost in going the fund route. “The cost of setting up a running a fund is E10,000 to 20,000 a year, if we are setting up a bespoke fund. But if it is an open-end fund, the costs are lower.” The good thing about open ended funds in his view is that there is more liquidity. “Also if more investors are scrutinising a fund, it is easier for problems to be detected.” But of the 30 or so fund structures used, only 10 are open-end funds, the rest are bespoke or limited partnerships.
Until the current market downturns, the portfolio had performed very well. “So in the 10 years 1991 to 2001, after tax returns averaged at 8.8% per annum, the highest in the Danish pension sector, showing that our asset allocation worked well. Even with the disastrous performance of equity markets in 2002 this figure is down only to 7.5% over 11 years.
“We consider expanding our programme in alternatives. We might go into real estate, there is a possibility of going into hedge funds.” Another area to be looked at is commodities.
“We do some hedging, which of course some of the funds do themselves. The extent depends on the currency, such as the Yen which is fully hedged and overall we are probably some 80% plus hedged.” The fund is looking at overlay, but not as a return generator but as a risk avoidance approach. “If we decide to do currency overlay, we could easily do it through a hedge fund, but the aim would be risk control primarily. If it generates an extra return, that would be fine.”
And how does the fund measure up to Denmark’s ‘traffic light’ territory classification? “It depends whether liabilities are taken at their market terms – taken on this basis with our reserves, we are in the green now. In our view, under the old rules, where the fund would be dipping into red, if a fund does not go into the ‘yellow zone’ at least in these equity markets - the worst since the 1930s – then the reserves have probably been too high,” Hasager observes.
“We do tactical asset allocation (TAA), but somewhat differently to others,” he says. Part of the TAA comes through strategic process, so for instance, if there are sharp declines in equity markets, this new information should imply that future returns will be higher. “We had very low expectations for equity returns before the bubble burst, but these have now been increased a little.” On top of this, the fund does operate on a more opportunistic basis and has been over-weighting high yields, for example. “But we do not do very short-term TAA, so our time horizon could be one to three years.”