Reeta Paakkinen assesses asset allocation trends among Finland's pension institutions

Sensing a recovery in global markets and wishing to divert from riskier state bonds, several Finnish pension funds are determined to boost their exposure to emerging market equities and debt this year. Although the ratio of equity investments outside the euro-zone among Finnish pension funds continued to make approximately 57% of the average equity portfolio, funds invested in the asset class grew from €27.6bn to €36bn in 2010. Whilst government bonds of the troubled southern European euro-zone remain a no-go zone for many major funds, the investors also feel lucky to have cut down on exposure to the Tokyo bourse before the natural - and nuclear - disasters caused a drop in Japanese equities.

Timo Ritakallio, deputy chief executive officer of €28.1bn Ilmarinen's investment department, says his fund recently increased mainly emerging market and Finnish equities and the trend is continuing this year. "In 2010 we increased equity exposure from 29% to 38% of all holdings. In emerging markets, this brought exposure up from 16.3% to 17%, materialising mainly in Russian, Latin American and Indian stocks, whilst in Finland our exposure went up from 40.9% to 43.5%," Ritakallio said. At Ilmarinen, the equity portfolio returned a healthy 20.6% last year.

Hanna Hiidenpalo, chief investment officer at the €9.36bn Tapiola Pension, says equity exposure went up from 28.5% to 34.6% at her fund - growth taking place especially in emerging markets and listed companies with a global presence. Tapiola Pension's equity portfolio pulled in a return of 23.1%, the funds overall return being 10.8%. "Forecast for emerging markets remains promising in the long term," she said. "This gives us the basis for stable exposure to the asset class - either directly or investing in firms which make a notable part of their turnover in emerging markets. There is extensive growth in emerging markets but some of the countries are ahead of others, which is seen in the growth of the private consumer sector," Hiidenpalo says. "Countries that seem interesting at the moment are, for example, Russia, Turkey and Indonesia," she adds.

The debt crisis in southern Europe and Ireland has prompted pension funds to revamp their bond portfolios and increasing investments in non-euro bonds, including emerging market debt, from 28.4% to 33.5% of the average portfolio.

Timo Löyttyniemi at the €13.9bn State Pension Fund (VER) says his fund made notable changes to its bond portfolio last year. "Last spring we sold out our government bond holdings in Greece, Ireland, Portugal and Spain. Italy remained, but exposure was radically reduced. These were replaced by new investments in emerging market debt, where we now have 10% of our bond portfolio, as well as Finnish, German and Dutch euro bonds."

Hiidenpalo of Tapiola Pension notes that her fund's bond portfolio also experienced radical changes in 2010. "The balance between government bonds and corporate loans changed significantly. There was a trend away from government bonds. At the end of the year nearly 60% of the bond portfolio was in corporate loans whereas the state bond holdings had been cut down on to a third of all bonds. The focus remained on Germany, Finland and France." Tapiola's strategy to avoid troubled euro-zone's economies in 2010 enabled its bonds to return of 6.3%, whilst the euro index pulled in 2.1%.

While diverting away from troubled euro states, some funds also revised their strategy in Japanese equities, a popular diversification tool in the Asian equity portfolios of Finnish pension funds. Sensing potential for macroeconomic problems, several funds cut down on their exposure to Japan over 2010 and early 2011. Although decisions to divest from Japan were made on the basis of macroeconomic analysis, several funds found their earlier decisions to have saved them from yet another setback after the earthquake last month and the ensuing drop in Japanese stocks.

Ilmarinen's Ritakallio notes that Japan has not been a particularly attractive investment for quite some time. At present, only 1% of Ilmarinen's total portfolio is invested in Japan. "This kind of an allocation does not play any significant role on the macro level so we are not going to divest from Japan right now. "

Hiidenpalo says Tapiola Pension divested from its Japanese stocks as recently as January 2011. Prior to that, however, its exposure stood at a mere 1.5%. "We sold our Japanese equities in January based on our analysis of the market. At that point, we, of course could not expect any kind of disaster of this magnitude to take place," Hiidenpalo says.

VER, on the other hand still has some 6% of its equities invested in Japan. "Despite the crisis, we are not planning to make any radical changes. However, if we talk about potential new asset classes in Asia property is one where we are making new investments in 2011," Löyttyniemi says.

Ritakallio said the main challenge in investment markets these days for a Nordic pension investor is the prevailing situation regarding low interest rates, low bond yields and eventually rising interest rates. "Increasing inflation and how to protect ourselves from it is also a question - as is how long the equity trend of the past two years will go on," he added.

Hiidenpalo agrees. "We are still living in post-crisis times. The indebtedness of euro states is bringing on further uncertainty. Hikes in food and raw material prices is not something anyone would hope for and this reflects in particular, in the weakening of the prospects for emerging markets."

Ritakallio notes several points of uncertainty in international politics which have the potential to affect a major institutional investor in Finland and globally. "In a way we could say the crises of these days have evolved from financial to increasingly political and strategic. Unrest in North Africa and the Middle East is increasing the price of oil. The situation especially in Libya is a worrying one as it has the potential to hamper the growth of work economy," he said.