Leading fund strategies
Nina Röhrbein outlines leading European pension funds’ investment strategies
ABP, the industry-wide pension fund for civil servants and teachers, improved its funding position by 8% between the year-end and June 2009.
Its solvency ratio rose from 90% at the end of 2008 to 98% at the end of June on the back of interest rate developments and investment returns. By the end of July, the pension fund achieved a 100% funding ratio.
The financial crisis had taken its toll on the pension fund, reducing its 140% funding level at the end of 2007 by 50 percentage points. The fourth quarter of 2008 alone contributed to the fall by 28 points.
Nevertheless, the composition of its investment portfolio only underwent the slightest of changes because the pension fund believed it was best to stick to its long-term policies. At around year-end ABP reduced its equity allocation by three percentage points in the context of its strategic investment plan 2007-09 and in return increased exposure to infrastructure, convertibles and hedge funds by one percentage point each because of the similar return expectations but lower risk profile of those asset classes.
The changes to the portfolio were more significant between 2007 and 2008. Fixed income exposure rose from 40.4% in December 2007 to 44.8% in December 2008, while its bond duration rose from eight to 10 years.
Equities and alternative investments on the other hand fell by 6.3 percentage points to 48.9% over the same period. However, according to an ABP spokesperson, it was a deliberate decision to play part of the equity risk mainly through fixed income credit exposures. “We thought we should hold on to those positions and play the recovery with the risk component through the credit exposure we have, as Dutch law forbids an increase in the risk profile when a pension fund is in recovery position,” he says.
Among the challenges for ABP are now the search for new investments and for the right balance between liquid and illiquid investments as well as the trade-off between short-term and longer-term orientation, as it is preparing its new strategic investment plan 2010-12. “Of course we want to have a long-term orientation but the challenge is to what extent do you also want to take into account the shorter-term risks.”
Alecta’s position has been strengthening throughout the first six months of 2009 after increasing its equities allocation.
Its collective funding ratio - a buffer to protect against fluctuations in investment return and insurance risks - stood at 135% at the end of June, up from 122% at the end of March 2009. Last year the funding ratio had dropped from 126% in September 2008 to 112% as of 31 December. As Alecta’s collective funding policy defined a normal range of 125-155%, the pension fund stated earlier this year that it would charge the full premium on its pensions in 2009 to ensure sustainability and restore the ratio closer to the target level of 140%.
The fund had reduced premiums for defined benefit (DB) schemes within its ITP Plan by around 40% at the beginning of 2008 after exceeding the 140% buffer target because it wanted to avoid further surplus funding.
Alecta returned to the equity market in recent months after sharply cutting its exposure from 40% at the end of 2007 to 27% at the end of 2008 and again to 26% at the end of March in favour of its fixed income portfolio. At the end of June its equity allocation was at 33%. Its exposure to bonds was at 60%, down from 67% at the end of March.
Overall the pension fund has returned 2.2% for the year so far, with the second quarter of 2009 producing 5.1%.
Last year Alecta reported a loss of 7.8% on the back of the global financial crisis, with the total return of Alecta’s product for the premium fixed pension, the Alecta Optimal Pension, amounting to -16.6%.
The pension fund previously said the interest rate effect on the pension liability accounted for two thirds of the deterioration of its collective funding ratio last year.
Arbejdsmarkedets Tillaegspension (ATP)
The Danish labour market supplementary pension fund ATP focuses on risk allocation. That is why it separates its investments into five risk classes rather than the standard asset classes. Its rates category consists of nominal bonds without credit risk such as government bonds, while its equity category also includes private equity. The other three categories are credit, inflation-protected assets and commodities.
“We strive for real diversification,” says Henrik Gade Jepsen, CIO beta at ATP. “In other words we want to make sure that we will be able to do well in a broad array of economic and financial scenarios. It also means that we do not want to overly depend on one asset class, such as equities.”
That is why the financial crisis also failed to change ATP’s target allocation. In risk terms, its portfolio has remained broadly the same, with equities, for example, continuing to make up one third of the total risk.
In the past 12 months, ATP started to invest in timberland, alternative energy and inflation caps. It also made additional new investments in certain credit segments such as bank loans.
“We ventured into these new asset classes in order to obtain more diversification within the risk classes,” says Jepsen. “Timberland and alternative energy, for instance, are two ways of diversifying our holdings in the inflation protected risk class. Of course, we also expect that they will be able to generate a meaningful rate of return.”
The new allocations were primarily re-allocated from the bond portfolio. However, they were financed by some of the short bonds without altering the duration or the risk exposure of the fixed income portfolio.
“Hedging the interest rate on our liabilities is a necessity for us, which has helped us a lot in the past 12-18 months,” says Jepsen. “Disaster protection is also crucial. When market liquidity disappears as in 2008, all risky assets tend to fall in price in which case diversification does not help you. In such events you need insurance strategies in order to limit your losses, which we applied to both our equity and our commodity portfolio during 2007-08.”
