Long-term investor, short-term horizon
Nina Röhrbein spoke with Truls Tollefsen, chief financial officer at Vital Forsikring, about the Norwegian insurer’s approach to managing its client’s long-term interests in the face of a strict annual guaranteed return objective
Short-termism has gained a bad reputation in the pension fund industry, not least because of the financial crisis: ideologically, institutional investors such as pension funds should strive to generate returns over the long term. However, often the regulatory environment makes this difficult and even imposes short-term targets on pension fund investors. This is the situation in which the Norwegian life and pensions industry - of which Vital Forsikring is the largest firm - finds itself.
The major share of its NOK240bn (€29.7bn) pension business is defined benefit (DB), with around NOK220bn in invested assets including the owners’ capital. This service dates back to the nineteenth century. This compares with the NOK11bn it holds in its defined contribution (DC) part, which was added just six years ago. The rest is individual products on a unit-linked platform. Anyone can buy a corporate pension plan from Vital, or purchase individual savings in the fund.
Norwegian law requires pension insurance companies to transfer the annual guaranteed return of their DB portfolio to their each member’s account every year.
“The paradox is that we manage long-term savings but have to focus on a 12-month investment horizon,” says Truls Tollefsen, chief financial officer at Vital Forsikring. “With our average guaranteed return standing at 3.5%, our whole investment strategy has to emphasise the generation of an annual return of 3.5% or above.”
In the event of any shortcomings, Vital has some buffer capital, which could help the pension fund achieve the guaranteed annual return. During years with good returns, the company can choose to put some of the value created aside to add to the reserves - but competitive markets limit this opportunity to some extent. At the moment, around 4% of Vital Forsikring’s invested assets act as a buffer. Nevertheless, a return of less than 3.5% could potentially prove very costly for Vital’s owners, as they will ultimately have to make up for any deficit with their own equity.
Vital’s DB portfolio is divided into five sub-portfolios with different risk profiles.
As of 30 September, 17.2% of the portfolio is invested in equities, 15.4% in current bonds, 15.4% in money markets, 33.7% in hold-to-maturity bonds, 16.8% in property and 1.5% in liquidity or other holdings.
The pension fund’s strategic aim is to have a global equity portfolio. However, Vital also has a domestic bias: 25% of its equity portfolio is invested in listed companies in Norway. The rest is made up of global equities, including emerging markets, based on the MSCI World index.
While the money market portfolio comprises Norwegian markets only, the current bond portfolio can be up to 75% invested in Norwegian bonds and up to 25% in global diversified, currency-hedged mandates. Overall it consists of regular government and investment-grade bond mandates with duration at approximately 4.5 years. Hold-to-maturity bonds are highly regulated and required to have a stable and predictable return in Norwegian kroner. In this portfolio, Vital currently only invests in bonds with high ratings both from Norwegian and foreign institutions, if they are packaged into Norwegian kroner. “Hold-to-maturity bonds are a good way to help us meet the annual guaranteed return,” says Tollefsen. “This is a portfolio with five years’ duration where we reinvest in 10-15-year paper. The portfolio has a booked return of currently around 5%.”
Vital’s real estate investments are undertaken by its own separate property management company, Vital Eiendom. “We own all the properties on our own balance sheet,” says Tollefsen. “Today, 70% of our properties are located in Norway - mainly in Bergen, Trondheim and Oslo - and 30% in Sweden. We wanted some diversification out of Norway but as we regard real estate as a local business, we needed to invest directly in a market that functions and is regulated similarly to Norway. Local presence in the Swedish market is organised together with the management company of life and pensions provider Länsförsäkringar Liv. On top of this, as part of our alternative assets, we have a small portfolio of indirect property funds. However, this is not a major part of our strategy.”
Vital’s DC portfolio, on the other hand, consists of three diversified risk profiles with a fixed allocation: Vital 30, Vital 50 and Vital 80, with the number reflecting the percentage invested in equities (the remainder is made up of Norwegian and global bonds and money market instruments).
The most popular DC strategy is Vital 50, which the pension company also recommends as the default line to employers.
Both portfolios, DB as well as DC, are almost exclusively managed externally. However, Vital monitors its mandates and managers, undertakes the manager selection and runs the overlay portfolios.
As it runs a unit-linked platform as well, fund manager selection is undertaken on several levels, including the DB portfolio level, through the use of external databases and consultants. In this area, Vital also co-operates with its sister company DnB NOR Asset Management, which has separate business areas in multi-manager investments.
For the DB portfolio, Vital’s strategic asset allocation is reviewed by its management and board of directors every year. But as risk metrics form an important part of the pension insurance company’s strategy, it is not a straightforward review of a fixed asset allocation strategy. Instead, it is more like a risk level discussion, which accommodates a dynamic approach to asset allocation.
“Dynamic risk management is a very important part of what we do,” says Tollefsen. “It is how we communicate the products to our clients. They pay a fee for the annual guarantee but the guarantee is priced in a way that gives us the right to de-risk if we are in a crisis environment.”
For example, the DB portfolio was invested 28% in equities in 2007, but following an analysis of the risk metrics in the portfolio Vital started de-risking by selling from its more liquid holdings: by summer 2008 it had sold almost all of its equity exposure.
“We first sold the entire equity derivatives portfolio,” says Tollefsen. “In other words, during and immediately after the financial crisis all our mandates worked with cash - we mainly took off the overlays. This also meant that when we increased the exposure again, to a large extent, it did not affect our managers. In 2009, we rebuilt the equity part of the portfolio up to today’s level. And judging by the current climate, we think this is approximately where we are going to be for the coming year as well.”
While Vital deals with the challenges of volatility in equities in combination with a low interest rate environment by trying to create a stable portfolio - with hold-to-maturity bonds and property making up half of its investments - it also has its eye on the introduction of Solvency II, the updated set of regulatory requirements for insurers in the EU, which comes into force in January 2013. Solvency II is an issue of particular importance in Norway, as Norwegian pension funds are classed as their own legal entities, meaning that the legislation will also apply to them.
Together with banking group DnB NOR, Vital Forsikring has been preparing for Solvency II for a number of years, a process which only intensified in 2010. It now aims to run an internal model until the start of Solvency II.
“As of today, Norwegian pension regulation is not very well adapted to the changes that Solvency II will bring,” says Tollefsen. “This is a major issue going into 2011 and as a result there may be changes in the regulation of the pensions industry. One of the issues is, of course, the annual guarantee. But there is also how much buffer capital pension insurance companies, like ourselves, can set aside, and how they can use it, as the volatility that accompanies certain interest rate environments creates an even bigger need to set aside a buffer.”