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Impact Investing

IPE special report May 2018

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Fruits of the forests

Some exotic, and decidedly non-traditional, investments are performing well for DIP. Fennell Betson reports Just across the street from the offices of Steen Villemoes is the old Copenhagen bourse building, dating back to 1640. For the investment director of DIP, the pension scheme for civil and academic engineers, such a monument of financial history can only be a reminder to take a longer term view. Not that such cautions are necessary in his case, as the long term is very much the focus and philosophy behind Villemoes' approach at DIP, which is one of the longest established of Denmark's professional schemes, going back to 1953. Like the newer labour market schemes, DIP is on the defined contribution basis adopted by the Danes, but it is much more mature and has a different cash flow scenario. We have a relatively high maturity, so we pay out more in pensions than we take in contributions, to the extent of Dkr100m (£13.5m) each year," he says. But the fund has a healthy intake of 500 to 600 new entrants each year, adding to the total membership of 13,000. More important, perhaps, is that the assets of around Dkr17.5bn are still growing thanks to its investment returns.
In the Danish context, the pressures are to ensure the returns are there - both long and short term. Since DIP comes under the insurance regulatory regime, a 4.5% annual return is guaranteed on the assets matching the technical reserves. "This has not been a problem so far for us, but the matter is under official discussion at present," Villemoes points out, referring to a ministerial committee examining the issue of guaranteed returns.
The highly complicated 'real interest tax' that hit institutional investment in fixed income securities was replaced last year with a 26% flat-rate tax on bond returns, while investment in equities is penalised for the first time with a 5% income tax. "Our overall tax burden has increased with these changes last year." The fund's returns net of tax were a sparkling 13.6% in 1996 and 14 3% in 1997, but eased last year to 5.5% The fund is concerned that with the trend to declining market returns and the taxation pressures that the returns obtained will be sufficient to meet the guarantees. "It is a problem in relation to our equity exposure as the bigger this becomes, the more reserves would be needed, so here is where the asset liability studies and modelling we have undertaken come into pla y." But the strategic shift of the funds' portfolio to equities has taken nearly 10 years, with around 40% now in equities. Over half of this exposure is in international stocks. He thinks that DIP probably is where it wants to be on the equity side, even though there are no longer any de facto official constraints on either equity or foreign exposures. The fund has room to manoeuvre and can increase its equities up to 45% tactically, if the trustee board agrees. On the international equities side, around 25% of the exposure is in a global index portfolio tracking the MSCI index, which is run for DIP and five other Danish funds by Danske Capital. "We split up the rest of the world into regions. We are overweight in Europe, where we have two portfolios, a large cap run by Carnegie here in Copenhagen and a small cap run by Singer & Friedlander in London." In the US there are two portfolios, one (mid caps) run by Wellington in Boston and the other (small caps) by Schroders, which also runs a Japan mandate, and along with BankInvest manages the fund's Pacific Rim portfolios ex Japan.
Bank Invest also looks after a small Latin America portfolio.
Villemoes points out that the current European equity portfolio is on a pan-European basis, though "so far we have nothing in eastern Europe". But if Denmark joins the Emu, which DIP hopes will happen, then he anticipates that the Danish equity portfolio, currently managed in-house, will become a euro-zone portfolio. "Euroland would then be regarded as our domestic market."
The fund has international fixed income portfolio of around 5% of assets, part of this is in a European non-euro convergence portfolio. "We hope this will give us the same satisfactory return from convergence as our previous European portfolio. The portfolio will invest in UK, Norwegian, Swedish, Swiss and Greek issues and can invest up to 25% in emerging Europe." This is managed by Jens Hoiberg, formerly of Carnegie, who also acts as the fund's international fixed income adviser.The fund is shortly to appoint an euro-credit portfolio manager. The non-credit euro area DIP will look after in-house, where it already handles the domestic fixed income assets, amounting to almost of the fund. Almost 10% of the fund is invested in real estate, directly in Danish properties, and indirectly in properties outside the country. But the quest for additional returns has pushed DIP into active involvement in areas where many funds would fear to tread so actively. As an alternative investment, forestry is not one that naturally springs to mind for pension funds, particularly making investments internationally, but this is where DIP has been active since the early 1990s, believing that it is particularly suited to funds' needs.
"We started that in Ireland around 1990. With another Danish company, LB Insurance, we have invested on a 50/50 basis in 2,200 hectares of Irish forestry. That investment is doing very nicely." The fund also invested with LB in The International Woodland Company, a consultancy advising institutions about forestry investment. DIP has since invested further in Ireland, alsong with two Danish pension insurers, PFA and Pensam.
But the fund proved it is prepared to go even further afield, participating in the UBS Weyerhauser fund launched two years ago. "We committed to investing in softwood plantations in the southern hemisphere," says Villemoes. "This has developed quite nicely in the first two years."
He adds: "We are attracted to forestry as an asset class - but it is long term, not only in returns, in decision-making too! It is somewhat difficult to convince people it is a good idea. It appears too exotic."
The other alternative area that DIP is concentrating on is private equity. "We anticipate more and more international venture partnerships." Recently the fund entered into an agreement with London-based Altius, which will act as the external manager of private equity funds choosing the managers under specific guidelines.
Earlier DIP committed itself to two US partnerships run by First Analysis Corporation in Chicago and the Scandinavia-based Prokuritas. "Last year we decided on a Dkr100m commitment to PE, with the intention of following this up this year with two further tranches of Dkr100m". If the indirect Danish PE investments through the listed Dansk Kapitalanleg or 2M Invest of Michael Mattiesson are included, Villemoes reckons the fund has 2 to 3% of assets in this area.
One thing he is convinced of is that alternative investment is not an area to be toyed with, but has to be taken seriously.
"They require so much attention and can be so troublesome that you will end up spending more time on them as an asset class, so unless you are convinced that you are going to have 2-5% in these asset, then do not get involved."
DIP will continue to use active managers, so long as they can show that they can deliver the required performance on an acceptable risk/return basis. But as Manlets become more efficient, it will be harder to out perform indices. So if and when Denmark is in Emu, the fund might well decide to run a Euroland indexed equity portfolio itself. He would not be surprised if in a number of years the alternative element was between 5 and 10% of the portfolio, with real estate at another 10%, and the rest of the equity would have "more and more of an index tilt". His firm view is that the extra returns for pension funds will not come from the traditional investment sources but more from asset allocation."

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