Gail Moss finds Finnish pension funds internationalising their portfolios in an effort to help offset domestic woes
Finnish pension funds are looking abroad to boost returns in the face of domestic economic doldrums. “There has been a deliberate effort to internationalise portfolios, especially in real estate, as Finnish investors look to reduce sensitivity to the domestic economy while also tackling the mixed outlooks for mainstream assets,” says Eric Zwickel, a senior investment consultant based in Towers Watson’s London office.
At a glance
- Pension insurers are internationalising their portfolios, particularly in property.
- As of 2014, around half of investments were outside the euro-zone, while 25% were invested in Finland.
- Non-euro investments rose by 4.3 percentage points during 2014.
Average nominal returns for 2014 were 7.4% across the sector, according to pension fund alliance TELA – the figures include both private and public sector employees’ schemes in the statutory earnings-related pension system. Returns for the previous year were a little higher, at 8%.
The 2014 results took the average annual real rate of return to 4.2% for the period from 1997, when the present risk-based solvency regime came into force for private sector funds, to 2014. Average equity returns, including hedge funds, were 10.7%, down from 15.7% the previous year, while fixed income returned 4.4%, an increase from the 1.2% generated in 2013.
Pension fund assets grew by €10bn over 2014 to reach a total of €172.5bn. This represents 85% of annual gross domestic product, up from 80% in 2013, but this was largely because the Finnish economy was stagnant in real terms during 2014.
According to TELA, listed equities, private equity and hedge funds made up an average 48.9% of total assets, a rise of 2.5 percentage points over the previous year. Fixed income formed 41.2% of average portfolios, a fall of 1.9 percentage points, while real estate also shrank, by 0.6 percentage points, to 9.9%.
At the end of 2014, around half of pension fund investments were outside the euro-zone, while 25% were invested in Finland, and 25% in other euro-zone countries. Non-euro investments rose by 4.3 percentage points during 2014.
Individual funds recorded investment success stories in specific regions. Varma Mutual Pension Insurance, Finland’s largest earnings-related pension insurer and private investor with assets of €40bn, returned 7.1% on investments for 2014. Although lower than the previous year’s 9%, gains were boosted by a strong focus on the US. Reima Rytsölä, CIO, says: “Instead of a stagnant Europe, we were involved in a growing economy.” US equities were the top performers of its listed equities allocation, returning 16.3%.
Other pension funds also found rich pickings in the US, helped by the stronger dollar. Elo, the €19.6bn mutual pension insurance company resulting from the merger of Pension Fennia and LocalTapiola, completed its first year as a new entity at the end of 2014 and returned 6.3% on assets. Equities, however, made a bumper 9.8%, constituting more than 30% of the portfolio at the end of December 2014. CIO Hanna Hildenpalo says: “We had a well-diversified equity portfolio across different global regions. Especially good portfolio weights in US markets, as well as investments in Asia, provided good returns. In particular, the US economy put in an unexpectedly good performance, partly due to the fall in energy prices.”
At the end of 2014, 18.9% of Elo’s listed equities were in Finland, with a further 36.4% in the rest of Europe, and 21.6% in the US. Emerging markets equities made up 17.1% of the total. Hildenpalo added that equity markets were also driven by macro themes and currency impacts, which were in the fund’s favour.
Some pensions mutuals are looking east to boost returns. Ilmarinen, with assets of €34bn, substantially increased its holdings in Chinese equities last year – they now exceed 5% of its overall equity portfolio. It also increased exposure to European equities, just under 40% of equity holdings. But it continued to reduce its exposure to domestic equities, with Finnish shares only accounting for 30.2% of the equity portfolio.
Ilmarinen has set a target asset allocation to be reached by 2020, aimed at returning 4% in real terms over the long term, as well as achieving the required risk and solvency levels for the insurer. At the end of 2014, equities made up 39.7% of its portfolio, close to the target allocation of 40%. Fixed income is to be cut from its current level of 39.9% to 30% by 2020, while real estate will be increased from 10.8% to 15% by 2020, with a further 5% in infrastructure and agriculture.
In real estate, the shift in emphasis abroad has led to a preference for direct and co-investments, reflecting a desire for transparency from investing in specific deals rather than through blind pools, says Towers Watson’s Zwickel. “We have also observed selective increases to skill-driven investments, as opposed to simple market exposure – for example, via increased allocations to hedge funds,” he says.
One example of this was an increase in Varma’s hedge fund allocation, to 17% of the portfolio; the asset class returned 7.8% for the year. The pension insurer said the return has been very good over a long period, with very low volatility.
In the short term, Zwickel says he expects investors in Finland will continue to search actively outside mainstream assets for investment strategies with reasonable prospects, to produce attractive risk-adjusted returns net of fees. “The internationalisation of portfolios seems likely to continue, while an increased focus on strategies with low correlations to equities could gather more interest,” he adds.
Looking ahead, Elo’s strategy for dealing with current economic problems is to expand outside the euro-zone, with its low growth and political uncertainty. Finland’s gross domestic product contracted by 0.1% in 2014, while rising unemployment and other uncertainties continue to undermine business and consumer confidence.
“The Finnish pension system is only partly funded and, by design, heavily dependent on our economy’s growth and employment development in the long run,” says Hildenpalo. “Unfortunately, the Finnish economy’s prospects are not so bright for 2015 and even bleaker than for the rest of the euro area on average. Therefore, we have decided to continue diversifying part of our investments into other growing regions and markets outside Europe.”
She also acknowledges the exceptionally low level of interest rates in the euro-zone, orchestrated by the European Central Bank. “Rates could stay at these levels for much longer,” she warns. “So we have increased the diversification of our fixed income portfolio – government bonds – outside the euro-zone considerably.”
Bonds made up 34.7% of Elo’s portfolio at the end of 2014, government bonds 19% and corporates 15.7%. But Hildenpalo also stresses the long-term nature of the investment strategy. “As a long-term investor, we focus on well-balanced targets – on the one hand, sustainable strategic asset allocation, and on the other, efficient portfolios within each asset class. We also have to monitor our own economy particularly patiently. During the year, we can make some well-considered tactical changes in our asset allocation when appropriate. This is always based on our own in-house analysis of meaningful changes in expected returns and risks in the markets, and between different market segments.”
From 2017, equity holdings for pension insurers will be limited to a maximum of 60% of portfolio, because new solvency rules will allow more flexibility in their liabilities, which in turn is expected to lead to increased equity allocations. While not necessarily an issue presently, the 60% limit will be imposed so as to limit future risk taking.
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