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Impact Investing

IPE special report May 2018

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Bucking the trend

On average pension funds in Sweden allocate 55% to 60% to equities, making them somewhat more risk friendly than some of their counterparts in continental Europe. But where the funding position is more comfortable, it seems that funds will happily move towards a more conservative position.
An example of such a fund can be found in the country's national telephone operator, Telia. “A couple of years ago we reduced the portion of equities from 55% to 30% because we saw that the liabilities were not growing as fast as we thought,” says Peter Antonsson, president of the Telia pension fund. “So we didn't need to take that much risk. Of course the market downturn also had an impact.”
A third of the equity portfolio is domestic and two thirds is global. “There are now more global equities in the portfolio because they are less volatile,” says Antonsson. “The Swedish market is very small and therefore can be very volatile.”
The global equity portfolio includes emerging markets US small caps, European small caps and some Pacific Region equities. The 60% bond allocation consists of 25% invested in domestic fixed income and 35% in inflation-linked bonds. “In the case of foreign bonds we would need to hedge the currency exposure,” says Antonsson.
Alternatives account for the remaining 10% and include 5% in hedge funds, 2.5% in private equity and 2.5% in high-yield bonds.
“When we went through the process to find the right mix of assets we thought it would be interesting to add hedge funds, private equity and high yield,” says Antonsson. Well, why not?
The fund does not have any direct holdings in real estate. “We have some real estate equities,” says Antonsson. “Index-linked bonds serve almost the same
purpose.”
Antonsson hasn’t planned any changes in the asset allocation. “If there are changes on the liability side it may need to change,” he says. “But for now this allocation looks very good. If the model works there’s no need to change it.”
The investment philosophy is based on a clear, if ambitious, aim to generate a return of 6.5%. The fund has achieved the target in all years apart from during the stock market downturn. “We want to keep stability,” says Antonsson. “To achieve more in the market we would need to take high risk, and we are not prepared to do that. Taking risk and losing money is much more painful than not getting the last kroner of return.”
All management is outsourced using specialist mandates; a question of control. Antonsson: “We would like to do the allocation ourselves.”
He adds: “Balanced managers almost never make the right decisions; it is very hard for them to find the right allocation over time. If you look back many of them have underperformed.”
The fund uses a mix of active and passive mandates for reasons of diversification. However, the use of active mandates is partly driven by the fact that for certain markets passive mandates don’t exist. As a result the relationships aren’t always happy. Antonsson: “Have you ever met an investor who is happy with active management?”
A still more conservative stance has been adopted by the Sparinstitutens Pensionskassa (SPK). Equities account for just 18% of the portfolio; bonds account for the main part, some 77% of the fund, with the remainder accounted for by fund of hedge funds.
The allocation to equities is way below the national average. Peter Hansson, executive vice president at SPK, provides some insight. “A lot of pension funds in Sweden have been underfunded, and they might try to do something to get out of that situation,” he says. “We have never been underfunded since 1944 when we were established, and we intend to stay that way.”
He adds: “We are here to safeguard the pensions of our members so we are very cautious.”
One of the main priorities of the fund is to focus on generating more return from the considerable fixed income portion, especially now that interest rates are so low.
The main change in asset allocation has been a further move into fund of hedge funds. Hansson explains that “leaving the hedge fund allocation with someone who monitors the performance of the individual funds all the time is less risky than choosing them oneself. This has been a trend across the market as a whole.”
However, there is no allocation to real estate. “The liquidity of real estate is not good enough if you want to actively manage the portfolio,” says Hansson. He adds: “We might invest in real estate in the future but the market is not at the right stage for that.”
In terms of regulation Hansson believes that there is room for improvement. “The market is changing so much,” he says. “Regulation is not keeping up with the issue of how to cover the liabilities with the new asset classes. The authorities are investigating new set of rules but I wish they would speed it up.”
Currently a discount rate of 3% is applied to pension funds. The rate is supposed to be around two-thirds of the long bond rate. For Hansson this presents more of a challenge than fine-tuning asset allocation. “We can talk about different levels of returns on different assets but if the authorities do something with the discount rate it will have an enormous impact on our liabilities.”
Looking forward, Hansson muses on the outlook of pension funds in Sweden. “Are we just Sweden or are we part of the EU? Swedes should broaden their horizons and take a more European or global perspective.”
Swedish funds have already moved towards internationalising their equity portfolios to spread risk and reduce dependence on the very small Swedish stock market. Viewing allocations next to the relative importance of the Stockholm exchange on a European or global level, some funds still have a way to go.

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