Late bloomer gains impetus from new policy mix
Finland’s State Pension Fund was encouraged by the success of its portfolio construction and development to enter IPE’s Awards. The €7bn civil servants’ scheme, which has 180,000 active members, has scooped the country award for Finland.
Founded in 1990, the State Pension Fund is neither a defined benefit nor defined contribution scheme. Its strict investment policy originally only allowed it to invest in Finnish government securities until 2000 when the Finnish government passed a law, specifically aimed at the fund, which opened its investment strategy to equities. Without any kind of in-house asset management, the fund recruited an independent company to help it make implement its new strategy.
The development of its portfolio and allocation policy has enhanced its asset management sufficiently during the past five years to meet international standards.
This has included building its own internal pensions staff, outsourcing major areas of its administration, introducing a benchmark-driven approach, a neutral allocation policy and a high standard of performance and risk reporting.
Equity investments began in earnest in December 2000 but the timing was a little off, as they coincided with declines in Finland’s domestic equity markets. The decision was therefore taken to introduce a strategic asset allocation policy that would only allow the fund’s equity weighting to reach 40% by the end of 2004. Accordingly, the portfolio’s exposure to equities gradually increased. The remainder of the portfolio consisted of fixed income securities. The strategy paid off as equities brought in an extra €3bn as the fund’s assets grew from €3.8bn to €6.9bn during this period.
Indeed, the fund believes the timing to start delving into the stock markets was spot on after all. Following the bear markets it suffered in the first two years, equities have rallied significantly since early 2003 to allow the fund a 6% return rate for its overall portfolio.
The State Pension Fund now benefits from both internal and external asset management. Internal management focuses on areas where the fund has developed its own expertise while it relies on mutual funds for areas where it is less confident. It says entering the equity markets was swift and easy as it used poled vehicles and mutual funds and is heavily overweight in small caps.
Half the fund’s equity investments are still made through mutual funds. There are some 50 funds consisting typically of small caps, value, enhanced index, active and specific regional and industry sector investments.
The fund’s managers decided to diversify yet further between 2003 and 2005. This has led to a 1.5% allocation to alternatives and the fund says it plans to increase this weighting in the years to come. Moreover, it has been actively involved in the development of new investment products and has begun investing in real estate, private equity and absolute return vehicles. The fund enlisted a number of consultants during this period to help develop the necessary strategies for these new investments. The real estate portfolio consists solely of indirect investments in private and public property funds. Real estate is earmarked as the main area the fund intends to diversify into in the near future.
The fund has been the best performing pension scheme among Finland’s large funds in terms of profits since 2003. It has achieved high levels of return with less risk than is usual in its market and with a high degree of alpha, driven by successful strategic and tactical asset allocation. Its 8.2% return for the first half of 2005 is not only the highest among large pension funds in Finland, but pensions insurance companies as well.
In line with the development of its portfolio construction, the fund also enhanced its risk and performance reporting during 2003 and 2004. Initially, the quality of its annual reporting depended largely on formal requirements. But in 2003, following a change of chief executive, it took the proactive step of hiring an external consultant to help redesign its reporting processes.
The company the fund recruited to take care of its investments measured performance for the internally-managed assets using traditional risk return ratios. However, reporting for the externally managed assets was minimal. The only figures available were for total returns and asset allocation breakdowns, but nothing for risk. The fund realised this needed to change and since 2003, full reporting for external assets is now undertaken each month by an external asset management firm.
Highlights and achievements
A severely restricted allocation policy meant this fund was something of a late bloomer. But its development since first dipping its toes into the domestic equity markets has led to a balanced and forward-thinking investment policy that is ready to exploit new ideas, such as alternatives.
Reaching and remaining in the top echelons of Finland’s best-performing pensions has given it added confidence and impetus.
But the managers of this fund are no fools and while they watch their investments grow thanks to well-drafted strategies, they have recognised the need to keep abreast of the level of risk they assume and transparency in reporting.