Ärzteversorgung Westfalen-Lippe (ÄVWL)
Germany
Lutz Horstick, Head of securities and loans

• Location: Münster
• Assets: €11.7bn
• Membership: 54,800
• Occupational pension fund for physicians in the region of Westphalia-Lippe

We are gradually breaking away from thinking about asset classes in the traditional sense. Instead, we consider the economic rationale of the underlying cash flows, and try to optimise our cash flow structure, and therefore asset allocation, across all asset classes as a whole, not separately within individual asset classes. 

Thus, the classification of assets in our portfolio is somewhat difficult. Our investments on unlisted infrastructure, which we are currently focusing on, may be seen as part of the fixed income allocation, because the cash flows are predictable, at least to an extent. The same goes for our commercial loans, alternatives and even real estate investments. 

That said, fixed income assets currently account for a share of about 46% of the ÄVWL’s total AUM. This includes a large variety of assets, ranging from mortgage loans to direct lending strategies. Fixed income is mainly managed in-house, but in specialist areas, such as emerging market debt, external specialists are mandated. External mandates account for about 25% of our fixed income assets.

Much of the traditional fixed income universe is not investable due to our general yield requirement of 4%. Thus, we do not have sovereign bonds from European or other developed countries in our current portfolio, since from our point of view we see them as a source of “return-free risk”. In an anti-cyclical move, we increased our corporate bond portfolio in the aftermath of the Lehman crisis, exploiting the bias against the banking sector, and building some significant exposure to blue chip companies. 

In recent years, we have adjusted and further developed our fixed income portfolio in the direction of asset-based investments and project financing, ranging from real estate project developments, to financing of aircraft and cargo vessels and oil and gas storage projects.

But we also maintain a high share of emerging market debt (about 8% of AUM), since the fundamentals of many of the emerging countries still look more promising than those of many of the developed countries. We intentionally accept higher volatility associated with this market.

We sought access to the US dollar and sterling credit markets, which is important because infrastructure and asset-based investments are to a large extent denominated in these currencies. To do that, we moved away from full currency hedging and accept some degree of currency exposure.

PP Pension
Sweden
Cecilia Thomasson Blomquist, CIO

• Location: Stockholm
• Assets: SEK13.5bn (€1.46bn)
• Funding ratio: 135%
• Second-pillar fund for the media sector

In the fixed income space we are invested in the Swedish market only. The portfolio is low risk and consists of core fixed income, split between sovereign bonds, mortgage bonds and some credit, with no allocation to high yield or distressed debt. We also use swaptions to adjust our duration. That has been the case for several years. Because of the size of our fund, it makes sense to only invest in the Swedish market. If we were a larger pension fund we would probably want more diversification, because the Swedish market is not very large.

The low-yield environment presents great challenges. But we are going to let our fixed income portfolio be, and prefer to take risks in different asset classes, such as equities and alternatives. 

We have increased our allocation to hedge funds, which is over 10% of the total and consists mainly of liquid strategies. That is a good place to seek return, and we prefer that to restructuring our fixed income portfolio. We have to find different sources of return, and rather than having more credit risk in our portfolio, we would like to take more market risk, but managed market risk, as it is in hedge funds, by skilled managers that can do that.

At the current yield levels, in all fixed income, you are not compensated for the credit risk you take in the portfolio. In corporate credit in particular, it seems potentially dangerous to just invest passively, because at current yields the upside is limited, whereas the potential downside is quite large. Therefore, from a risk-reward perspective, to us it seems more rational to invest in hedge funds, provided that you understand what they are doing and that you select the right ones that offer potentially attractive returns. Plus, when people are getting paid to borrow, which is unprecedented, it is easy for misallocations to take place.

The problem is that while investors are used to working in free markets, we have central banks all over the world buying bonds and holding rates where they want them to be. This is a new playground, with new rules, which you have adapt to. We work in a regulated market that functions in a different way than before. Additionally, if growth does not pick up, we might have unaffordable levels of debt in the economy. But with low yields, low energy costs, the technical revolution we are experiencing, and efficiency gains in many sectors of the economy, there is also a strong case for continued growth in the markets.

Sparinstitutens Pensionskassa
Sweden
Peter Hansson, CEO

• Location: Stockholm
• Assets: SEK24bn (€2.55bn)
• Funding ratio: 134%
• Second-pillar fund for the banking sector

Last year we implemented an overhaul of the strategy and our resulting asset allocation has been transformed. In changing the strategy, we began from the fact that interest rates had been falling for 25 years. We had a fixed income portfolio made up of 70% long bonds, and for many years we reaped a free return riding down the curve. We realised that could not continue, and at the same time, regulations had changed, with the regulator adopting a Solvency II-type liability curve, fixed at the long end. We simulated the possible outcomes for our portfolio with a liability curve of that kind, using a Monte Carlo simulation, and realised that the volatility of the liabilities would have been significant in the new regime. As a result, we lowered our allocation to long bonds, which made our portfolio particularly vulnerable to swings in interest rates and therefore liabilities. The total of the combined portfolio – return-generating assets plus liability-matching assets – was then reduced, which in turn allowed us to transfer risk budget from the liability side to the asset side. 

We implemented what we call a ‘flexible fixed income’ portfolio, meaning the managers can build net negative duration in the portfolio, if needed. So far, even though rates have been volatile this year, this has led to a positive return this year. The funding ratio is still 134%, well over our minimum regulatory funding requirement of 104%.

For the portfolio, we target a 5.5% average return over 10 years, and up to the end of June this year we were on track at 3.5%. In future, with lower interest rates for longer, getting returns will be harder, which means we will need to manoeuvre our portfolio more frequently. Because we use funds, we can hire managers and let them go more easily. This is necessary because for us in these markets alpha becomes more important than it used to be, and we need to have more frequent contact with managers. 

We have a risk management system that tells where we are, so we keep our long-term view. That said, we did reduce our equity allocation this year and shifted to alternatives. But we do not think we are smart enough to have a view on individual asset classes. At the moment, 45% of the portfolio is invested in fixed income. Equities are 24% of the portfolio, alternatives are at 20%, real estate is 5%, and the remainder is in cash, but we plan to shift that into real estate and infrastructure.

Interviews conducted by Carlo Svaluto Moreolo