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Outstanding performance from innovative newcomer

The Gildi Pension Fund is a new name in Icelandic pensions, but it has now won the country award in the first year of its existence. The fund was established on 1 January 2005, from the merger of two pension funds, the Framsyn Pension Fund and the Seamen’s Pension Fund. It is the third biggest pension fund in Iceland, with €2.1bn in assets.
Gildi has been a beacon for other Icelandic pension funds in terms of portfolio management and performance. Over both the past year and the past five years, it has outperformed other Icelandic pension funds, based on reconstructed figures from the two constituent funds.
The fund returned 21% for the 2004 calendar year, which was 6% above its peer group average. And on a five-year rolling basis, the fund returned a cumulative 10%, which was 13.8% above the peer group average for the same period.
The fund’s annualised return for the first six months of this year is 19.1%. Furthermore, the fund has never lost money, doing well in both bull and bear markets.
Gildi Pension Fund ascribes this top-flight performance to its portfolio construction process, the implementation of asset/liability management and its use of currency overlay.
Another key component of its success has been the creation of new articles of association earlier this year, as well as a new structure for the accumulation of pension benefits. The effect of this has been to reduce the implied imbalance resulting from demographic fluctuations.
Gildi Pension Fund has been one of the first pension funds in Iceland to use a portfolio strategy based on asset/liability modelling (ALM).
ALM is an important tool for selecting the right investment strategy and portfolio management for the fund. The objective is to select an investment strategy and framework for portfolio management that allow the fund to match assets with liabilities.
Portfolio construction is based on the fund’s fundamental structure and characteristics. Fundamental considerations include the regulatory environment surrounding pension funds, the age distribution of the fund’s members, future cash flows and benefits versus contributions.

After considering these issues, the managers decide on their investment strategy, taking into account risk and return analysis. They estimate how the different investment strategies will affect the fund’s asset/liability ratio, the level of maximum drawdown, and how much risk the fund can tolerate.
Having made these calculations, the managers can then estimate the likelihood of being fully funded in the future for a given portfolio structure. Performance is compared monthly with the fund’s goals, and the make-up of the portfolio is changed according to the fund’s investment strategy.
Gildi Pension Fund and its predecessor funds have used ALM as a basis for portfolio construction from 2003 onwards, and the fund says that using this technique has been a major factor in its successful performance. In addition, ALM has also created more discipline in investing, and raised the level of work generally to a more professional standard.
In 2001, the fund became the first Icelandic pension fund to use currency overlay. It says that this technique has distinguished it from its peers over the past five years, and has proved very successful.
The fund hedges a substantial part of its foreign currency exposure into local currency (the Icelandic krona) because its liabilities are in local currency. This enables it to take advantage of the yield difference between Iceland and other countries, while lowering its own risk profile at the same time. The hedging ratio is managed on a daily basis, with the fund running an active management programme. According to the fund, the key components of currency overlay are the selection of a benchmark, hedging ratio and the management style (active or passive).
As a result, currency overlay has been one of the factors in the fund’s outperformance against its peers. In fact, the return from the currency overlay was 1.5% last year and 5.2% over the past five years.
However, the successful application of financial techniques cannot succeed without a firm basis in a fund’s legal constitution.

Earlier this year, Gildi Pension Fund carried out a constructive review of its rules on procedures and benefits, which were over 30 years old. This resulted in new articles of association, as well as a new structure for the accumulation of pension benefits, which reduced the implied imbalances resulting from demographic fluctuations.
The accumulated pension obligations will now be balanced against the fund assets every year to ensure that the obligations are fully funded, and that the benefits commitments at any time truly reflect demographic changes as well as risk factors – chiefly the risk of invalidity.
This revision of the basic rules was also intended to provide fund members with more transparency about benefits. The revised set of rules has already been adopted by a number of other Icelandic pension funds, and some of the biggest pension funds are planning to adopt them too. This is proof that Gildi has been a genuine pioneer in this field.

Highlights and achievements
The Gildi Pension Fund has developed and implemented both a portfolio construction and management process and a method of strategic decision-making that have led to outstanding performance.
The process starts by considering fundamentals such as pension fund regulations and the demographics of the scheme’s members, as well as the balance between contributions and benefits. Using ALM, the managers can then select the right investment strategy for the fund.
Gildi was the first Icelandic pension fund to introduce currency overlay, hedging a large part of its foreign currency exposure into local currency to match its liabilities. Besides lowering its risk profile, the fund has also benefited from yield differences between Iceland and other currencies.
The fund has also revised its articles of association, and set up a new structure for the accumulation of benefits, which has reduced potential imbalances from demographic fluctuations.
While this constitutional revamp has provided a model for other Icelandic pension funds, the changes in their entirety have enabled the Gildi Pension Fund to outperform its peers over the past one- and five-year periods.

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