Icelandic pension funds performed strongly last year. “The real return in 2004 was 10.4%, and some pension funds have informed us that the real return for the first six months of this year on an annual basis was over 10%,” says Hrafn Magnússon, managing director of the National Association of Pension Funds (NAPF). “Icelandic pension funds are more than 100% of GDP. Total assets of the pension funds within the NAPF amounted to ISK982bn (€12.2bn) at the end of December 2004 and in February the total pension fund assets exceeded ISK1trn.”
“The greatest contribution to performance came from equities,” says Tryggvi Thor Herbertsson, a member of the board of Frajalsi, the pension fund of KB Bank, Iceland’s largest financial institution. “The stock market here did very well and consequently pension fund assets showed great returns.”
And this has continued into 2005. “Since the beginning of the year Iceland equities have gained 25-30%,” says Magnússon. “The ICEX 15 has risen some 35% this year and 41% over the last 12 months.”
“While realistically one cannot hope that this will continue at its recent pace, a lot of the factors that contributed to the performance appear to be well grounded – for example, companies have been expanding their base of operations – so we are not fearful of a significant correction, not on a major scale,” says Stefan Halldórsson, managing director of the Engineers Pension Fund.
Nevertheless, there are underlying concerns that the stockmarket rise is building to a bubble and this has been one factor behind a trend to diversify outside Iceland. After a period of growing strength the Icelandic kronur is expected to weaken over the next six to 12 months. “This suggests that we should now be looking at foreign investments and at the same time reducing our hedging of foreign exposure to make use of this change,” says Halldórsson.
But pension funds have also been facing pressures on the fixed income side. Local interest rates began falling following a regulatory change at the government Housing Financing Fund, whose issuance to provide mortgage finance is the backbone for the local bond market. “Long-term interest rates have been falling because the banks entered the long-term mortgage market,” says Herbertsson. “This might create problems for pension funds because the actuarial assessment has to work on the basis of a return on bonds of above 3.5% for them to show positive returns, and they are pretty close to that margin now. So if the interest rate falls further they may have to switch from mortgages to other asset classes.”
“Although domestic bond yields are better than those available in many other countries, they are considerably less than we are used to and I don’t think we will be seeing a significant return from the fixed income market so we have to look to other pastures,” adds Halldórsson.
Herbertsson identifies two other trends: “Continuing consolidation in the sector through mergers of the funds and a movement by pension fund accrual rules from linear towards an age-related system.”
The merger between unskilled workers’ fund Framsyn and seamen’s fund Sjomanna was completed on 1 June to form Gildi, and two regional Icelandic pensions funds, Sudurnes and Sudurland, merged on 1 July to form the Sudurlands pension fund. Lifidn and Samvinnu will merge in 1 January while a decision on a union of Almenni and the doctors’ pension fund Laekna has been postponed until the autumn. However, discussions about a far larger merger – between commercial fund Verslunarmanna, Iceland’s largest private sector pension fund, and Sameinadi, itself the result of the merger of eight pension funds – have fallen through.
The move away from a linear system reflects the transformation of Icelandic society since the pension system was initiated with trade union participation back in 1969.
Under the linear system a contribution by, for example, a 25-year-old gives rise to the same pension benefits as that of a 65-year-old, even though the former will earn a return over a much longer period than the latter. But establishing a structure on the basis of equal rights between young and old was a fundamental requirement at the beginning.
“Most pension funds will change from linear to age-related,” says Magnússon. “Gildi and Sudurlands have done so as part of the merger process and Austurlands, the Eastern Province Pension Fund, has already changed. At the beginning of this year pension funds with an age-related scheme accounted for just 8.5% of total assets. Today it’s 30% and Verslunarmanna is expected to change at the beginning of next year.”
Since the merger Gildi, which with ISK158bn under management is the second largest private fund, has been developing its new investment strategy that will be implemented in the autumn, says chief investment officer Tryggvi Tryggvason. “We are now running the merged fund as one unit,” he says. “It was not really difficult to combine the two portfolios as they were very similar.”
But there have been some changes. Framsyn’s asset management, which had been outsourced to local firm Joklar, has been brought in-house and some reallocation of the foreign investment outsourcing is underway. “We had to fit the structure into our investment strategy,” said Tryggvason. Gildi is in the process of negotiating more advantageous prices from asset managers now the fund is twice the size.
Although the merger went into effect in mid-year, Gildi has issued consolidated performance figures from end-December 2004 showing a real return of 15.1% on an annual basis, with a nominal return of 19%. The portfolio is roughly 60% domestic bonds, 20% domestic stocks and 20% global investments, mainly equities, says Tryggvason.
Verslunarmanna had total assets of ISK151bn at the end of last year, up 22% on the year, says managing director Thorgeir Eyjólfsson. “The return on the portfolio was 16.4%, with domestic equities showing a return of 77% compared with a 59% rise in the ICEX index. Our domestic investment is done in-house and over the last eight years we have outperformed the index by 79.6%. Investment income of domestic bonds was also good. Foreign equities contributed with a small negative effect as a result of the decline in the dollar last year against the kronur. Domestic bonds made up 57% of the portfolio, domestic equities 17%, foreign equities 22%, foreign bonds 2% and alternatives 2%.”
Iceland’s largest pension fund is that for state employees and it too will be taking advantage of the strong kronur to increase its foreign exposure. “Our target is to have about 35% in foreign equities over the next few years to meet our long-term investment policy,” says State Employees Pension Fund managing director Haukur Hafsteinsson. “And we will also increase what we have in foreign bonds.”
In 2004 the fund had 60% in domestic bonds, 24% in foreign equities, 15% in domestic equities and 1% in foreign bonds. “We also had a small amount in private equity, below 1%, and that is included in the foreign equities. We have been looking at structured products and have been buying a little. We have not yet invested in hedge funds but we are studying them and there is a possibility that we will put something in but not this year. We are starting to look at real estate.”
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