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Impact Investing

IPE special report May 2018

Sections

First with funding

Volvo tells Fennell Betson how it started a trend
Small causes can have big effects. When Swedish motor manufacturing giant Volvo hit a problem with the book reserve system used by most industrial groups to cover their ITP second pillar pension commitments, it little thought it would start a serious trend to funding among industrial employers.
As Eddie Dahlberg, who runs the group’s pensions plans at the Gothenburg headquarters, explains: “When an employer puts a pension debt on their balance sheet, they have to cover it against default through the FPG mutual insurance arrangement. But by the mid-1990s, we had gone through the level of cover available to Volvo from these insurers, so they could not offer us any more insurance.” This resulted in paying premiums to SPP the insurance group with the monopoly for insuring ITP contributions. The ITP pension accounts for about 10% of the pension entitlement – the balance coming from the state system.
“This meant we running two systems,” he says, “so we decided to look at all the options open to us.” The conclusion was to go for a foundation, which is similar to a trust under UK law. “It is legally separate from the company and according to the law which regulates these foundations there has to be a clear division between it and the employer. So, for example, we are not allowed to buy Volvo shares without permission, or can only make loans to the group if they have very good security.” Foundations are supervised at a local level, which means submitting accounts to the local authority, though they have the right to inspect the books and ask questions at any time.
From Volvo’s perspective, the move improved the balance sheet. “A foundation enables reserves to be created, as you do not have to take funds out to pay pensions, so you can save until you need the funds. When it is being drawn on, it need not be for ITP pensions, but any pension cost related to people covered by the scheme.” All this gives a degree of flexibility, as well as ensuring that investments are diversified. “Under book reserve system all the money is invested in Volvo,” Dahlberg points out.
The decision to go ahead was taken in 1996 and the first investment was made in 1997. At that point, assets of Skr4.2bn (e490m) equal to all the ITP liabilities to white collar workers were transferred into the two foundations established. The first and by far the bigger, absorbing over Skr4bn, was in respect of everything earned up to the end of 1995, with the second foundation taking over from then on. Altogether, some 25,000 workers are covered.
A pension foundation must have 50% employee representation and its board has overall responsibility for the investments, though in Volvo’s case there is a sub-committee that advises on the area and has freedom to invest within certain limits. “This is for a fairly small amount, so the big decisions are taken by the board,” says Dahlberg.
In drawing up its strategy, the board decided that an asset liability study would not be needed as a first step. “We know that there is a long-term investment horizon, so if a study was to show that the period is 19 or 20 years, it really does not matter.” Anyway, if the foundation turned out to be under-funded, it is still down to the employer to meet the pension liabilities.
The initial strategy was conservative, particularly in relation to equity investing. “The board wanted to move rather slowly in this direction from start-up and our plan was to move gradually into equities. Currently, we have 55% in equities and 45% in fixed income.” The process was one of adopting an approach that suited the board in terms of the amount of risk it was prepared to take. “We now have a benchmark of 50% equities, with the ability to move between 40% and 80%.”
About half of the portfolio is managed internally, as Dahlberg and his small team look after the short-term interest bearing portfolio, and around 20% of the equity portfolio. “We have five external equity managers, three for the Swedish and other Nordic markets, and two for global equities. All are active managers. We did think of going passive, but if you go this route you have no chance at all of beating the index. Also, we wanted to increase our competence in the equity field.” For the global equities, the currency risk was hedged back into kroner.
“Now we have completed the first phase of getting the investment side to where we wanted it to be, we are going to evaluate this month how we have been doing and decide what we need to change.” In the three years the value of the assets has increased to Skr6.2bn but this includes new contributions of around Skr1bn less payments of Skr200m. “Our returns have been much in line with what we expected, with our conservative and largish Swedish equity portfolio, where returns have been in the 25 to 20% range.”
But now after three years’ experience, the fund will review its whole approach. “The board knew it had to be conservative at the start, because if things turned bad in the first year, the whole project could be in danger. But they knew they were giving away some returns by this approach. Now, the returns have been good enough to motivate re-examining what we do. So we will look at real estate, emerging markets, commodities and other alternative investments.” The question of passive management for part of the portfolio could also be discussed.
Also, the external managers are under the spotlight. “We are likely to make a new start now by taking the ones we have and analysing them and some others to see which come out best. One thought is to do this anonymously, so the board won’t know who they are, and will evaluate them without any bias as to names and reputations. Volvo used consultants when choosing global equities managers.
Dahlberg does not see the fund going more specialist – into, say, US or European mandates. “If we did, the size of mandates might become too small to be of interest to managers. Were we to go so specialist, we would probably invest in funds rather than segregated portfolios.”
On the fixed interest side, corporate bonds will certainly be on the agenda. “There is a strange anomaly here, many investment policies allow you to buy the equity of a company with junk bond status when it comes to issuing debt, but you can’t buy their bonds!”
He adds: “While we are looking at many areas in December, they are just being discussed and put on the map for future consideration. It could be some years before they come on stream, if at all.”
Dahlberg and his team’s responsibilities extend beyond the foundations to other pensions plans, such as those for executives and to other foundations, which give out grants, as well as the sizeable bonus result scheme foundation for all employees. “Altogether they are the same size as the pension fund, but they can be run to different strategies, as the bonus fund has a horizon of only four years, and its rules require that half of the money be in Volvo shares.”
But during the course of this year, the team was confronted with the possibility of losing around a half of the pension foundations’ assets, following the acquisition of the car corporation by Ford, which could have set up a foundation of its own, or paid the assets over to SPP. Currently, the intention is to continue as before, but run as a common foundation for both groups and with the car corporation having increased representation on the board. As Dahlberg points out: “This is possible because all the companies in the scheme have their own assets clearly designated for them. So there is not much sense in starting a new foundation, with the additional expenses and so on. The finalisation of this solution depends on permissions and the legal agreements.”
Since Volvo took this step of forming a foundation there has been a number of moves by the larger Swedish industrial groups to look at the mechanism and funding liabilities and Dahlberg acknowledges the increasing interest in this approach, on which the group has been consulted.
His interest is confined purely to the Swedish scene, but it could widen if moves to have a common pension plan for Europe became a reality. “Then we might like to group everything together in one place.” But until that day comes, his focus will be on his existing battery of foundations. “Things have to be running smoothly, with the new strategy well in place, before we can consider looking for new opportunities.”

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