Martin Steward spoke with Dorrit Vanglo, LD Pension’s new CEO, and head of investment and finance Lars Walberg about tendering €6bn worth of investment mandates
When Dorrit Vanglo succeeded Carsten Koch as chief executive of LD Pension (Lønmodtagernes Dyrtidsfond), she found herself at the head of an institution that, like many other pension funds, is winding down.
But that is where the similarities end. LD Pension was winding down when Vanglo joined in 1989. In fact, it was winding down pretty much from day one: LD is no normal pension fund.
The clue is in the name, which translates as ‘Employees’ Shortfall Fund’. It was an endowment of just over €1bn made by the government in 1980, representing the inflation-linked salary that would otherwise have been paid by employers to the 2.5m Danes in the workforce between 1977 and 1979. Since then it has provided a non-guaranteed lump-sum for those members, which they are allowed, but not obliged, to take at the age of 60.
So far, about 1.6m accounts have been cashed in - and they have done very well out of it, too. The net average annual return for members who left their share in the default LD Vælger (‘LD Discretionary’) portfolio for the past 30 years is more than 10%.
The set-up is simple. Members get to choose from 10 different ‘pools’, or the default LD Vælger. Eight of the pools are ‘plain vanilla’: Danish equities; global equities; short-term Danish bonds; mixed global sovereign and corporate bonds; and four of Denmark’s biggest mutual funds (balanced funds from BankInvest, Danske Invest and Jyske Invest, and a portfolio of Danish bonds and European credit from Nordea Investment Management). Then there is an environment and climate change-themed equity ‘pool’ (replacing an environment and health-themed ‘pool’ discontinued at the end of 2010); and an innovative ‘pool’ called LD Kontra, made up of very short and very long-term bonds, gold resource equities, low-beta stocks and options, designed to protect wealth during financial turmoil - which it did, admirably, in 2008.
Around 9% of LD’s members shop around in these ‘pools’, leaving the vast majority in LD Vælger. Today, that portfolio has 49% in government and mortgage bonds. The 20% it has in non-Danish equities is split 38% US, 10% Japan, 13% UK, 22% other developed markets and 3% emerging markets. In terms of sectors, its global portfolio is fairly reflective of standard benchmarks.
Since 2004, when the adoption of new legislation led to a re-organisation of LD Pension, all of the assets outside the four mutual fund offerings have been managed under a five-year contract with LD Invest, an independent subsidiary spun out to pursue third-party clients. LD Pension owns 33% of LD Invest and at the end of 2010 its members’ assets accounted for more than 70% of the firm’s assets under management and 40% of its revenues.
However, when LD Invest was first established, LD Pension owned virtually 100% of the business - which was why it did not have to open the mandate to a competitive tender. Five years later, when its contract expired, LD Pension was required to go to market. It did so in spring 2010, with a total of €6bn worth of business - the entire fund with the exception of its private equity and property allocations, the BankInvest, Danske, Jyske and Nordea ‘pools’, and LD Kontra (members who chose this ‘pool’ are being moved into a near-identical retail mutual fund offered by LD Invest, with a special fee rebate).
LD Invest is a robust independent business. While LD Pension’s assets account for 40% of its revenues, the mandates out for tender represented only 16%. It has more than 50 other clients for its asset management business, including most of the major Danish pension funds. Pitching against the biggest names in the fund management industry, it held on to half of the LD Pension’s Danish investment-grade bonds and Danish equities allocations, and all of its Danish money-market assets. Perhaps more impressively, it is retained as a standby for global equities.
“We wanted managers that were not so huge that we would get lost among a crowd of other, bigger clients, but also not so boutique that they would struggle to deal with large mandates,” says Vanglo. “It is difficult for a boutique like LD Invest to compete with the international firms - but that is why it is impressive that they came through our process with some mandates, even in the face of that competition.”
EU procurement rules were not the only reason to change the arrangement with LD Invest. To understand the longer-term perspective, remember that it has no inflows and that its remaining members were all in the Danish workforce between 1977 and 1979. The youngest are in their late 40s and the average age is about 55. The proportion of over-60s who can withdraw their savings is growing, not just for the obvious reason that they get older each day, but also because more and more are postponing withdrawal to older age.
“About 25-30% withdraw at age 60,” says Vanglo. “About the same proportion again withdraws at age 62, because many Danes can draw on a late-unemployment scheme from that age, while Denmark’s public pension plan isn’t available until 65.”
