Two leading Finnish pension funds see potential in frontier markets and China equity, finds Reeta Paakkinen

Finnish pension funds increased their investments in foreign assets over the first half of 2014, according to TELA, the Finnish Pensions Alliance. Over the second quarter, assets totalling €170bn, were invested outside the euro-zone. Investments in Finland reduced marginally, whereas non-domestic investments rose by a small margin.

But this looks like a blip in a long-term trend towards domestic investments. Maria Rissanen, analyst at TELA, notes that 27.6% of all pension assets are now invested in Finland, about €2.8bn less than previously. “Although domestic investments have reduced over a short period of time, and exposure to other markets has increased, the total invested in Finland has been increasing year-on-year over the past decade,” Rissanen says.

Geograhically speaking, non-euro-zone countries, including the US, UK and Japan, account for nearly half (47.2%) of assets, while those in the ex-Finland euro-zone now come to a quarter (25.2%).

In terms of asset classes, there was a minor shift from fixed-income to equities. Bond allocations reduced by 1.4 percentage points, while equity investments increased by the same amount. Overall, 47.1% was invested in equities as of 30 June 2014, 42.5% in fixed-income and 10.4 % in property. 

Timo Löyttyniemi, managing director of the €17.1bn State Pension Fund (VER), affirms that low interest rates are still the main challenge. VER’s fixed-income investments returned 3.6% over the first half of 2014, which Löyttyniemi attributes to a strong decrease in rates as inflation exceptions remained moderate and geopolitical risks rose to the fore. “Markets with higher credit risk gave the best returns, while emerging markets bond and the government bonds of peripheral states gave the best absolute returns,” Löyttyniemi says.

“[Persistent low interest rates] reflect weak prospects in Europe, but at the same time enable a rapid increase in interest rates. Markets will move between these two scenarios.”

At a glance

• The long-term shift has been towards domestic investments although the proportion of non-euro-zone assets increased marginally in 1H 2014.
• The average portfolio is invested in Finland (27.6%), the euro-zone (25.2%) and outside the euro-zone (47.2%).
• Currently, pension funds name low interest rates as the main challenge for institutional investors.
• China and frontier markets are seen as new alternatives to Russian equities.

At present, over half (51.8%) of VER’s portfolio is invested in fixed-income, 39.5% in equities and 8.6% in other assets. The portfolio returned 4.8% during the first half of 2014. 

Timo Ritakallio, deputy CEO and chief investment officer at the €33.5bn Ilmarinen Mutual Pension Insurance, agrees that low interest rates continue to pose the greatest challenge. He was recently appointed as Ilmarinen’s next president and CEO; next February he will replace Harri Sailas, who will retire by May 2015.

“Obviously, low interest rates are a challenge for us,” he says, underlining that geopolitical events continued to cause concern among investors through mid-2014. “The crises in Ukraine and the Middle East are rattling nerves in both the equity and fixed-income markets. The situation in Russia is very disconcerting for Finland’s economy,” Ritakallio noted. 

Economic and political relations with Russia remain a sensitive topic, where many retain memories of the Cold War, when anything related to the eastern neighbour was best communicated in a cautious and diplomatic manner. 

The EU’s economic sanctions against Russia, as well as the countermeasures Russia has taken, are weakening the economic outlook for all of Europe, Ilmarinen’s CIO mentioned. At Ilmarinen, exposure and risk in the Russian market was reduced before the crisis escalated, Ritakallio notes. “We sold all remaining listed equities we had in Russia at the beginning of the current year,” he said. 

But the pension insurer remains a major owner in several listed Finnish companies that have a strong presence in Russia. “Our portfolio could still be exposed to some indirect negative impacts,” Ritakallio says. “They will be especially significant in the profit outlook of those Finnish companies that have business ties with Russia.”

VER’s Löyttyniemi, in contrast, says the crisis in Ukraine and the sanctions against Russia have not had a direct impact on VER as an investor. “Naturally, the global conflict has created uncertainty, and partly and permanently changed the way we think about risks,” he said carefully.

According to Löyttyniemi, when the crisis in Ukraine began to show signs of settling down last spring, the equity market outlook looked favourable. “However, after the second quarter of this year, the situation in the country has taken a turn for the worse, which has also been reflected in the development of the stock market in the late summer,” he adds. 

Ilmarinen’s Ritakallio believes the outlook for the equity markets will be cautiously positive and that long-term interest rates will gradually rise. “At present, we find emerging markets offer the most promising potential for institutional investors. We have increased our investments in the Nordic region outside Finland and this is shown in our equity portfolio as an increase in our exposure to European listed stocks,” he said. Ilmarinen’s total return for the first half of 2014 stood at 3.4%. 

Over the first half of 2014, exposure to emerging markets within Ilmarinen’s portfolio was due to the weaker development of those markets in comparison with others. “On the other hand, we have reported on our investments in China separately, and the allocation to that market did grow,” Ritakallio said. 

Löyttyniemi also notes that China’s economic growth has been reinvigorated after a weak start to 2014. “The stock market in China has had a good return, although the turmoil in Hong Kong has had an effect lately,” he comments. Apart from China, Löyttyniemi also finds frontier markets most promising. ”Frontier markets have risen strongly and they have offered us the best returns out of all markets. Our investments in these markets have, however, been relatively small. The increase in exchange rates has at times been even too strong,” he said. 

Currently, 65% of VER’s equity investments are in Europe and the Nordic region, 15% in the United States and another 15% in emerging markets. Some 5% is invested in Japan.

A few years ago, VER established a new private credit asset class in its portfolio, which Löyttyniemi says has performed well. Currently, VER has €300m invested in private credit and has committed an additional €200m. In 2013, the asset class returned 8.1% for the fund. ”If returns from private credit continue to be sound, we will increase our exposure to the asset class,” VER’s managing director says. “We continue to have a neutral weight in equities but we are ready to change the exposure if the market situation changes,” 

“The new elements we are considering are diversifying fund investments, such as risk-premium investments, which we expect to provide both diversification as well as good returns,” Löyttyniemi adds. 

And VER recently developed its property portfolio by investing in a Finnish logistics fund: “Each year, we invest in a few new funds and property funds are important in our portfolio as we are not able to invest in property directly.”