Denmark switches lanes
It’s hard to avoid the traffic lights in Denmark these days. When the Danish Financial Supervisory Authority (DFSA) introduced its two new colour-coded stress tests to assess the financial strength of life insurers and pensions institutions, Danish pension funds suddenly found themselves slamming the brakes on a steadily rising exposure to equities.
The DFSA’s so-called ‘traffic light’ system works on two scenarios: a ‘red light’ under which pension funds and insurers must be able to make up their loss in the event of a fall of 12% in share prices and a 0.7 percentage point change in the interest rate; and a ‘yellow light’ where pension funds must be able to cope with a 30% fall in equities and a single percentage point fall in interest rates.
If a pension fund fails the stress test it can be obliged to reduce its risk profile. Factor in the recent falling equity markets along with the historical pension guarantees of up to 4.5% per annum that once characterised the Danish DC pensions market, and the result has been a wholesale switch of vehicle by Danish schemes anxious to shore up their risk profiles and escape being pilloried by the Danish press.
Daniel Broby, chief investment officer at BankInvest, explains that the decision by the Danish regulator to force pension institutions to match their long-term assets with their liabilities affected most funds in Denmark, with the result that many sold out of international equity and moved into bonds. The counter cyclical logic of such a move, with funds being forced to sell equities at the bottom of the market, caused consternation amongst Danish investors.
And Per Skovsted, executive vice president at Gudme Raschou says the effect of the regulation is dominating the scene at the moment, despite the fact that pension guarantees are regularly lower than 2.5% today.
“Many institutions have spent a lot of time during the last 12-18 months with hedging strategies trying to reduce equity exposure or going into collar strategies using derivatives. Some have also hedged their exposure on the fixed income side in order to keep a return on fixed income that could meet the guarantees.”
As a result, he says it is not unusual to see institutions with only 10% equity exposure at present, compared to 40% only a few years ago. On average though he believes Danish pension funds are probably now holding between 20-25% in shares.
The fact that pensions funds find themselves under such scrutiny with little room for a long-term investment horizon has effectively turned them into short-term managers.
Those that want to buy equities may not be in a position to do so.
Many note that Danish pension funds can now be found closely examining their risk budgets to see what kinds of moves they can make to generate returns without leaving themselves exposed.
Most are waiting for new signals from the DFSA on how the traffic light system will be governed in the future, but few expect the restrictions to be loosened.
As one Danish investment manager comments: “This could be a permanent scenario that we are facing, whereby equity exposure will remain at these relatively low levels and funds have to be very aware of where they expose themselves to risk and what kind of satellite mandates they enter into. It’s difficult to generalise, but most people are sticking to domestic fixed income products, and on the equity side there is a preference for the local markets.”
For Denmark’s smaller funds such an approach has meant a shift back to balanced mandates away from any sorties into specialisation.
The country’s larger institutions, however, still tend to operate a quasi core/satellite structure with some indexed or enhanced index mandates (or active mandates with low tracking error) complemented by alpha-seeking active briefs.
Such equity exposure tends to be global rather than regional and may include emerging markets for non-correlation reasons.
On the bonds side, Danish fixed income is still the mainstay, with diversification coming through global bond or high yield mandates, although many predict that increasing noise on a second euro referendum could yield greater eurobond exposure as pension funds anticipate paying out their liabilities in euros.
Real estate continues to be an important portfolio constituent, while on the alternatives side private equity funds are picking up money over hedge funds, with the latter producing more talk than action.”
Flemming Madsen, director and head of Nordic markets at US house, TRowePrice, believes, however, that the forced selling of equities meant too many quick decisions about moving into fixed income without enough thought about the risks in bonds. “Most clients are now actually talking about what assumptions they should have in their model.”
According to Broby at BankInvest, much of this asset/liability work continues to be carried out in-house: “The consultancy market in Denmark is still limited. There are a few high profile names but they tend to be used as sparring partners rather than for pure asset/liability or selection issues. Danish pension funds still don’t see the justification for the additional consultancy fee.”
For the Danish asset managers then it’s a question of managing the core local products well, while seeking to differentiate in other areas.
Bankinvest launched its alternative energy private equity fund earlier this year and Broby says the firm is looking to raise more money both here and in biotech funds.
“The Danish market is one of the least penetrated in Europe for private equity, so there is room here for pick up. Good returns are quite elusive in the Danish market and private equity has delivered more in terms of IRR than many asset classes, so I do think that this is going to be an explosive area for Danish pension funds.”
Skovsted at Gudme Raschou believes that the current market set-up necessitates a dual business approach: “We see ourselves increasingly as a combination of manager and advisor. We cannot be experts at everything and we try to stick at what we’ve been good at – local products, plus some international equity and fixed income.
“For other products we are building up relationships with international fund managers. One example is that we’ve just established a partnership with West AM on global high yield due to increasing in this product demand in these difficult markets. It’s an asset class that is expected to havea couple of good years ahead of it.”
Danske Capital is also refocusing its institutional business. Niels Ulrik Mousten, director, believes that in the current low growth, low inflation environment, clients will demand more index products alongside real value-added active mandates.
“I believe this is our route now in the institutional market – selecting areas to really add value to clients. You have to be competitive in European products – both equity and fixed income, but we believe we can add something with our sector focus, selling regional products that look at European companies from a global perspective. I think this gives us an edge.”
Certainly, competition has increased in the last few years with Nordea consolidating its Danish presence and Sweden’s SEB entering the market and building a track record. Schroders also continues to run a healthy business in Copenhagen.
TRowePrice, has made notable in-roads and Fleming Madsen believes one factor in their favour has been a shift to disciplined, valuation-sensitive managers on the back of poor performance by predominantly momentum growth managers in the Nordic region.
“Pension funds here are now looking at style consistency and the consultants are focusing on this, which has been a help to us.” He adds: “As a result we already have about 20 Danish institutions on our books.”
Madsen still believes, however, that it is relatively hard for foreign managers to court the Danish market, particularly if they don’t have a serious presence on the ground: “There is still a need for the local networks and contacts. Pension funds have become increasingly reluctant to talk to new managers. The big foreign players are undoubtedly still cherry-picking mandates from the larger institutions in Denmark, but if you don’t have people on the ground it is hard to stay consistent and committed.”