The atmosphere surrounding Swedish pension funds has been positive over the past 12 months with good returns, especially from equities, boosting confidence.
However, some see the impending implementation of the EU pensions directive as a cloud on the horizon.
One fund that sees adjusting to the pensions directive as a challenge is Kapan Pensioner, the DC scheme for government employees previously known as FSO. “Next year interest rates will affect the mark to market valuation of our liabilities,” says CEO Gunnar Balsvik. “The underlying effect of interest rates could have a negative impact and will definitely affect the performance.”
But this year so far has been positive, with the SEK23bn (e2.46bn) fund posting an over-all performance of about 9% on its investments. The portfolio is split between 58% bonds, 35% equities, with the balance in real estate and hedge funds. “We are overweight in global emerging markets and Sweden, and both markets did well,” says Balsvik.
The fund is responding to the interest rate risk and the novelty of valuing its liabilities. “Like everybody else, we are hoping for higher interest rates,” says Balsvik. “But we are also moving to reduce the interest rate risk. So we will probably extend our exposure to swaps. We will have to work more with derivatives in the future.”
The fund currently invests about SEK1bn in equity derivatives and SEK2bn in swaps. “We will have to double or maybe even treble that next year,” Balsvik says.
Another challenge is introduction by the Financial Supervisory Authority (FI) of a so-called traffic light system intended to assist with the early identification of pension funds and insurance companies with excessively high financial risk. “I think it is a little bit too strict, especially with the equity risk,” says Balsvik.
In theory the traffic light system should measure how pension fund and insurers’ capital buffer is affected by changes in Swedish and foreign interest rates, share prices, real-estate prices, credit risk and exchange rates. A green light would be the equivalent of an all-clear, an amber-light would mean that the FI cannot assess with certainty whether a fund is prudent, the red light would imply an exchange of details between the fund and the FI.
According to Tomas Floden, the FI economist in charge of developing the traffic light model, the system was not intended to change pension funds’ asset allocation decisions. “The traffic light system will put more focus on ALM,” he says. “Asset allocation changes are more likely to be a consequence of the EU pensions directive, which will lift a lot of quantitative restrictions on the investments and opening up for a higher use of derivatives.”
Benny Karlsson, president of Vattenfall Pensionstiftelse, the SEK5.5bn DB pension fund of power utility Vattenfall, is more worried about getting the right tactical allocation and communicating with beneficiaries that the traffic light system.
The fund is a legally independent entity, with contributions paid by the employer and with no liabilities because the sponsor carries all the risks, explains Karlsson. The structure, he said, is typically Swedish. “We don’t know what is going to happen with reporting requirements,” he adds. “Rumour has it that the fund will have to report to all employees but officially we do not have liabilities and we don’t have any members. The employer has beneficiaries, so how would we go about the job of reporting to the employer’s beneficiaries? I hope it becomes clear in the next few months.”
However, the fund has had few problems on the performance front over the past year. Its Swedish equity portfolio returned 32%, international equities returned 18% and fixed income, which accounts for 48% of the portfolio, yielded 12%. The fund also allocates some 13% to alternatives, consisting of Swedish hedge funds, which posted an 8% performance.
“The good performance of equity, bonds and currency markets, and the strength of the US dollar was good news for us,” Karlsson said. “But there is still the issue of implementing the pensions directive”
Gunnar Andersson, CEO of KP, the Co-operative Society Pension fund, also ascribes the fund’s “good” absolute returns to the “substantial contribution” to KP’s foreign equity portfolio of a strong Swedish equity market and the appreciation of the US dollar. But he sees the implementation of the EU directive as a drive to increase the need for “new competence” to focus on ALM simulations, which require more resources in the risk management field.
”The greatest challenge for the pension funds in Sweden in the short term is to understand, adopt and adapt to the new pension regulations,” says Andersson. “In the medium term the low level of interest rates in combination with low expected returns in the equity markets could be a greater challenge.” and demographic changes represent the key long-term challenge. “But I consider it as being possible to deal with,” Andersson says.
Richard Gröttheim, executive vice-president at the SEK50bn national buffer fund AP7, has not been so happy with the USD’s movements. The fund had a 50% currency hedge on its international holdings. “With the dollar moving up and the Swedish currency weakening a bit, the result has not been helpful,” he says. But AP7 does not plan to change its hedge for the time being as it regards it as a long-term investment, says Gröttheim. The fund’s return in the first six months of 2005 was about 12%.
Gröttheim adds that over the last few months he has been focusing on with the stock market pickup and on active management to garner extra alpha, especially from Japanese and Asia/Pacific portfolios. And in a further bid for alpha, AP7 is considering a new currency overlay project.