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OECD cites investment restrictions for AP funds' 'sub-optimal' portfolios

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SWEDEN - Investment restrictions at Sweden's buffer funds could be leading to "sub-optimal" portfolios and over-exposure to certain asset classes, the OECD warned as it published its submission to the review of the AP funds.

The review of AP1 through AP4, as well as AP6, was announced last summer, with the Swedish government saying it would consider the closure of one or more schemes in an effort to reduce management costs.

In its report, the OECD noted the "unique" approach taken by Sweden in opting to spread pension reserve assets across several vehicles and said arguments could be made both for consolidation and for maintaining the status quo.

But it did not favour one approach over the other, arguing that such a decision was best left to the inquiry board established last year, as well as the country's parliament.

Mats Langensjö, investigator for government's AP fund review and a former managing director at Aon, said the report was commissioned to allow for an "international benchmark and reference point in terms of the OECD benchmark".

"We share most of their views on what needs to be addressed and what problems there are," he said.

"We may, in the end, come up with other conclusions, but, in broader terms, we share [their views]."

He added that the report would also serve to launch a debate within Sweden ahead of the government-commissioned report being published in mid-August.

However, the Paris-based think tank was critical of the lack of a coordinated investment strategy on part of the first four buffer funds and said that establishing a specific investment objective to measure performance was "essential".

Langensjö seemed to share the OECD's concerns over a performance benchmark.

"I have said before, the competition between the funds has not been useful for the pension system," he said. "It may have been good to keep people on their toes in each organisation, but it has not helped and may even have driven to short-termism."

He referenced the UK's Myners Report, which more than a decade ago dismissed peer group benchmarks as leading to "herd-like behaviour" among the country's pension funds.

The OECD said that while the mandate for the buffer system did reference the funding of Sweden's public pension liabilities, the role the funds played could be made "clearer and more specific".

The report argued that it was unclear if the system's aim was to improve on the current 12% funding it provided for future payments, or if investments were simply meant to reduce the risk of the country's balancing mechanism being triggered - resulting in a cut to benefits.

It was also critical of the investment restrictions placed on the schemes, saying these could lead to "sub-optimal portfolios and over-exposure to certain types of assets".

"Furthermore," note authors Clara Severinson and Fiona Stewart, "restrictive investment regulations leave the AP funds with less room to adopt varying investment strategies, and thus take away some of the potential benefits of competition and diversification from having four different funds."

Addressing the fate of AP6, which is currently limited to investing in Swedish private equity, Severinson and Stewart argued for the relaxation of investment restrictions and said the fund should be allowed to invest in a way that was "aligned with the overall investment mandate of the AP funds" - allowing non-domestic exposure.

"Should the Swedish parliament decide that specific financing for the domestic private equity market is a priority to be maintained, then there may be an argument for doing this independently and without any ties to the state pension system whatsoever," they said.

The suggestions are broadly in line with discussions occurring in Sweden, with Langensjö telling IPE last year that there had been "ongoing discussions" about allowing non-Swedish investments for AP6.

The OECD also argued in favour of the launch of an independent committee to steer matters of investment objectives, performance measurement and nominating board members - suggesting this could be part of the remit of Pensionsgruppen, a multi-party working group.

However, Langensjö would not be drawn on whether the OECD report would be the blueprint for the final report to government, saying it was only one of the submissions.

"One thing I learned is that pension reserve systems tend to be very specific to each country, depending on where the system comes from, what the history is and what the system is defined for," he said.

"Therefore, some of the proposals, which are good ones, may need to be reviewed and put into a Swedish context."

At the end of last year, the five AP funds under review had combined assets of SEK872.5bn (€97.7bn), down from SEK895bn in 2010.

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