Investing in a cold climate

Three years of falling equity markets in Sweden have acted like a cold shower for the institutional asset management in Sweden and their pension fund clients: initially acting as a shock to the system, but ultimately invigorating. Fund managers have shivered but emerged fitter from the experience.
Many of the problems Swedish asset managers have faced over the past year are not specific to Sweden. The sale of equity portfolios, the attack on costs, the consolidation of the industry, have all affected the asset management industry throughout Europe. However, there have been some surprises – notably an increased interest in active management at a time when one would expect pension funds to be hurrying for the relative safety of a passively managed portfolio.
Tom Pedersen, managing director of T Rowe Price Global Investment Services (TRPGIS), the European arm of the US based global asset manager, says that the expected reduction of pension funds’ exposure to equities has been at the expense of the indexers.
“Indexing has actually been reduced while the active management has not seen the same downturn. The reason is that when markets that are going up year by year it’s very difficult for an active manager to beat the index. However, when the market turns and you are expecting to go sideways or down for a considerable period of time this is precisely when the active managers add value.”
The renewed interest in active management by institutional investors is understandable. Against a background of single figure returns, fund performance matters, Pedersen says. “In the bull market institutions were not conscious of losing a couple of hundred basis points here and there. In the general scheme of things the market was returning between 15% and 20% a year. This has all changed.
“Where you have markets that are going sideways and you have returns of 6% to 8%, 150 basis points suddenly becomes crucial. So there is much more of a magnifying glass on the investment process.”
This has enabled some of the more interesting medium sized players in the domestic market to show what they can do. Earlier this year, the Swedish Foundation for Strategic Research (SFF) surprised the industry by reducing the domestic equity mandates of the large banks that were managing its portfolios and handing a SEK50m (E5.5m) chunk to the Stockholm based asset manager Catella Kapitalforvaltning.
Catella, which is owned by the family that runs the IKEA retail, is a new kid on the block. Three years ago it recruited two analysts, Jonas Gustafsson and Gunnar Hakansson from Swedbank, where they had built an institutional asset management operation from scratch into a business with SEK30bn assets under managment.
Its investment process is unusual. Gustafsson and Hakansson pick a small portfolio – no more than 25 stocks – and include four to five ‘event driven’ companies – companies where a turnaround is expected as a result of a sale, merger or other rationalisation. They may even take a stake – up to 4% – in these companies. The results of this process have been impressive. Its domestic equity model portfolio, based on a real rather than hypothetical fund, increased the spread between its performance and that of the Swedish equities index by 32% in its first year, 78% in its second year and 132% in the third year. Earlier this year the spread widened further to 169%. It was this performance that persuaded SSF to award it a domestic equities mandate.
Mans Palmstierna, Catella’s communications director, says: “Our ambitions are not to be the big players like Alfred Berg, Carnegie, or Handelsbanken. As a specialist with a particular investment style and philosophy, we are not looking for 100% of pension funds’ portfolios to manage. A fund will typically have 50% in bonds 15% in global shares and 5 % in Swedish index. We are interested in what is left.”
The new emphasis on active management could put pressure on fees. It has already encouraged investors to ask for performance fees rather than fixed fees.
Active management also puts a premium on independent, in-house research. Events in the US have highlighted the conflicts of interest that can occur between an investment bank’s asset management and securities activities. European institutional investors are now beginning to question the value of brokers’ ‘sell side’ research.
P O Ost, director of institutional marketing at Carlson Investment Management in Stockholm, says that proprietary research has become a key selling point for asset managers. Carlson employs a team of 64 research analysts, 45 of them looking at equities. “We have always had a strong focus on fundamental research of Swedish companies.” He says, “Sometimes we have been the only manager who has met the managing director, been out to his firm, and kicked the tyres.
“In the past, people haven’t been very receptive to the idea of independent research, although we have been helped by investment consultants who have said that all other things being equal it ought to be better to have only in-house analysis. In Nordic countries the trend has been that asset managers are part of the larger organisation of the bank. We have always been the odd man out. But now our stance is becoming accepted and people can actually see the effects of mixing investment banking and asset management. Now we can really capitalise.”
One effect of separating asset management from investment banking could be to raise the barriers of entry to institutional asset management in Sweden, he suggests. “You will have less coverage of small caps, since it is the large companies that are the most profitable. Broker research will struggle to make a profit. Proprietary research from becoming a luxury will now become a necessity.”
Certainly, one of the effects of the equities downturn has been to encourage the universal providers to concentrate on core competencies. Many of the large Swedish banks are now outsourcing some of their activities. Handelsbanken is outsourcing its non Nordic assets. Nordea is concentrating the business on Copenhagen; SEB closed down three years ago the London office and outsourced activities.
Pontus Bergekrans, head of institutional clients at SEB Asset Management in Stockholm, explains: “We had a strategy before that we would be a top ranked institutional asset manager in Europe.
We therefore based our equity investment management for Europe in London. We have changed that and adjusted to a strategy for our domestic markets. So we have moved our centre to Stockholm.”
Bergekrans says that the three year down-turn in the markets has forced the asset management industry, and the wider financial services industry, to adapt to a different scenario: “A year ago we changed out strategy from a growth and volume-oriented startegy towards a more profit-oriented strategy. We have been aggressive about bring down costs.”
Investors now want to look under the bonnet and see how the engine works, he suggsets. “What has grown in importance for clients is business management capabilities. Clients are much more interested in knowing who is running the business and what capabilities does he or she have? That is something we have been putting a lot of emphasis on.”
To some extent this is bad news for the global asset managers who have entered the Swedish market, recently with the expansion of the AP buffer fubnds’ investment activities. Swedish investors may want their managers close at hand when times are hard, Bergekrans suggests.
“Sweden is normally quick to adopt influences from a abroad and that is also true of the asset management industry. We saw the beginning of a strong presence from the international providers, but recently there has been a lot of disappointment about the distance between the client and the person looking after his money. Being able to listen and take action – this is now very important,” he says.
“Certainly there is now a very strong international competition in the Swedish institutional market. But the need for a very close relationship with the asset managers gives room for us being based mainly on the domestic market, in a way that was more questioned three or four years ago.”

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