Denmark enters the euro fray
Denmark’s geographical position on the cusp of mainland Europe translates well to the set-up of the country’s approximately Dkr1,200bn (e161bn) institutional investment market. Four to five years ago, with the euro in mind, Danish investors began gradually diversifying equity portfolios away from the relatively small domestic market.
Jens Bisgaard-Frantzen is head of equities and vice-president at Copenhagen-based Kommunernes Pensionsforsikring (KP) pension fund, The $9bn (e8.6bn) KP fund covers approximately 220,000 municipal employees. Bisgaard-Frantzen says: “Four years ago we decided we could see a future where the Danish krone would be part of the euro and so we diversified into Ecu assets and US fixed-income. In equities, the fund moved to a 50/50 domestic-overseas equity split.”
Danish regulations allow for funds to hold up to 50% of European economic and Monetary Union assets – a straight switch from the prior Ecu quota – as well as 20% in non-Emu currency assets.
However, the country’s rejection of euro membership has broadened investment diversification for many funds, as Bisgaard-Frantzen, notes: “We have now shifted to a two-thirds foreign equity bias on our 35% overall holding, with 66% in overseas shares and 33% domestic.”
As Daniel Broby, chief portfolio manager at Unibank Investment Management in Copenhagen, points out: “In the long term, we are saying to funds that the euro endgame is to have almost all of Europe as part of the single currency, so in reality a euro approach is only an intermediary step.”
Overall asset allocation levels are around 23% domestic equities, with 9% overseas, 59% in domestic bonds and 2% in foreign paper with real estate at 6% and cash a 1% portion, say 1998 figures from William M Mercer. Mercer figures also show the market set-up consists of insurance companies having 42% of pensions assets, bank-held schemes comprising 14%, pension funds for professionals 18%, company schemes 4% and the ATP and other public funds at 22%.
All employees are required by law to be members of the ATP scheme, which is also administering temporary compulsory pension contributions of 1% of gross salary. And the industry-wide schemes are expected to be a strong source of growth in the coming years as contributions grow from current levels of 4% to 9% in the next five years.
The diversification of assets itself is raising a number of important questions in Denmark. While a large proportion of the country’s funds have opted for an international blue-chip equity exposure allied to Danish small-cap holdings – a mixture many in the technically proficient market can manage themselves – emerging market investment is also gaining a foothold, alongside interest in US and Japanese securities.
Gudme Raschou, a 100% subsidiary of Landesbank Kiel in Germany, has Dkr8bn in assets, a portion of which is managed for around 40 institutional clients. Morten Schou, head of portfolio management, says: “Five years ago we changed our international equity approach, to concentrate on market leaders, on a sector-driven approach with no geographic consideration. It is taking time, but I think we will see more clients going the sector route as equity investment becomes even more international.”
Danske Capital Management is part of Den Danske Bank, and manages and advises around Dkr260bn (e40bn), including the mutual fund arm assets of Danske Invest. Anne Broeng, senior vice president at Danske Capital, says there is a definite trend towards outsourcing the more technical mandates. She adds: “The big question is how far some of the larger pension funds will go and how far they decide they can go it alone.”
The debate is also pushing forward the question of passive management.
However, as Steen Svendsen, managing director at Schroder Investment management, points out, diversification should not mean a stampede out of Denmark. “We have carried out a study showing that Danish pension funds should not have more than 40% abroad due to their krone liabilities,” says Svendsen.
Investors are tending to retain Danish government bonds, however, with yields comparatively strong compared to their euro counterparts at 5.5%. Danish mortgage bonds, yielding about half to three-quarters of a percentage point above Danish gilts, have also remained untouched – particularly as they can be managed in-house. Consequently, bond investment in Danish schemes is still well above the 50% portfolio mark.
As Broby at Unibank remarks: “Domestic bonds still have a spread over and above German bunds, so from an asset allocation point of view, why not be exposed to the Danish market?”
Peter Preisler, senior vice president at Danske Capital, believes more exotic products may be a source of greater bond income, however, he says: “In currency terms, we recommend hedged global bonds as a relevant asset class on a global basis to add gains and spreads on different country interest rates. Without losing much diversity, you will still have a much more interesting asset class.”
Interest in credit risk is growing, although Broby at Unibank notes: “We predicted corporate treasuries would really take off because of the excellent yield pick up, but we haven’t seen the flood of recognition of that.”
Private equity is also gaining support, with many suggesting that this could rise to around 2.5% of portfolios in the coming years. And managers say while funds are also looking at alternative investment such as hedge funding, its current tax-inefficient status is a barrier.
Danish funds are adopting proactive ethical investment stances for asset portions. Flemming Madsen, assistant director at the Copenhagen office of Dresdner RCM Global Investors, which manages about $300m in Danish assets, says: “The KP pension fund, for example, is using UN criteria on child labour, pollution and equal rights for part of its investment, which fits in with the screening and research that we do here.”
Surprisingly, though, for a developed investment market, external consultancy is the exception rather than the norm, and little change is expected. Strategic asset allocation still tends to be carried out by funds in conjunction with asset managers and there is little argument that the Danish market is a close-knit community. Fund managers believe few Danish investors would be prepared to pay for consultants unless absolutely necessary.
Similarly, the presence of foreign managers has not so far posed any major threat to the Danish status quo. But several new legislative factors look set to open the floodgates. Changes to capital gains tax law, due from the beginning of 2000, mean the present levy on the real rate of interest will be switched to a flat rate of 26% on bond investments – a move expected to have a number of effects over time. The levy will be 5% on equity capital gains. Broby says: “This will open the market up to competition.”
Mikael Randel, managing director at Carnegie Asset Management, managing Dkr18–Dkr19bn in the Danish market, principally through global mandates, believes the mutual fund market is set to become more important in Denmark as a result.
Svendsen, at Schroders, explains the changes in legislation mean the company is already repatriating $200m of Danish money in Luxembourg funds to Denmark. “To qualify for 5% capital gains tax on pension yield, funds have to be distributive fund vehicles, which distribute capital gains on any equities held less than three years.” Schroder is currently creating a range of sub-funds of its Danish mutual funds to begin marketing in Denmark.
Insurance companies are also conscious of the regulatory impact on their own business. Hasse Jorgensen, chief financial officer at PFA Pension, with corporate pension assets of Dkr130bn, says: “The guarantee on insurance contracts is at 2%, 3% and 5% at the moment and this can be problematic, particularly when interest rates have dipped. The new capital gains tax of 26% will make this harder to achieve in the long run. Products are definitely being developed such as unit-linked and it may be that a trend towards separating the insurance and savings parts could develop.”
The result of the new legislation certainly suggests a greater focus on investment performance, reporting and fees.
While good local investment competence and the language barrier may still be considered paramount, the competition is hotting up. One fund manager says: “Denmark is certainly a target market, Swedish fund managers are here, alongside the likes of Mercury and ABN Amro, looking for the European mandates.”
In terms of market consolidation, Denmark is no exception to the rest of Europe, with few managers doubting the possibility of further mergers and acquisitions. Nevertheless, the Danish players are coming out fighting into the European ring. Unibank is set to roll out “aggressively” into the German market shortly, says Broby: “I believe we can get a foot in the door in Germany and will be better able to do this than the UK or US players.”
Priesler at Danske Capital fires out Den Danske Bank’s salvo for the European asset management battle. “We don’t feel our location as an investment manager is important because we want to be a European manager, which is a question of having the core products and client servicing to do so,” he says.