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Special Report

ESG: The metrics jigsaw


Finland: Overseas returns

Reeta Paakkinen writes that Finnish pension funds are looking to diversify their real estate portfolios in their quest for worthwhile returns in the current low-interest-rate environment 

At a glance

• Finnish pension funds are diversifying their asset allocation.
• It is a struggle to achieve good returns from bonds and equities.
• Overseas property represents an alternative.
• Funds are looking for diversification into emerging markets.

According to the Finnish Pensions Alliance (Tela) Finnish pension assets stood at €180.9bn at the end of 2015. 

Nearly half (48.9%) of this was invested in equities or equity-like investment vehicles. Some 41.6% invested in fixed income and 9.5% in real estate. The average return was 5%, – equities returned 8.7%, real estate 6.3 % and fixed income 0.5%.

The €41.1bn Varma Mutual pension insurance company is among the funds that plan to increase their exposure to international real estate funds in the medium term. Over the first quarter of 2016, its portfolio yielded a negative return of 1.4%. Property made up 9% of total holdings. The notable change over the period was a drop in equity exposure from 45% to 38% and growth in fixed income from 30% to 35%.

Reima Rytsölä, Varma’s executive vice-president and chief investment officer notes that times are particularly challenging for large institutional investors in terms of returns from both equities and bonds. “It is actually difficult to find returns these days from almost any asset class. We have reduced our exposure to European equities over the first quarter of 2016. If visibility on economic outlook improves we are ready to increase our equity exposure again, but not yet,” he adds. 

He says that Varma’s property investments had been focused on the domestic market. “Our plan is to increase our exposure to international property by making new investments. At present, approximately 10% of our property holdings are outside Finland. We are not going to reduce our exposure in Finland, but our exposure will simply reduce through the new purchases that we will make overseas, which will either be property funds or joint ventures. What we are interested in is funds which have strong local expertise in the area they operate in,” explains Rytsölä.

Niina Bergring, chief investment officer of the €2.8bn Veritas Pension Insurance company, says property exposure will also be increased at her fund. In 2015, Veritas restructured a large direct property investment into a fund and divested from a few large investments. As a result, the fund’s overall allocation to property decreased last year. Currently 11% of all holdings are invested in real estate. “We have some interesting new projects in the pipeline and our long-term target allocation into property is much larger than it is now. We are making our first commitments to international real estate funds soon, so our real estate exposure will go up again once our projects materialise. However, we will take very careful steps as I do think some parts of the global real estate market are currently overpriced,” says Bergring. 

Mikko Mursula, chief investment officer of the €35.8bn Ilmarinen mutual pension insurance company, has similar plans. According to him, Ilmarinen has made a strategic decision to make direct investments in overseas property. Its current core market in real estate is Nordic and European office buildings and it has invested in Brussels, Berlin and Washington DC, however 85% of Ilmarinen’s property portfolio is invested in Finland. “I would estimate that in the medium term, this will be more like 70% invested in Finland and 30% overseas.  We keep on being an active investor also in Finland albeit our new commitments overseas grow more. In Finland, we have launched the construction of 1,000 residential flats in growth centres recently. The reason behind our determination to diversify to invest more in foreign property is that the property market here is so closely tied to the well-being of the national economy. The main risk here in property investments is times when usage of office buildings drops,” Mursula says.

Average asset allocation, 2015

Over the first quarter of 2016, Ilmarinen’s investment portfolio generated a return of minus 1.4%. Listed equities yielded a return of return of -5.5%, fixed income was -0.5% , and direct real estate 0.7%. “During the first quarter, investors continued to be concerned about the slowdown of China’s and the entire world’s economic growth and the development of raw material prices. Concerns about Europe’s structural challenges, such as the Brexit debate gaining momentum, weighed on the markets,” Ilmarinen’s president and CEO Timo Ritakallio says.  

“Of the main equity markets, the US and emerging economies reached positive figures at the end of the quarter, while Europe and Japan remained clearly in negative territory. The geographical distribution of equities thus had an exceptionally large impact on investment returns in the early part of the year,” he continues.

Chinese economic development continues to push funds to look for emerging market diversification. Bergring says Veritas has a small exposure to China through its Asian active stockpicking funds. “But, this is very minimal and very bottom-up-driven exposure. We have stayed away from commodities for a long time due to our worries related to China. This worry is slightly reflected in the overall risk level of our portfolio because China would have a major impact on the global economy if things were to go wrong, which we do not see as imminent,” she says.  

One alternative area is India. “India still has huge long-term potential in terms of growth, but it is a very difficult market to access,” says Bergring. “We have found a way to access Indian growth through a credit angle rather than the equity market. Our equity allocation has been geographically very stable and I do not foresee big reasons to change this,” she notes.

“The issue here is that whilst equities overall are not really yielding impressive returns, interest rates are historically low. This is still challenging for a pension investor. Asian economies seem to be faring better than Brazil and Russia and that’s where we see more potential when talking about emerging markets,” says Rytsölä.

Mursula describes the current market as unique. “Whilst in 2008, we still got some 3-4% or higher yields from government bonds, an investment with small risk premium, these days we are talking about 0.2% yields. German government bonds, for example, are now yielding negative returns all the way up to eight years. This situation is a unique situation, which we need to tackle by searching for returns from other asset classes, like property, infrastructure and equities,” he says.

Mursula says the volatility will continue during the rest of the year. “Concerns about the global economic growth rate and companies’ earnings power in times of low economic growth will be reflected in strong share price volatility going forward. Additionally, for example, any forecasts of the impacts of record-low, even negative interest rates on the financial sector, corporate investments and investor behaviour are only guesswork. This is the first time ever that we are witnessing a situation like this,” he says.

Bergring notes that an investor has to try to keep some duration in the fixed-income portfolio even if it feels too risky. “Some parts of the credit market are yielding returns which we feel compare favourably with the expected returns from equities taking into account the risks.”

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