Skies over the Danish pension landscape have remained remarkably blue during 2005, with equities lifting fund performance. The only clouds on the horizon are interest rates, which remain worryingly low.
Leif Hasager, chief investment officer of the BankPension, which covers around 11,000 employees for companies in the Danish financial sector, says performance in 2005 has been “extraordinarily good” with a return of around 11% in the first eight months of the year.
“Equities, in particular emerging market equities have been positive for our performance, Real estate has also done very well. In fact, nothing has done badly. Everything is really positive, “ he says.
Yet Hasager has no illusions that this benign situation will continue indefinitely. “Looking forward, I think there’s plenty of reason to be concerned. Equities do not seem that attractive any longer. Good opportunities are still there but they’re not as easy to find.”
The future of fixed income returns is also uncertain, he says. ”As a pension fund, we’re more concerned about falls in rates than increases in rates because of liabilities. I don’t see any signs that European rates will increase to any great extent, and there’s always a risk that they might drop further.”
Hasager says this has not led to any change in investment strategy, however. “So far it hasn’t, but if rates continue on this low level and even drop further it could be an option we would have to explore.”
Peter Damgard Jensen, chief executive officer of Pensionskassernes Administration (PKA), Denmark’s third largest pension provider, says PKA has also had a good first half. The eight pension funds that PKA administers have returned an average of over 12%. Danish equities have performed particularly well, with returns of more than 25%.
“The reasons why we have such a good half-year is that we still keep what, in a Danish context, is quite a large proportion of shares in our portfolio, and a large part of that is in the Danish stock market.” says Damgard Jensen.
Derivatives used to hedge against interest rate risk have also performed well as interest rates have fallen. Falling interest rates have also helped PKA’s exposure to real estate, which is currently 10-12%. This is because the valuation of real estate rises as interest rates fall.
Yet falling interest rates can be a double-edged sword, Damgard Jensen says. This is chiefly because the marking to market of liabilities. Denmark introduced the marking to market of liabilities in 2001, well ahead of the rest of Europe. This coincided with the introduction Danish Financial Services Authority‘s traffic-light stress test in response to the equity market collapse. In this test, pension funds and insurers have to show they can survive sudden falls in equities as well as changes in interest rates.
“Because we have a system in Denmark with market values and stress tests, it means that if the interest rate should fall even further, and not just five or 10 basis points, it could mean that we have to change our investment policy. So a major worry for us is where the interest rate is going?”
The result of Denmark’s introduction of marking to market of liabilities was that pension schemes could increase their allocation to bonds by 40%, while lowering their equity holdings by more than 70%. Since 2001 PKA has reduced its allocation to equities to 30% from 45%.
Danish pension funds’ equity exposure has always been relatively modest, says Damgard Jensen. “This is partly because of tradition. Danish pension funds have never been up to levels of 70% or 80%. At the moment we are 30% and we are aiming at 35%, and part of the reason why we won’t go to 45% or 50% is that we learned in 2001 in 2002 that it was too high.”
A longer-term concern is a possible demographic change that could have wide-ranging consequences, says Damgard Jensen. “Denmark has been one of the countries where – we are not sure why – life expectancy hasn’t risen as it has in the rest of Europe. But now there seem to be tendencies that it’s going up, and it could go up rather steeply.”
Finally, there is a broader concern: what will the impact be of the extension to the rest of Europe of the marking to market and stress testing that Denmark has, in a sense, pioneered. Currently the Netherlands, Sweden and the UK are coming to terms with both tougher risk management regulations and the application of international accounting standards, which include marking to market.
Damgard Jensen suggest the resulting scramble for long-dated bonds could depress interest rates further: “If everyone, or some of the main countries which have pension funds, are going to mark to market and have their own kind of stress test, then there could be more funds changing from equities to bonds and especially long-term bonds. And we have seen from time to time that it’s quite a small
“So if there’s a great move in that direction it could depress the interest rate, especially at the long end of the curve. And that could be a problem for a lot of European pension funds.”

Hasse Jørgensen, investment director at the €22bn insurer PFA Pension, agrees that falling interest rates have been a mixed blessing for Denmark’s pension funds. “The falling rates have been helping a lot of pension funds and insurance companies to reach relatively high returns,” says Jørgensen. “And the first half of this year has produced some relatively high returns including not only gains on bonds but also gains on derivatives bought for hedging purposes.
“That’s nice in the short run. But if interest rates are going to stay at this relatively low level let us say for infinity, it will be difficult if not impossible to accumulate the kind of returns that are needed to pay like 4.5% after tax, after costs on the savings accounts.
If interest rates continue to move down, most Danish pension funds will seek to hedge their exposures, he says. “But probably there will be great differences in how much they hedge. The starting point may be that they want to be safe even if interest rates go to 2% or the starting point may be that they want to be safe if the interest rate goes to 2.5% that makes a big difference.
However, what is happening in Denmark is insignificant compared with the situation in Europe, Jørgensen suggests. “There you have countries where the hedging activity is starting and you have countries where it hasn’t really started at all. This is very much related to the speed at which the accounting rules is being changed in Europe. So we have been somewhat lucky in Denmark to start early with mark to market regulation on the liabilities side.”
Jørgensen suggest that the appetite for long-dated bonds is already depressing interest rates. “If you look at macroeconomics, interest rates ought to be at higher levels than they are now. And part of the reason that they are at the levels that we see right now is the demand for long-dated bonds for the purpose of getting the duration that you need in the portfolio.
“So this effect is already putting a downward pressure on long-term interest rates. I would very much like to be able to give a forecast on that but it is terribly difficult to say how long this effect will go on and whether it will become even stronger than it is now.”
One thing is certain. If rates continue to fall, Danish pension funds will have to re-think their relatively high exposure to fixed income. Yet any change in asset allocation could help to correct the problem, Jørgensen says. “It’s a game of equilibrium between supply and demand. And that in itself would make interest rates go up a little bit and become more attractive.”
One issue that does not greatly concern Denmark’s pension funds is the impact of the European pensions directive, which comes into force this month. This is because Danish pension funds are already operating within the terms of a directive – the third life directive. So for Danish pension funds there are one less cloud in the sky.