Sweden’s stiftelsen, the foundations that underpin much of the country’s university research, are at a crossroads. They were charged initially with protecting and, if possible, growing their capital. They have done this successfully, more successfully perhaps than anyone expected. This is reflected in the lengths of their lifetimes, which have been extended from 10 to 15 or even 20 years.
However, the foundations, like other institutional investors, are under pressure. An unprecedented three-year fall in equity markets is forcing them to reduce the size of the grants they make annually. It is has also brought home the importance of returns on their investment.
Foundations are becoming increasingly dissatisfied with the management of their investment by Sweden’s banks, which they accuse of closet indexing. They are now turning to smaller specialist managers that can provide absolute rather than relative returns.
The aims of the research funding foundations have changed somewhat since they were created. They began life as the so-called ‘wage-earners’ funds’ created during the late 1980s by the then social democratic government. These were an attempt to ‘socialise’ Sweden’s companies by redirecting some of their profits.
In 1991 an incoming conservative government closed down the wage-earners’ funds and invested the money in a number of research funding foundations. Four years later a new social democratic government was returned to power. Its first thought was to try to recover the money.
However, the foundations were constructed in such a way as to make this impossible Instead they imposed control through the appointment of new administrative boards to ensure that the money was spent on the right things. Although initially suspicious of the foundations, the government has come to see them as a useful way to patch up government budget deficits.
The idea that the foundations’ assets are in some sense public money lies behind the investment policy of the Stiftelsen For Kunskaps-och Kompetensufveckling (KK), the Knowledge Foundation, which is to invest only in Swedish companies.
Hans Mertzig, the investment manager, restricts his portfolio to quoted domestic equities and bills: “We have had the same strategy all the time, to invest only in Swedish shares quoted on the Stockholm stock exchange. We have about 80% of the capital in Swedish shares and the rest in short money such as three-month bills.
“The foundation thinks it’s valuable to have investments only in Swedish companies because the money from the start, as they see it, has come from the Swedish employees,” he explains.
Mertzig, who has managed the fund since 1994, is one of Sweden’s ‘sjärnmäklare’ or star fund managers. He has 35 years’ experience of the Swedish financial markets, first as a broker with Carnegie in Stockholm, then as managing director of one of the wage-earners’ funds.
He manages the KK fund actively and invests cannily. He has remained consistently underweight in Ericsson and Nokia, the telecoms companies that have dominated the SIX, the Swedish stock exchange index. “When Ericsson reached 35% in the stock exchange, I had only 10%,” he says. The foundation allows him to invest up to 15% in one company, but he has never held more than 10%
“We think we have succeeded rather well. Since 1996 we have paid out Skr3.6bn (e387m) and we still have more than Skr5bn.” However, current volatility on the equity markets has hit Swedish shares and, indirectly, the size of grants, which have been reduced slightly from Skr500m to Skr400m.
He says there is no immediate need to look beyond Swedish companies for higher returns. “We will continue our investment strategy because so far it has been very successful. But if it is possible to get higher returns elsewhere in the coming year we could change.
“I think it’s very good for the investment strategy that I work in-house, because all the time I have information on how quickly the foundation needs money to pay out. This is a problem for other foundations because they have to inform both the Swedish and foreign investment companies about the need of money.”
Another foundation that manages its assets in-house is the Bank of Sweden Tercentenary Foundation – known as the Jubilee Fund – which funds humanities and social science research.
Torgny Prior, the Jubilee Fund’s director of finance, manages the foundation’s assets with an investment team of two (including himself) and a back office staff of two. The team manages 90% of the equity portfolio – two thirds domestic and one third international. SEB (formerly ABB), a Connecticut firm, manages the remaining overseas equities, a US small caps portfolio benchmarked to the Russell 200.
Prior’s team also manages 97% of the fixed income portfolio, which is entirely domestic. The remaining 3% are ‘special funds’ (hedge funds managed by two Swedish hedge fund managers).
Policy guidelines suggest that the foundation holds 50% in equities, although it can in theory hold anything between zero and 75%. Equities have fallen from a peak of 67% of the portfolio in 1999 to around 40% today.
The equity portfolio has outperformed the benchmark. Between 1997 and 2001, domestic equities returned 160% compared with a return of 71% by the SIX index. Overseas equities returned 159% against 75% in the MSCI over the same period.
