With a capital value of some €14.5bn in 2002 but with returns in decline, Finland’s llmarinen Mutual Pensions Insurance Company (Ilmarinen) is looking to incorporate structured products, derivatives and commodities into its investment strategy as a means of helping it achieve its main objective of ensuring the best possible long-term returns.
The past few years have seen the company diversify many of its equity and bond investments by region and sector, with the equity portfolio now split into three clusters – defensives, cyclicals and growth stocks. Ilmarinen believes adding structured products and commodities will help it further optimise its risk management.
Decisions concerning the investment plan are taken annually by the board of directors, though individual investments, carefully evaluated in terms of risk, are determined independently by the investment teams with respect to the plan. The various boards and managers meet on a monthly basis to ensure there is overall compliance with the investment plan and asset allocation strategy.
Overall Ilmarinen’s investment capacity employs 58 members of staff, including asset managers and analysts for domestic equities and other asset classes where Ilmarinen feels it can analyse risk and return potential itself. Other markets, such as Asian, Japanese and Eastern European as well as the private equity and hedge funds are handled by external asset managers. But this is something that is changing as Ilmarinen continues to diversify. The 5.4% of assets outsourced at the end of 2002 is therefore expected to rise rapidly.
Despite the increasing diversification of its assets, Ilmarinen still doesn’t make use of a permanent consultant, preferring instead to employ advisers for various projects as and when necessary. In addition it handles all its own administration in-house, and as such employs dedicated risk management, trade settlement and accounting teams. However, custody is outsourced to several different custodian banks.
Ilmarinen has an extensive client-base, providing pensions insurance services to some 80,000 corporations and entrepreneurs as well as actual pensions to 230,000 retirees. In general, the contribution rate is just over 21% of salary, of which the employer bears the brunt by contributing an average 16.8%. However, the contribution rate is expected to increase by some 5% in the next 30 years, a rise to be borne by both the employee and employer.
Ilmarinen has a dedicated investment administration team whose job is to ensure the smooth running of the investment process. Its 11 members are legal and financial specialists and their activities, including analysing quantitative risk and monitoring performance, are key to the fund’s success.
Asset liability modelling
Imarinen undertakes asset liability matching to ensure it can forecast its liabilities and relative risk levels. Ilmarinen says the pensions liabilities need to be continuously covered and they do this by designating a ‘solvency border’ or buffer zone. The ALM is designed to optimise the asset allocation and risk levels by considering volatility and the asset allocation’s impact on the solvency border.
Ilmarinen’s investment strategy incorporates both active and passive management styles and the fund believes its policy of continued diversification is leading to a mosaic of assets that places it at the forefront of Finland’s pensions insurance market. Ilmarinen says distributing its assets over a wide investment spectrum ensures higher returns, better diversification of benefits as well as superior elements of downside versus upside risk.
Though it has adopted a diversified approach to investments, Ilmarinen says it still analyses all its investments rigorously with respect to the portfolio as a whole and to overall risk. Its objective is clear: to ensure the fund remains solvent to be able to meet its pensions obligations and to maximise returns using minimal risk.
With the strategy in place, Ilmarinen’s chief investment officer, in conjunction with a head strategist, overlooks its implementation in five main asset class areas: listed securities; real estate; client loans; private equity, and hedge funds.
Risk management is an integral part of the investment plan and Ilmarinen considers both absolute and relative risk, depending on how far the investment team tactically deviates from the absolute risk mandate. Ilmarinen measures absolute risk by using a modified version of value-at-risk whilst it calculates relative risk by tracking error, beta and absolute risk volatility.
However, measuring risk for derivatives is different, and Ilmarinen, only recently having added these to its portfolios, now employs two dedicated derivatives experts in its risk control and middle office teams to ensure it can effectively measure and analyse risk in this market.
The chief investment officer heads up a special management committee that assesses the various types of risk on a daily and weekly basis.
Highlights and achievements
Traditionally the bulk of Ilmarinen’s investment strategy success can be found in its equity portfolios, where its management teams have consistently outperformed their benchmarks from year to year. Ilmarinen says this is mainly thanks to domestic stock picks and market timing.
But since the markets began to decline in the spring of 2000, the company has had to look further afield to guarantee a high rate of return. Most notably, its acquisition of real estate company Alexia allowed it to switch €1bn from equities into the high-yielding retro-cyclical property market.
Furthermore, Ilmarinen’s recent foray into the derivatives and structured products’ markets has meant it can play around with low value added risk and it is already seeing risk adjusted returns from these products of 50% per annum.