Managing home bias
IPE asked three pension funds in three countries – in Finland, Ireland and Switzerland – the same question: ‘Do pension funds have a duty to invest in local industries?’ Here are their answers:
Bríd Horan, general manager of Ireland’s ESB Pension Fund, which has AUM of e2.8bn.
“Irish pension fund trustees must put their members’ best interests first, which I understand legally to mean financial interests. In my opinion, the key goal is optimum balance between return from an investment and the associated risks.
“Those who argue for investments to be made primarily in local industries can justify this only if they can be sure such investments meet the normal return and risk criteria. A vital aspect of risk management is diversification.
“If you have a concentration in your local equity market, you can face high stock-specific risk. This varies from market to market, but in a relatively small one like Ireland the top 10 stocks account for 80% of the market, and the top stock represents about 15%. With a high allocation to this market, a fund can be unduly affected by the fortunes of a small number of companies.
“Concentrating investments heavily in one market can also involve a strong sector bias. Again in Ireland, over 40% of the market is in financial stocks. These financials have a heavy reliance on the domestic residential property market. Should there be a significant property downturn, it could mean a double blow for pension fund members, hitting both their house values and their pension funds.
“I believe that funds should look behind investments and try to understand any unintended risks as markets may be skewed in other ways. Some analysts claim the Irish market’s out-performance relative to global markets in recent years reflects the strength of the Irish economy. But it may also reflect the Irish market’s bias towards smaller capitalised stocks, which out-performed internationally in the same period.
“When you invest outside your local market you have to be aware that, while you may be reducing certain risks, your liabilities are in your local currency and you may need to manage currency risk. With the introduction of the euro, we tend to look at investments in the Euro-zone and globally.
“So, I think pension funds should concentrate on both return and risks, seeking to protect benefit security, helping to ensure cost-effective benefit provision in the long-term and, particularly in defined contribution arrangements, seeking to maximise members’ individual funds and benefits.
“For me, it would be a long stretch to say pension funds have a role in protecting local industries given all of these issues and priorities. We live in a globalised world: increasingly people are working in international companies, and investment moneys are flowing in all directions. Just as an Irish pension fund invests internationally, a US or UK fund is also investing overseas. International ownership of Irish equities is now a common feature and liquid global investment should serve the interests of all investors.”
Hanna Hiidenpalo director of investments at Tapiola Pension, which has AUM of e6bn.
“The topic is very current in Finland, there is something about it in the newspapers almost every day. The debate has become heated during this year and there is increasing pressure to invest more in local companies and boost employment.
“I have chaired an industry working group that has been considering the issue of whether in their investment decisions Finnish pension funds should pursue best returns or whether they should have some role and seeking to alleviate unemployment by boosting investments to local companies. These two tasks are extremely difficult to combine.
“According to the OECD Final Guidelines on Pension Fund Asset Management, released in January, the establishment of minimum levels of investments, or floors, for a given category of investments should be prohibited. It says floors force pension funds to invest specified portions of their portfolios in particular asset categories, leaving their asset managers with little or no ability to walk away from what they might determine to be unwise investments or investments that are inappropriate for their portfolios. Floors might also artificially inflate prices in particular asset classifications.
“These are strong guidelines and as a representative of a quite small country and market, I totally agree with these arguments.
“The current market capitalisation of the Finnish equity market has been around e180bn and the total assets on the pension industry – including fixed income, real estate as well as equities – are about e90bn. The current allocation to the domestic equity market among Finnish pension insurance companies is reasonably high, at about one third of the total equity investments.
“But there are only a few big institutional investors on the market and in addition there are only few really big European-level companies listed on the Finnish stock exchange and the liquidity of the most of the companies is a real hindrance from an institutional investor’s perspective. Also our market is tilted towards a couple of big sectors and too heavy a weighting of Finnish equities might link pension funds too closely to the business cycle.
“So I believe we should follow the OECD guidelines. There has been a discussion of whether we should allocate a minimum amount to Finnish companies, but I think that if we did so the correlation between investment and economic performance would be too high.
“Of course we have considered the Euro-zone as a home market for a long time because we are euro-based investor and our currency is the euro. And the rest of the Finnish pensions industry does too. For example, they have diversified their fixed income portfolios on a European level, although the change has not been so big on the equities side, although most use the EuroStock 600 index as their benchmark.
“From the theoretical perspective, I don’t see that investments have any direct impact on employment development. The reality is that more than half of workplaces in the top 50 Finnish companies are located outside Finland, and only one-fifth of these companies’ turnover comes from Finland.
“The companies have already diversified, so why shouldn’t we as investors do the same at a reasonable price to achieve required investment returns. After all, from the pension fund perspective it is a question how well Finnish companies are able to compete and win market shares in the global open market that will determine the health of the whole Finnish economy as well as the pensions industry in the years ahead.
“This development will ensure a future where Finnish companies are competitive, growing and employing people also in Finland. Besides that, fiscal policy and business confidence are the key elements. In the long run, that is the only way to keep the future pension promises.”
Daniel Gloor, head of asset management at BVK, the Civil Service Insurance Fund Canton of Zürich, which has assets under management of CHF17.9bn (e11.6bn).
“There are so many empiric analyses that say that pension funds, and especially Swiss pension funds, should go abroad for diversification reasons. However, there are a lot of Swiss pension funds with a heavy home bias. But in Switzerland, apart from 15 or so stocks on the Swiss Market Index, the SMI, stocks are not as liquid as measured by international standards. So that’s a problem.
“You can invest part of your money in Swiss stocks but without investing abroad it would cost diversification effects.
“Some years ago the majority of pension funds, especially public pension funds, thought that it was their duty to support part of the economy by investing in local enterprises. There was a reservoir of non-listed companies looking for credit or equity capital.
“However, nowadays this is not seen as the wise thing to do, and pension funds are required to look for performance on their assets. And according to the experience of our pension fund and I’m sure others, the Swiss market has in general proved unable to offer the kinds of investments in that area which used to be successful.
“We have to ask why these companies want pension fund money and why their business plan and prospects have not persuaded banks to give them money. And if the banking industry hasn’t granted them any money, why should a pension fund?
“In my experience it doesn’t work. There are some pension funds that grant money but as far as I know with nine out of 10 of these investments if you are not losing money you are happy but almost certainly not making any.”