Norway’s long-awaited pension reform allowing defined contribution (DC) schemes will come into effect next year. Among the main provisions is that all employers with two or more employees will have to provide some type of pension plan for their staff.
This will bring 600,000 new pension savers onto the market. The employer must contribute at least 2% of salary to the scheme. Estimates of the capital that this will generate annually vary between NOK2.5bn and NOK5bn (€300m and €600m). “At the start there will be rather a limited amount of money,” says Espen Kløw, partner at Oslo-based consultant firm Pensjon & Finans. “Many companies that have to set this up are small and in low margin industries – they may incorporate this into their wage negotiations.”
The size of the new inflows will not experience particularly rapid growth. “Because of the cost to employers, there will not be any increase in the contribution for some years ahead,” says Dag Simpson, a director at Nordea IM in Oslo. “Employees could use personal savings but it is not the tradition in Norway to save for a pension.”
Many are looking closely at this opportunity. “As a result of this major attraction the largest non-life companies are now cross-selling with a new DC product,” says Hans Aasnæs, managing director at Oslo-based Storebrand Investments. “Local banks will also benefit as their SME customers will look to them for the pension product.”
Until now the main insurance companies have dominated the DC sector. “One reason is that the customer also wants an insurance package that includes things like disability pensions,” says Kløw. “The life insurance companies are not prepared to sell these other products to other providers because they want to monopolise this business. The regulator must resolve this issue.”
The Norwegian Post Office recently moved all its 30,000 employees to a DC scheme. Aage Schaaning is CIO at KLP AM in Oslo: “We focus on defined benefit (DB) but have to consider DC as a product just in case existing clients make such a big move,” he says.
Employers offering DC are likely to do so in the form of a number of investment options. Aasnæs notes: “Reform of the system will mean the break up of portfolios into different risk profiles and guarantees. We will need to be very flexible and have very efficient operational systems to meet these needs.”
Individual investment choices will be driven by a desire for higher investment return. Kløw believes that “overall we will see higher market risk with a higher proportion of investments allocated to equities than now – closer to mutual funds where the preference is for a higher proportion of equities.”
While equity investments overall may experience an upturn there has been a significant decline in the home bias in equity investments. Ten years ago Norwegian companies accounted for 90% of the total instutitional equity holding, which averages around 25%. Today the figure is between a quarter and a third due to regulations which sought to limit exposure to a market so heavily skewed towards energy (44% of the market) and shipping.
But the upturn in Norwegian equities since 2003 has been very strong. “Norwegian equities have outperformed, so maybe pension funds have missed an opportunity by reducing their exposure,” says Simpson. “But at least pension fund performance is more stable now.”
As a result of very low interest rates, many pension funds have been forced to look to alternatives in the last two years. “With a current short-term interest rate at 2.25% and long-term pension obligations at 3.5-4%, we have seen a massive allocation into real estate,” says André Vatsgar, a director at Danske Capital Norway.
“Life insurance companies have increased their exposures from
12-18%, and smaller pension funds have jumped from almost zero to 8%. One of the reasons is much easier accessibility to this asset class. In the two last years, we have seen a huge growth in the Norwegian property funds market; a substantial amount of money has been allocated to this asset class. The result has been an enormous decline in running property yields.”
Vatsgar adds: “Back in 2003 and 2004, an investor could purchase properties located in an attractive
section of Oslo at a running yield of 10-12 %. Today, investors are lucky to achieve 6 to 7% for the same location. In my opinion, this concentrated allocation to Norwegian property could be a greater risk for pension funds than their allocation to Norwegian equity. Therefore, we have advised our clients to consider other property markets, like the European market.”
The need for absolute returns has generated a variety of solutions. “We see that Norwegian pension funds need absolute returns such as dynamic fixed income using fund of funds,” says Simpson. “There has been some competition in this area over the past six months.”
But he adds a note of concern: “The regulator takes a long time to approve new products.”
And that is not the only area where the attitude of the authorities is proving unhelpful. The pension reform will bring in the mark to market principle for the valuation of liabilities. This means that more long bonds will be needed than is currently in stock. “We lobby the Norwegian government to issue more long bonds,” Simpson points out. “But the government doesn’t need to issue bonds; it only issues them to have a bond market. So far the government hasn’t had the pensions market in mind.”
Maturity bonds, which have been a popular investment choice, are experiencing a declining interest. “They have given us a buffer to handle the low rates in the short term but in the long-term rates we will have a problem,” says Aasnæs.
The duration of bonds is very dominant issue among investors. “It has come down from three to two years to reduce the interest rate risk,” Kløw points out.”
Managers are keen to switch from segregated portfolios to funds. “This is a cost question for the manager,” Kløw explains. “It’s a cheaper way of running the business.”
An aspect of the regulation of mutual funds in Norway is that it must carry the same price, regardless of the size of the client. “In response, managers are setting up different funds with the same investment characteristics so as to allow different prices to be offered,” says Kløw. “But the result is that the funds don’t have the risk structure that is suitable for the client – on credit exposure, for example. The client loses flexibility on fee and portfolio strategy.”
With returns constantly under pressure the issue of cost efficiency is becoming much more important. “Investments are moving towards core satellite where indexed products pay for documented excess return products,” says Schaanning. “Now around 50% of portfolios have the core satellite structure, the rest are balanced.”
The growing diversification of portfolios is opening the door to foreign managers.
“There is intense competition in all non-Norwegian assets,” notes Aasnæs. “This is partly due to consultants who organise international tenders.”
Global equities are a particular area of focus for foreign managers. “It is very difficult for Norwegian managers to deliver good global equity performance,” says Kløw. “Some responded by moving to indexing, and some of these have been quite successful.”
But local managers must take note: “The increasing popularity of foreign managers is driven by dissatisfaction with local managers and increased sophistication of the client,” Kløw continues.
It is interesting that in such a wealthy country there should be such pressure on fees. Of course the key is supply and demand. One source points out that if the commercial ambitions of the main players are added together we have a figure that is two and a half times the size of the current market.
Kløw notes: “There are too many players chasing too little business. Asset managers will need to make themselves more efficient to compete in DC, which will put price pressure on an already price-pressured market.”
He suggests that “two or three of the main managers could manage all the money in Norway but we have all the Norwegian players and the foreigners as well”.
Simpson believes that consolidation will be an inevitable result of the competition and pressure on pricing. “And some foreigners will leave again,” he predicts. “The foreigners will need to form alliances with local players to succeed.”
SRI is gaining ground among Norwegian institutional investors. “I expect this to continue in the nearest future,” says Vatsgar. “Norwegian insurance companies are much more experienced in this area compared to the other Nordic countries.”
He adds: “The Norwegian State Petroleum fund has also increased its focus in this area, and it will be a good reference for other pension funds in Norway. This will increase the focus on SRI from fund managers, corporate management, shareholders, governments and clients investing in our funds.”
While the asset managers ponder the future opportunities, a question mark hangs over the mathematics of the first pillar system. “Opponents claim that the state fund will have to grow faster to meet participants’ future obligations,” says Vatsgar. “Ending 2004, the fund had a total asset value of €23bn, of which 65% had been loaned to the Norwegian Department of Finance.”
Problems of this nature with the first pillar may encourage further private sector investment in pensions and hence the possibility of further business opportunities for asset managers.
Overall the future for asset managers in Norway appears to be bright. “The new legislation brings more awareness among the population of the importance of saving something extra for one’s retirement,” says Simpson. “So there will be more assets to manage, especially because the economy is doing better, mainly because of oil revenues. Of course there will be great competition from foreigners for this extra money.”