British Telecommunications (BT)
The BT Pension Scheme (BTPS) became more cautious with its investments during 2008. Its allocation to fixed income and alternatives rose from 21.5% to 27.2% and from 7.6% to 12.4% respectively between the end of 2007 and 2008. It also increased its inflation-linked investments from 10% in 2007 to 14.2% at the end of 2008, while cutting its equity positions sharply. However, while it almost halved its domestic equities allocation to 9.7%, foreign equity exposure was only cut by 1.5%. Real estate was reduced by 4.3% to 11.1%.
Bayerische Versorgungskammer (BVK)
BVK more than halved its equity exposure in early 2008 from 11% to 5%. In return, it added new investments such as timber and infrastructure and increased its exposure to foreign real estate by almost 1%. It also added to its conservative bond portfolio.
As the scheme is still very immature - it collects contributions from 1.5m active members but pays out pension benefits to only 290,000 members - and set to grow in assets for the next decades, liquidity is not an issue. “This allows us to think long-term,” says Daniel Just, CIO and head of investments at BVK. “It also means that alternatives which suffered badly in the crisis have not been a problem for us. And that is why we have positioned ourselves anti-cyclically in timber, infrastructure and real estate. In particular, we added foreign real estate over the last few months and are currently working on an anti-cyclical position for our next private equity portfolio. We have also tried to move into the sustainability area with our allocation to timber. On top of that, the long-term bias has helped us to invest in inflation protected assets.”
However, the pension fund left its strategic hedge fund position unchanged as, despite its losses, the asset class outperformed its benchmark in 2008. BVK’s equity allocation has also remained stable in recent months, but compared to other German institutions is still at the higher end of the spectrum.
One of the lessons of the crisis for Just has been that surprises can lie in wait even with investment managers that were previously perceived as safe such as Hypo or Lehman Brothers. “Therefore with regard to the distribution of risk, diversification remains one of the most important lessons despite the relatively high correlation between asset classes, in 2008.”
Government Pension Fund - Global
The total market value of the Government Pension Fund rose by NOK227bn (€26.5bn) to NOK2,363bn in 2008. This increase was due to the injection of NOK384bn of petroleum revenues and the fact that the depreciation of the Norwegian krone increased the krone value of the fund’s overseas assets by NOK506bn. At the same time, the poor returns on the fund’s investments reduced the value of the fund by NOK663bn.
The global financial crisis has been felt in the management of the Government Pension Fund. The investments of the fund had a negative return in 2008 of -23.3% measured in foreign currency.
The equity portion of the Government Pension Fund - Global rose to 50% in 2008 following the decision in 2007 to gradually increase it from 40% to 60%, a target it has since met in 2009. Of all the shares the fund now owns, 40% were purchased in 2008. This has resulted in the fund’s average ownership stake in the world’s stock markets increasing from 0.5% to 0.75%.
“The right to a larger portion of the future profits from listed companies all over the world means that the pension fund has in fact strengthened its long-term ability to help fund the welfare state,” said Norwegian minister of finance Kristin Halvorsen in spring. “And the combination of high oil prices and falling equity markets means that it has never been more profitable in the history of the fund to transfer value from oil to shares than it was in 2008.”
Between year-end and March 2009, the total market value fell to NOK2,076bn before increasing again to NOK2,385bn by the end of June.
Pensioenfonds Zorg en Welzijn (PFZW, -previously PGGM)
PFZW’s objectives are to provide a good pension at an acceptable price, in other words a real pension based on indexation relative to the growth in wages over time, topped with an acceptable premium. These objectives are highlighted in its ALM process and determine its strategic asset allocation.
The pension fund says it already put a big emphasis on creating a robust mix with its asset allocation and decreased equities in its portfolio in the years prior to the financial crisis. The annual review confirmed that the current asset allocation and its underlying assumptions are still right for the pension fund. Therefore the financial crisis did not lead to any strategic changes. However, in the future it will increase its emphasis on stress tests to test the reaction of elements of the portfolio to stress - in other words there will be more focus on the downside in the portfolio construction process.
Over the past 12 months, the pension fund rolled out its existing programmes as planned, such as for example in microfinance, but it did not introduce any new asset classes to its existing mandate.
PFZW has confidence in its long-term policy but is aware that with a shorter horizon assets will occasionally come under pressure. That is why it took no particular action to raise its funding level - it says the combination of its premium policy and asset mix provide the expected returns and the inflows into the fund, which in time will contribute to restore the funding level again.
PFZW was one of the co-signatories to the UN PRI and integrates responsible investment in its portfolio. And with climate change and good governance high on the global agenda the pension fund expects more similar opportunities in future, creating a very strong impetus for it to further strengthen its position in the field.