Prior is pleased with the fund’s performance. “We are proud about that. But if we have too small an equity portfolio and the index is performing well, it’s not so good. I think probably we will try to focus on absolute returns.”
The real rate of return is the most important thing, he says. His objective is a real rate of return of about 5%. Between 1997 and 2001 the fund’s average rate of return of was 17.1% This includes a negative result of minus 6.9% in 2001. Over the same period inflation averaged only 0.9%, giving a real rate of return of 16.2%
Reserves at the end of 2001 stood at Skr4bn. The size of grants, after costs, has fluctuated, rising from Skr250m in 1997 when to a peak of Skr500m in 2000. Last year the pay-out fell back to Skr354m. There is buffer fund of three years’ grants totalling Skr1.2bn. “So we still have net reserves of Skr2.8bn. But it is going fast.”
Some Swedish foundations feel they do not have the expertise to manage their own investments, and have outsourced the management of both their domestic and international assets. However, they are becoming increasingly dissatisfied with the performance of their managers, which have tended to be the large Swedish banks.
Vådelstiftelsen, which has assets of Skr500m and gives around Skr40m–50m a year to healthcare research, has sacked both its external managers and is looking for a replacement. As a temporary measure it has hired the finance director of another foundation to manage its investments.
Åke Smids, president of the Vådelstiftelsen financial committee, explains: “We are doing it ourselves because we think the large asset managers in this country don’t take enough account of the customer’s situation. They have one model portfolio and the main task is to keep it as close to the benchmark as possible. In general, their portfolios for our discretionary mandates are no different from their own funds, and these have not performed very well.”
The new manager, when he is appointed, will manage a smaller number of holdings, says Smids: “The banks have 120 different shares in their portfolios and we think that’s too much for our foundation.” He will also be expected to select stock more carefully. “In the market now, you have two categories of stocks – some stable and some not so stable. We would want to pick the stable shares. It’s not so much stockpicking, more a case of avoiding certain kinds of shares.”
Smids says that other foundations are likely to take the same path. “I have not met anyone who is not disappointed by the big banks’ management. If you want to have a management that is adjusted to your objective, you have to arrange something yourself, or hire some specialist firms.”
The latter option has been chosen by the SKr9.6bn Swedish Foundation for Strategic Research (SSF). The foundation has 10 external managers, both domestic and international. Bjorn Brandt, director of administration at the SSF says “We have not built up competence to manage the capital, and we are not yet prepared to take the risk in having one person’s judgement manage the whole capital.”
The bulk of the fund (Skr5.5bn) is invested in domestic fixed income, with Skr1.8bn in Swedish equities, Skr1.3bn European equities, Skr500m in Japanese equities and Skr400m. in hedge funds. Last year, the foundation sold its entire US portfolio, which had been managed by Barclays Global Investors. “We were not at all dissatisfied with Barclays – they did a good job for us. The main reason was that we expected US equities to fall.”
The foundation tendered earlier this year for managers for its domestic holdings. The new managers take over on 1 September. Brandt says that the foundation has wanted to replace its domestic managers for some time. “Basically we are dissatisfied with the way the large Swedish banks manage our assets. We feel that we get something that is almost an indexed portfolio at a much higher cost. Although it is a discretionary mandate, they deviate relatively little from the index. So we are moving towards looking for absolute returns. We plan not to give the new managers an index to work against, but rather an annual target measured as a percentage.”
SSF has its eye on three new managers. Brandt prefers not to reveal their names at this stage. “I can say that it’s a move well away from the large Swedish banks towards smaller managers. Two of them are very small, one is not so small.”
However, there are no plans to bring investment management in-house, he says. “We are still using external managers and there are no definitive plans to make any changes. But it’s an open issue. One could foresee a situation where only a fraction of the capital is managed by external managers.”
The key is to achieve the necessary returns, Brandt emphasises. In the face of market conditions, SSF has had to reduce its annual allocation of grants from Skr900m to Skr500m next year. “The main thing is we don’t want to lose money. That’s why we’re no longer interested in the index. If the index goes down 50% and we go down 48% we regard that as an extremely bad result.”
Sweden’s foundations have given notice to their investment managers that, with lower equity returns and growing pressure on their funds, they will no longer be satisfied with the deceptive reassurance of relative returns.
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