That means that a full 30% of LD Pension’s assets could be withdrawn within two weeks, says chief finance officer Lars Wallberg. “However, the average member has about DKK60,000 (€8,000) in the scheme - so it’s usually only a small part of their total wealth and pension provision and withdrawal tends to be a gradual process,” he says. “We’ve had some success persuading members to leave their money in the short-term bonds pool if they don’t need the cash when they retire, but for the same reasons we are also quite sensitive to policy changes around pensions.”
Add all this up, and it is inevitable that assets are on the way down from their 2005 peak of DKK63bn (€8.4bn). About €600m is withdrawn or transferred each year and the expectation is that the fund will be half its current size in 10 years’ time and will cease to exist a few years after that.
At least two consequences follow from that fact. The first is related to portfolio management. “We have been reducing unlisted assets like private equity and property,” says Vanglo. “But we are looking at liquidity in the quoted equity and bond portfolios, too.”
The fund’s equity allocation has been reduced since 2004, from more than 50% to its current level of 35%, reflecting the fact that volatility is almost as bad as illiquidity in tougher times - while LD Pension has no guaranteed liabilities as such, no one wants to see members cashing in after a crash of 20% from peak value.
“We haven’t taken any specific measures to target low-volatility returns aside from reducing our overall equity exposure,” says Vanglo. “We are more comfortable advising our members not to withdraw money in bad times unless they really have to, which has been a successful approach in the past. We think that’s better than potentially giving up some returns in order to keep volatility low.”
The fact that broader pension provision has increased and members are more willing and able to postpone withdrawal helps them to ride out volatility, adds Wallberg. “The first time we experienced negative returns, in 2001-02, we had members shouting down the phone for their money,” he recalls. “After 2008 they were quite calm and fewer than expected withdrew.”
The second consequence of diminishing assets is related to costs. The contract with LD Invest was agreed at fixed cost in 2004 - which obviously means higher cost-per-krone as assets decrease. That is not to say that the deal was not a great one for LD’s members or, even, that it would not have continued to be good for a few more years yet.Speaking to IPE during the procurement process in 2010, Henrik Parkhøi, LD Invest’s managing director doubted that the fund could get a better price on the market with asset-based fees. Vanglo is the first to agree: “Asset-based costs will start to save us money against the old fixed costs, but it’s true that it will be more expensive at first,” she says. “Which just goes to show how good the LD Invest contract was!”
LD Pension is keen to stress that price was not the be-all-and-end-all of its procurement process, but Wallberg indicates that it had a 30% weighting in selection and emphasises the importance of operational value-for-money - a diverse range of brokers, for example, or superior execution capabilities. This is an imperative for the fund, because a decreasing asset base will inevitably mean economies of scale being lost, even as savings are made from the shift away from fixed costs. As such, LD Pension designed the procurement to maximise price competition.
“The relatively small size of our mandates might have been expected to present high costs, but we have tried to mitigate that by avoiding complex and expensive investment strategies,” says Wallberg. “We also tried to mitigate that by creating large mandates - other funds of our size can easily have twice the number of mandates - but at the same time we divided some of the biggest into two to create competition. In the end, we think we saw all the price competition we could have asked for.”
In addition, a structural change to ‘cross-pool investment management’ was implemented to maintain economies of scale.
“Before, each ‘pool’ had its own separate portfolio,” Vanglo explains. “Now, we are much more like a fund of funds manager, bringing together the money from separate ‘pools’ for each asset class before we go to each mandate manager, creating scale and getting a better price. For instance, we have investment ‘pools’ and a mandate in LD Vælger that all have exposure to Danish equities: now they will all own part of the mandates we have awarded for Danish equities.”
Given this emphasis on maintaining value, some may be surprised that LD Pension currently has no place for passive management - particularly as it used to get its asset allocation service included in the fixed price from LD Invest and is now taking responsibility for those decisions back in-house. As at least one of the two new hires it made last year has asset allocation as one of his remits, why not offset this cost by focusing on this top-down decision and implementing it with index funds?
Active management is to some extent written into the DNA of the fund - it believes in it (“at the right price”) and has pursued it since the days when all assets were run in-house. “That’s not to say that we won’t look at passive management as the asset base shrinks,” notes Vanglo. “We may reach a point at which it becomes more efficient in terms of cost per unit of return.”
And in a way that sums up the story of LD Pension: a changing, evolving effort to squeeze the best value from the asset management industry for a diminishing group of members with a shrinking pool of assets, negotiating the obstacles and compromises along the way. It has done a great job so far - but on that score there is little doubt that its last decade or so will also be its most challenging.