Iceland shakes off market volatility
Pension funds in Iceland have shrugged off the turbulence affecting domestic financial markets, with one industry commentator calling the situation a “blip on the screen”.
The central bank raised interest rates by 0.75 percentage points to 11.5% at the end of March amid a deteriorating macroeconomic and currency outlook. The current situation was sparked by, among other things, negative reports from Fitch Ratings and Merrill Lynch.
“This turbulence doesn’t affect our view much,” said Tryggvi Tryggvason, chief investment officer of the ISK214bn (e2.5bn) Gildi pension fund. “We have a long-term strategy at the pension fund that we are working on.”
However, he added the scheme is increasing its exposure to overseas assets. It now has 25% exposure abroad, but it could riseto as much as 30%.
“Many funds have even more,” said Tryggvason.
The Icelandic stock exchange has been Europe’s best performer for some years and the kronur had been strengthening for a considerable time, bolstered by hot money attracted to Iceland by high interest rates predicated on local housing market funds.
Pension funds have seen a market correction as being likely and expected the kronur to soften so have already diversified abroad.
Tryggvi Thor Herbertsson, an economics professor and director of the Institute for Economic Studies, told IPE that a “large chunk” of pension fund assets – between 30% and 40% – is already invested abroad.
According to Herbertsson, who is also a member of the board of KB Bank’s Frajalsi pension fund, many schemes own a large amount of guaranteed government and housing bonds.
“In general the turmoil we’ve been seeing in Iceland does not affect the pension schemes to a great extent,” said Herbertsson. “Stocks are a bit down, and foreign assets are up. So, it doesn’t really affect the total assets of the fund.”
According to the Central Bank, Icelandic pension funds still have a lot of scope for investing outside the country.
Its 2005 annual report said that at year-end securities issued abroad were almost one-quarter of the pension funds’ net assets, and this ratio has been steadily growing in recent years.
“However, pension funds still have considerable scope for foreign investment,” it added.
A report issued by the bank last month stated pension funds are “prominent players” in heavy foreign portfolio investment owing to “large amounts of disposable funds that have problems in establishing a suitable portfolio composition in the domestic market”. Pension fund assets rose by 21.6% in 2005 to almost ISK1.2trn (e13.6bn) compared to a 19.7% rise in 2004. Average net assets in 2005 were equivalent to 110.6% of GDP, in comparison with 102.3% in 2004, the annual report said.
“Pension funds’ securities portfolios are divided equally between fixed-income securities (bonds) and variable-income (equities and mutual fund units). The latter grew by 35.6% over the year, slightly faster than the 32.1% growth recorded in 2004.
“Most of the increase was due to a
positive revaluation of more than ISK120bn over the year, while net purchases amounted to only ISK30bn,” said the report. The funds’ domestic equity assets grew by ISK58bn.
A March report by Denmark’s Danske Bank dubbed Iceland’s economy “the most overheated in the OECD area” and on the verge of a financial crisis.
It added: “There are some areas where the Icelandic situation is better than the ones Turkey and Thailand faced. The extension of credit has to a large degree been used to fund foreign equity acquisitions. These assets are probably yielding a positive cash flow that might help fund corporations and banks.
However, it continued: “Against this background, we see a substantial risk of a financial crisis developing in 2006 – 7. The bank’s funding squeeze will probably force it to reduce lending to domestic players and could force a sell-off of external assets.”
According to Herbertsson, the market turmoil is temporary. “The foundations of the economy are strong and the central cank seems to be reacting aggressively with its monetary policy.”
Kristjana Sigurdardóttir, fund manager of the ISK70bn Almenni, pension fund agrees the market tremor will be short-lived.
“Pension funds are not suffering from what is happening in the market, absolutely not,” she said. However, she said pension funds that have invested heavily in local equities would be affected.
She also warned that inflation could impact the liabilities of schemes. Inflation over the last 12 months is pegged at 4.5% and this may rise to 6% or 7%.