Danish pension funds need to be clearer about the risks they are taking with their alternative investments, the country’s regulator has said.

Financial watchdog Finanstilsynet said it would step up its focus on alternative investments through inspections, as well as in other ways.

Carsten Mygind Feldt, deputy department chief at Finanstilsynet, said: “Some firms should analyse to a greater extent whether there is a sufficient liquidity premium and make sure they are paying enough attention to the valuation of the investments – for example, through sensitivity analysis.”

But he said the general impression was that companies did tend to evaluate the relationship between return and risk in their alternative investments.

The regulator said its analysis had shown that most pension companies should improve this to match best practice in the industry.

On average, pension firms had 7% of total assets in alternatives, and many companies expect that figure to rise, it said.

Overall, pension fund investment in alternatives is concentrated in a small number of funds, according to the end-2012 data.

Almost 60% of the total in alternative investments was held by the five largest investors, Finanstilsynet said.

In some cases, funds should take a more critical stance about ongoing valuations of their alternative investments, it said.

Although several companies mentioned liquidity risk, some said they were not exposed to this because they followed a buy-and-hold strategy, and so did not need to assess this risk type separately, the regulator said.

However, companies nevertheless need to assess liquidity risk continuously because a change in the credit rating of the assets could lead the firms to reduce their credit risk by selling before maturity, it said.

Other risks associated with alternatives mentioned by the pension funds include political risk, administrator risk, legal risk, model risk, financing risk (gearing), natural disaster risk, technical risk and correllation risk, Finanstilsynet said.

The analysis follows a fact-finding exercise conducted in 2012 when pension funds reported details of their alternative investment holdings.

In all, Danish pension funds had DKK152bn (€20.4bn) invested in alternatives, including private equity, alternative credit, infrastructure, agriculture and hedge funds, the regulator said

It added that the prospect of many years of low yields in Denmark and Europe has prompted many pension providers to shift part of their investment towards alternatives to gain higher returns.