Last year Sweden’s pensions arena was overshadowed by impending implementation at the beginning of 2006 of the EU pensions directive, which frees pension funds from investment restrictions and allow them to allocate assets according to the prudent person principle, and the introduction of a so-called traffic light system, to enable the regulator, the Finansinspektoren (FI), to identify pension funds that are in danger of not meeting their liabilities because of their funding level and/or asset allocation.
“These were the main drivers of our 2005 performance,” according to Peter Hansson, executive vice-president and CIO of SPK, the pension fund for savings bank employees. “They meant that during 2005 we were forced to have certain amounts of assets to cover liabilities. So the low equity allocation last year was due to low interest rates forcing us to have a lot of fixed interest to cover liabilities.”
In the event, SPK posted a return of 7.8%. “Last year and before, pension funds could only have 25% of the assets that were covering their liabilities in equities and the risk of the overfunded part was also in equities. But the money to cover their liability had to be in fixed interest. So our 2005 asset allocation was around 70% in fixed income, 5% in fund of hedge funds and the rest in equities.”
At almost the other end of the allocation spectrum was AP7, the default option for those who do not choose from among more than 700 funds to invest the 2.5% of their gross salary that is earmarked to a funded individual account. As a mutual fund it was not subject to the same investment restrictions. “We have almost 90% in equity, if we include private equity and hedge funds, and that gave us a tremendous return of 25% last year,” says AP7 executive president Peter Norman. “We just have 10% Swedish index-linked bonds. And they performed as expected - a couple of percentage points - so the bulk of the return came from the equity part.”
Equities were also a key factor for Telia Pensionsstiftelse, the corporate pension fund for Swedish telecoms company Telia Sonera AB. “The main drivers for last year’s result was equities and particularly in the emerging markets and the Far East,” says Telia Pensionsstiftelse’s president Peter Antonsson. “In total we have some 30% of our portfolio in equities and of those two thirds are in global equities, with the emerging markets and Asia being just less than 10%. We also have 10% in Swedish equities. Fixed income totals 60%, with domestic inflation linked bonds and domestic fixed income accounting for 40%.”
Telia Pensionsstiftelse’s return on investment last year was 16.9%. “We’ve had better years, in the 1990s, but it was one of the best years,” says Antonsson.
As a Pensionsstiftelse, Telia is not affected by the traffic lights because Telia Sonera AB carries its pension liabilities on its books. “We are a pledge rather than a pension fund and so don’t have anything to do directly with the liabilities,” says Antonsson. “But although theoretically we have more freedom of action than pension funds that are governed by the traffic lights, in practice we are very focused on what we believe the development of the liabilities will be and we try to have a stable performance. In fact it’s more a philosophy to link part of the assets to the development of the liabilities, and that’s for matching the accounting principles in the IRS 19. But we have quite a good match, and as long as we don’t seem to have too bad a match we can live with it.” SPK’s Hansson welcomes the introduction of the prudent person principle, but dislikes the timing of its implementation. “If they had implemented the prudent person rule way back when you had interest rates of 8-9% and you had guarantees of 2-3% it would not have been a problem,” he says. “But implementing it now with extremely low interest rates has added stress to the system.”
AP7’s approach spares Norman from having to worry about such questions. “We don’t make tactical asset allocations; we don’t think we have the ability and we question whether anyone else has it either,” he says. “So we stick to our portfolio. However, that meant that for the first six months this year our return was zero. We had an upswing in the first quarter and a downswing in the second. But that is our philosophy. We will stick to the portfolio.”
And AP7 has weathered other storms. “Our strategic asset allocation was first formulated in the summer of 2000 and in 2002 our return was -27%. But our board was so confident in our work that it stuck to the portfolio so that we could take advantage of the upturn. We included hedge funds and private equity in 2003 but since then the portfolio has been quite stable.”
But further changes are on the horizon. “We plan to expand the portfolio into new asset classes,” Norman says. “We are looking into REITs, into some commodities and we are also trying to structure the portfolio differently. We have introduced almost a new kind of asset which we call ‘pure alpha management’. That means that we are looking for managers to whom we can allocate risk and some slice of capital to cover margin calls but who will fund their long position by going short in the market, the way currency overlay managers work. We would like to see equity managers work as well. So we would like to find, for instance, a European equity manager that says ‘I can work as a pure hedge fund, I don’t need any money, I need someone to cover my margin calls but I will fund myself in the market’.”
Hansson is also looking for something new. “If one talks about a risk-budgeting process, a low volatility asset class is obviously attractive,” he says. “So I would go for more stable equities. That does not necessarily lead to hedge funds, it could be a long-only strategy, but we are trying to find stable equities or ‘stable stocks’ as we call them, an asset class that has the characteristics of equities but not the linkage to index. The general index does not pay pensions. I want to find managers with a process that is different from a relative process, that picks the best stocks in the market irrespective of the movement of indices.”