What is your strategy in developed market sovereign bonds?

APK Pensionskasse
Christian Böhm
• Invested assets: €3bn (including Vorsorgekasse)
• Participants: 300,000 (including Vorsorgekasse)
• Both DB and DC
• Solvency ratio: 100%
• Date established: 1989

Although we do not fall under the scope of the insurance regulation Solvency II, it would be difficult not to invest in euro government bonds due to our euro liabilities.

Our exposure to developed market government bonds currently stands at 27% of our overall portfolio although we have been reducing this exposure since 2009. We were always underweight or did not invest in European periphery bonds at all, mainly because we had a bond strategy that was not purely benchmark-oriented.

Our exposure to non-euro government bonds, however, has been increasing. This is mainly allocated to emerging countries, although the distinction between developed and developing markets is not always an easy one to make. The typical criteria for developed markets is OECD membership but nowadays the OECD also includes countries such as Mexico and South Korea, which are still widely regarded as emerging markets.
With regard to developed markets, we have a tendency not to invest in government bonds that have a negative real interest rate.

We have been witnessing a narrowing of the spread between different European countries, which means that some European countries have simply become too expensive to warrant exposure to their government bonds. In the meantime, others have become too cheap. French sovereign bonds, for example, seem relatively expensive to us at present, while Italian bonds look favourable again.

We do not feel obliged to buy German Bunds. Instead we keep an eye on the spreads in relation to the fundamental economic outlook. We see that Austria has an equally high risk from an economic perspective as Germany, and by looking at the historical spread between those two countries, we have concluded that Austria now represents the better investment opportunity.

The alternative is to increase the exposure to non-government bonds, particularly within Europe, such as corporate bonds.

Another important topic is inflation - we are sceptical whether inflation can continue the way it has in some of the countries with low interest rates.

As we run a dynamic strategy, we will continue to watch the market, particularly as recently the bond markets have been as volatile as the equity markets. It is easy for the markets to get carried away these days. They have shown how dependent they are on politics and central banks. In the case of Austria’s country rating, for example, it was heavily influenced by the events in Eastern Europe.

Blue Sky Group
Bruus-Jan Willemsen
Senior portfolio manager FI
• Invested assets: €15.6bn
• Fiduciary manager of several Dutch DB pension funds including that of KLM
• Members: 90,000 participants and pensioners
• Funding ratios: 105.3% to 119.9% (Aug 2012)

At present, our exposure to developed market government bonds consists of nominal and inflation-linked government bonds from highly-rated countries.

These investments are mainly concentrated in the matching portfolio and currently make up 27.5-35% of the total investment portfolio, depending on the pension fund.

The current low interest rate environment has meant that we have decreased our exposure to nominal government bonds. Today we mainly invest in inflation-linked government bonds. Their exposure makes up on average 25%, whereas the allocation to nominal government bonds averages 10% of the total investment portfolio.

In 2008, we decided to sell our investments in the European periphery, in other words we sold the Greek, Portuguese and other troublesome bonds we held. Since then, we have only invested in core euro government bonds from Germany, the Netherlands, France and Austria, with a focus on the former two.

As a result, for most of our clients, developed market government bonds make up a relatively small investment today, compared to their inflation-linked bond portfolios although for the majority of pension funds overall they are still a core investment.
Following the financial crisis, one of our pension fund clients sold all the nominal government bonds in its matching portfolio. It now merely invests in inflation-linked government bonds in this portfolio, which greatly outweighs its return portfolio.

Its nominal government bond exposure was replaced by a mix of high yield, emerging market and corporate bonds in its return portfolio.

This is a development we have witnessed more often over the past 12 months among our clients although they have always had a relatively large allocation to high yield and emerging markets in their portfolios.

However, we recently increased the allocation to emerging market government bonds from previously 8% to 10%.

The US, France, the UK, Sweden, Australia and Canada meanwhile provide us with inflation-linked sovereign bonds.

A rising yield curve environment remains the biggest challenge for us. Once yields start to rise again, returns for pension funds from bonds will diminish and they will have to start looking at other solutions, including their interest rate hedging strategies.

Henrik Olejasz Larsen
• Assets: Net DKK135bn (€18.1bn), gross DKK186bn
• Danish common management company for
collective labour market pension schemes
• Defined contribution scheme with guaranteed and non-guaranteed life annuities

Sampension has a large overall DKK89bn exposure to fixed income, which includes the use of repo finance. DKK65bn is invested in developed market government bonds.
Our benchmark allocation to developed market bond is 50% Danish and 50% other European government bonds. The latter includes more than just euro bonds - we hold, for example, an allocation to Swedish government bonds.

Occasionally, we also invest in US, Australian and other developed market bonds, but as these are not in the benchmark portfolio, they tend to be minor positions only.

Danish government bonds used to constitute most of our sovereign exposure but over the last few years we have moved out of Danish sovereigns to a more diversified European bond portfolio. We have since added more long-dated, high-quality European government bonds such as German, Austrian, Dutch and French ones. Because of the huge differential in spreads, last year we started moving into European government bonds of lower grade quality.

We have particularly increased our short-duration exposure to the two major bond issuers in the periphery - Italy and Spain.

We see them as a good alternative to taking on more risk through emerging markets. It is a way of introducing a type of risk investors would have previously taken in their emerging market debt portfolio. They also promise good returns compared to other types of credit risk. But although our peripheral exposure is close to a benchmark-weighted European bond portfolio, compared to our peers in the market, we have a substantially higher allocation to peripheral bond markets than they have.

Our emerging market portfolio is likely to increase again. At the moment, it makes up little more than 1% of the entire portfolio because it reflects the increase in our allocation to peripheral European countries and the fact that high yielding emerging market bonds are now yielding less than what we can get in many European countries, especially if you want to currency-hedge local debt.

In our strategic asset allocation analysis, we are looking for alternatives to Danish, German and other government bonds that currently yield less than expected inflation. These typically include opportunities in less liquid, but still fairly high-grade exposures such as covered bonds, asset-backed bonds and other types of high-quality structured credit. In Denmark, we are looking for real estate under rent control but are considering infrastructure debt too.