Denmark finds success in rejection

Denmark is in good shape – a resolute “no” to the euro, a booming stock market and now 95% of the population covered by occupational schemes. Proposed reforms to the tax system and equity restrictions have rounded off an excellent year, while domestic consolidation within the financial sector and MeritaNorbanken’s purchase of UniDanmark lead to one conclusion – Danish asset management is flourishing and investment managers are keen to grab an increasing share of the business.
Many of the local managers interviewed claimed the referendum on the euro will have little effect on their business although rejection has maintained currency risk. “If we had voted yes then the need to look at the currency risk on our portfolios would not have been there,” says Christian Clausen, member of the executive board at Nordic Baltic Holding, the newly named group following Unibank’s merger with MeritaNordbanken. “It may be a small risk but you have to look at it, be aware of it and control it,” he says.
Denmark’s rebuffal of the euro is likely to have less effect on many of the smaller, local asset managers. Gudme Raaschou is a medium-sized manager with Dkr10bn (e1.3bn) under management and Morten Schou, its head of portfolio management, says the effect will be negligible, as most of its clients are local. Nevertheless, refusal to join means the retention of investment restrictions that would otherwise have disappeared. Institutional investors are allowed to invest only 50% in Euro-zone equities and Schou says acceptance of the euro would have ended this restriction.
This hasn’t restricted diversification and, despite the Copenhagen stock exchange’s impressive performance, there has been a shift into international and, in particular, European equities. Institutions are also cutting their fixed income stakes and moving from domestic for foreign bonds. According to Greenwich Associates, at the end of 1999 Danish institutions held 52% of their investments in fixed income and 42% in equities. At the end of 1998, corresponding levels were 58% and 34% and institutions surveyed by Greenwich believe this shift will continue – only 6% feel the share of fixed income will rise by 2002 while 46% feel the equity component will rise over the same period.
Supply of Danish equities is limited and diversification is not a new phenomenon. “The reasons for diversification are much the same as on the bond side. You have a small market, you have 10 or 20 stocks that are liquid and the rest are illiquid,” says Schou. At the Danish Lawyers and Economists pension fund, strategist Jesper Jacobsen says they have halved their exposure to Danish equities in the past six months to about 10% of the overall portfolio.
Institutions with heavy exposure to Danish equities, though, have every reason to be satisfied. Says Schou: “Last year everybody was saying ‘equities are dead, we don’t want to invest in them anymore’… this year you have a relative return to the world market of 35–40%.” This outperformance has been driven by two and threefold increases in a handful of stocks including Vestas, the wind energy company, William Demant, the hearing aid producer, and fibre optic company GN.
Poor fixed income returns are partly responsible for the switch out of bonds. Says Jarl Kure of the Danish financial supervisory authority: “Lower interest rates have lowered the solvency buffer and this has meant some of the companies have focused on their solvency ratio and the stronger companies have changed their assets from bonds to stocks.” Again smaller players have had less reason to shift from domestic fixed income as the volumes they are dealing in aren’t sufficient to produce liquidity problems.
Schou says many of Gudme’s clients are diversify out of domestic bonds but aren’t willing to sacrifice yield and as a result are buying up German Pfandbriefe and corporate bonds above, and including, investment grade. “There are very few that have dared to start investing in high yield bonds though,” he says. In other areas, Danish institutions are becoming more adventurous and beginning to embrace alternative investments. Investors remain relatively conservative and have so far shunned hedge funds but private equity is going mainstream.
Nowhere is this better demonstrated than at Pensionselskaberne, Torben Möger Pedersen’s labour market pension scheme, which invested only in listed stocks until a year ago. “We decided to diversify into private equity and by 2004 we expect 5% of total assets will be invested in it, preferably through fund of funds,” he says. PK has reached a size where it feels it can venture into private equity and its primary partner had been Danske Bank, which launched a number of private equity funds in the spring.
At the macro or institutional level, a stream of pan-Nordic mergers in the financial sector means the four countries are amalgamating into one financial zone. Danske, Denmark’s largest bank, bought its rival RealDanmark valuing it at Dkr25.8bn in a deal creating one of the Nordics’ largest banks. The new entity will have assets totalling Dkr1.31trn. MeritaNordbanken, now the largest bank in the region, has been snapping up banks this year. In March it bought Unidanmark, Denmark’s second largest bank and only last month it announced Christiania Bank, Norway’s second largest, had agreed to an increased offer. As Vesa Vainio, chairman of Nordic Baltic Holdings, said before the deal was finalised: “We are close to reaching a long-standing goal of creating a truly Nordic financial institution… this is one of the most important pan-Nordic initiatives ever.”
Clausen says the consolidation is changing attitudes in the region and the large players now think in Nordic terms. NBH manages E104bn in assets, up form an equivalent E89bn last year. Many of the newly merged institutions are pitching aggressively in neighbouring countries. “It’s evolving into a Nordic market. You can see the frontiers of the Nordic financial area coming down and you can now regard it as one financial area,” he says.
