Like most Danish pension funds, the Copenhagen-based Laegernes Pensionskasse (LPK) is a defined contribution (DC) arrangement, but operates under the guaranteed return basis. This requirement is raising real concerns in parts of the pensions and insurance sectors, since they both work under the insurance law.
“We have different rates of guarantees among our members, the highest of which is 4%,” says Claus Stampe, chief investment officer, adding: “Many other schemes are at 4.5%.” The worry is the increasing difficulty of the guarantees, which are harder and harder to be sure of achieving in the current investment climate. “Our highest guarantees are isolated in a closed fund, and last year we reduced the funds’ minimum guaranteed rate from 4.75% to 4.0%, compensating all members for the reduction.” Our new open fund guarantees 2% on new contributions, he explains. That apart, the fund has been one of the top performers for many years and has had no real problems in meeting the requirements.
The fund is exclusively open to medical doctors, and has around 23,000 active members and just under 4,000 pensioners. “We have practically all the doctors in Denmark in the fund,” he says. The fund, which had assets at mid year amounting Dkr35bn (E4.7bn), has 25 employees. The fund’s investments are managed by an internal investment committee, that implement the strategic benchmark set down by the fund’s board of directors annually . The members of the committee are managing director, Niels Lihn Jørgensen, CFO Lars Ingemann, Stampe and his colleague Peter Bo Kiaer on the investment side. “Our aim is to have a small team of skilled investment professionals, enabling us to have fast, efficient decision making.”
The fund’s CFO also runs the real estate portfolio and his team is primarily assigned to such items as internal performance measurement, settlement of trades and other functions. “We do not publish the exact weights in our strategic benchmark, but the equity weighting is close to 45%,” says Stampe. The fund’s strategic benchmark is also used to evaluate the contribution from tactical asset allocation and the contribution from the range of managers used. While the in-house team manages part of the portfolio, its main role is seen as focusing on the overall asset allocation and implementing risk control for the fund. “The team manages a fixed income portfolio and a low risk profile Danish and European equity portfolio, with tracking error of less than two.” One of the main reasons for internal management is that it should contribute to better decision making when it comes to the overall asset allocation and risk control of the fund. The process is very top down, explains Stampe.
“When it comes to equities, we do a lot of outsourcing” – one of the key functions of the in-house team is to hire, monitor and fire where necessary the raft of external managers, currently comprising seven non-domestic and three Danish managers. These managers are concentrated into the international equities segment accounting for 30% of the total assets. All in all, there are eight different mandates covering 12 portfolios, says Stampe. “Risk budgeting considerations play a role here, which is why we have a passively manaaged US large cap portfolio combined with actively managed small cap portfolios that are managed with high active risks by what we believe are skilled stock pickers.”
The model portfolio comprises seven specialist regional portfolios, managed either actively or passively with what he calls “an overlay in actively managed global portfolios,” made up of three externally managed portfolios.
The aim is to obtain risk diversification coming from small and large caps, style and geographic factors. “From a risk budgeting standpoint, active risk is allocated to types of managers and mandates that are most likely to create high information ratios.”
This high international equity stance, unusual by Danish standards, is something the fund has been putting together for a decade or so. “We have a selection of matches particularly on manager styles.” The most important thing in selecting a manager is investment process and quality of the key investment professionals, maintains Stampe. The preference is for active managers running concentrated portfolios with a “high risk profile”, and these are then mixed with passively managed portfolios for risk control purposes.
In fact in the last year, two searches were completed in which the fund used consultants, “This was the first time we have done so, which was mainly to see how they went about it and to widen our universe of potential managers.”
In relation, the Danish equity portfolio counting for some 7.5% of total assets, about 90% of the portfolio is in an internally managed large cap portfolio benchmarked against the KFX index, with a low active risk. “The rest is invested in an externally managed small cap fund, where the philosophy is to have an active corporate governance policy.” This is a fund managed by Bankinvest where LPK co-invests with another pension fund.
When it comes to fixed income, this is very much a core portfolio that is internally run. “Our universe is Danish bonds and plain vanilla bonds denominated in euros,” says Stampe. This accounts for 80% of the fund’s fixed income portfolio, which makes up 45% of the total assets. The tranche of this in euros will be in government and credit bonds trading close to the swap curve, he points out.
“During the last couple of years, we have been setting up satellite portfolios investing in both investment and non-investment grade bonds. This year we established a US portfolio with a mandate to invest in US mortgage bonds and investment grade corporates.” The purpose, he explains is to diversify risks away from the domestic mortgage market and in particular the “prepayment risk” associated with these bonds. He adds: “For several reasons we preferred a US portfolio to euro corporates, the US fixed income market gives us better risk diversification, higher swap spreads and a much broader market in both mortgage and corporates. So it didn’t make that much sense to us to go more into the euro corporate market.” About 10% of the portfolio is in US investment grade in an externally managed portfolio. Another 7% is in global high yield, through an externally managed investment fund, an exposure that has been built up over the last couple of years. And the rest of the fixed income portfolio is in emerging market debt. “Almost all international fixed income investments are hedged back into Danish Kroner.” International bonds make up about a third of the fixed portfolio.
“Over the past five years we have been very happy with the performance of the core portfolio. But the real area of outperformance has been on the equity side, where the fund was ahead in increasing its international equity exposures back to 1993 and 1994. The returns overall have been excellent, with an annualised 9.8% since 1991, putting it an equal first for funds over this period and a five-year return of 11.6%. Last year was a creditable 6.4%, given that it was a punitive year for international equities.
An unusual feature of the fund is the approach to tactical asset allocation, where it sees itself as being much more proactive than most other funds on the market. “Our reasons for engaging in TAA – and historically we have only taken one or two major bets a year – is not just to add value, but to control risk, in particular our free reserves.” For example, in the last quarter of 2000, Stampe says they reduced the equity exposure from 45% to 35% to good effect.
An important aspect of TAA, is that it provides an ongoing incentive to the in-house team to follow the markets very closely, even those that are externally managed. But any activity is highly controlled and follows a very structured process.
Though Stampe and his colleagues are dedicated investment professionals, they know that when it comes to internal management their area of operation is strictly circumscribed as to the mandates they can handle and what “we believe we can handle on a competitive basis”. It clearly brings the advantages of close market involvement and access to sell side research and strategists, and it also provides an in house experience and insight that is extremely helpful when coming to evaluate their roster of managers or searching for new ones.