Unlike Finland, Sweden, Denmark and Norway aren’t members of the monetary union and, according to Clausen, this makes them marginally different to the rest of Europe. He says the distinction between the Nordic region and the rest of Europe will eventually disappear. “Right now though, it seems the process within the Nordic region is faster,” he says. Consolidation in the region is far from over with many locals predicting further mergers. “You will certainly see consolidation and everybody expects the Swedish banks to be the next trying to get a foothold in Denmark,” says Pensionselskaberne’s Pedersen.
Foreign managers are also trying to muscle in or have already done so. Schroders is ahead of the game and has had an office in Copenhagen since 1989 and a glance at its client list shows it has proved its credentials. Managing director Steen Svendsen has built the business to over E4bn in assets under management in the Nordic region and, in Denmark, its clients include PFA, SkandiaLink and many other large pension funds. Earlier this year Schroders repatriated E800m from Luxembourg Sicavs as changes to Danish tax laws in January meant capital gains on equities held for less than three years had to be distributed. It set up 11 Danish-registered sub-funds with unit trust and unit-linked products for institutions.
Svendsen says Mercury Merrill Lynch is doing well and Fidelity, Morgan Stanley, Deutsche and Putnam are often listed as managers making inroads into the market. In reality though, the large Nordic institutions pretty much have a stranglehold on the market and foreign managers face pretty stiff competition. “You still see a very high concentration around the two major Danish players,” says Morten Schou.
Denmark’s legislators have been busy and have set themselves a couple of goals including rejigging tax levels. Prior to last year, taxes were levied on real returns – that is, returns after inflation. The government changed this to a fixed 5% on equity returns and 26% on fixed income but this was flawed. When interest rates fell, many of the pension funds and life insurance companies found they had insufficient reserves to cover guarantees they had offered policyholders.
Under the previous system, during lean periods the tax burden was less severe. To counter the problem the government considered options to hedge against falling yields, a solution that would likely have complicated the issue.
Instead the government proposed closing the gap to 8% and 21% but has since gone the whole hog and opted for harmonisation at of both rates at 15%. “This change is positive as it simplifies taxation. The guaranteed rate of return issue isn’t solved by the tax alteration but it postpones the acute problem as tax on fixed income is lower,” says Steen Villemoes, head of investment at DIP, the Danish pension fund for engineers. Others are less than happy and some pension funds say it will deter investment in equities and penalise those with large equity holdings.
Along with the decision to harmonise tax rates, the prime minister said the government was reviewing the 50% equity limit imposed on Danish funds. Two years ago the government raised the restriction from 40% and seems likely to lift it to 70%. One scenario is for funds to apply individually for an extension that will depend on their reserves, something Jarl Kure of the Danish financial supervisory authority describes as “an administrative nightmare”. A decision is expected some time next summer but any rise would be welcomed by the industry.
On the consultants side the Danish market remains under-developed and services under-utilised. Foreign consultants are active in the Danish market as are many of the large international accounting firms more and more institutional investors are warming to consultants. Manager selection is now more professional and Clausen says clients are urging greater transparency and higher returns.
This shift is in line with international trends though. Aon, William Mercer and KPMG are some of the largest players. Mercers and Frank Russell have both done work in Denmark but as in the other Nordic countries, using consultants is in its infancy. One of the local players doing well is Kirstein Finansraadgivning, an investment consultancy set up seven years ago.
Says Jesper Kirstein, founder and head of the firm: “It’s a limited market and the main competitor is either the companies themselves or it could be the accounting firms.” Unsurprisingly the larger institutions are less averse to using consultants and international mandates often involve them. Manager selection often involves consultants and, for example, the DIP used Frank Russell and Watson Wyatt for manager selection and London-based private equity specialist Altius associates for their private equity investments. Villemoes in fact leaves DIP to set up a regional office for Altius in the new year.
Growth in the use of consultants will continue, particularly since outsourcing in Denmark is growing in popularity. It is not uncommon for pension funds to outsource international mandates and many of the more specialist, small cap portfolios. Unibank and Carnegie manage PK’s global portfolios and all its equity is outsourced as well. Pedersen says they focus on asset allocation, risk control and, to some extent, the bond portfolio.
The lawyers and economists’ pension fund reflects the typical attitude towards outsourcing in Denmark. This year alone it has pushed its Danish small cap equities out to Bankinvest, the remainder of its Danish portfolio to Unibank and Dansk portfolio and its European index fund to Unibank, SEB and Bankinvest. According to Jakobsen, the fund’s size means the move makes sense. “We’ve realised we have to outsource and concentrate our resources on what we think we can manage,” he says.
Denmark hit the headlines earlier this year for rejecting the euro. Given the performance of the market in the past 12 months and the emergence of foreign and Nordic managers on the scene, it shows it’s doing something right, and doing it on its own. 2000 was a great year for the Danish market.

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