Reeta Paakkinen spoke to Finnish pension fund chiefs about their changing asset allocation in the face of low yields and the euro-zone crisis

Uncertainty in the euro-zone has led Finnish pension funds to increase their portfolio exposure to markets outside Europe, in particular to emerging markets. At the same time, fund managers are starting to see light at the end of the crisis tunnel.

“The very fact that there is now discussion among institutional investors on a possible return to Spanish and Italian markets, and when this would be timely, shows that new confidence is starting to emerge,” says Timo Löyttyniemi, managing director of the €14.3bn State Pension Fund (VER). “The existence of this kind of conversation – even if limited – is a big step towards stabilisation. Investing in Spain and Italy is being discussed for the first time in two years.”

Timo Ritakallio, chief investment officer at €28.6bn Ilmarinen, emphasises the importance of investor confidence and the role it plays in recovery: “Instead of focusing on potential future problems, politicians should now focus on trying to get investors to return to Spain and Italy,” Ritakallio says. “Growth in confidence would lead to positive investment decisions, and that would contribute to the recovery process and ease the burden on euro countries and the European Central Bank.”

Staffan Sevon, chief investment officer at €2.1bn Veritas Mutual Pension Insurance, lists political instability in the European Union and the euro-zone as the main risks for his fund in the short term. “But in the long term, the ultra-low yield environment causes even more uncertainty. How can we achieve the returns needed to ensure the healthy, long-term solvency of the Finnish pension system?” he asks.

Despite market volatility, Finnish pension funds achieved sound returns from their investments over the first half of 2012, 4.3% on average, according to statistics published by the Finnish Pensions Alliance (TELA). Equities enjoyed the best returns (5.4%), followed by bonds (3.8%). Property investments yielded 2.8%.

“Although returns highlight recovery, some issues overshadow this result. First, there is the concern that the low yield environment for government bonds does not offer good returns,” says Löyttyniemi. “The second concern is that money markets offer even lower real returns, about 0.5 percentage points, whereas inflation stands at between 2-3 per cent. An environment like this will be challenging in the long term.”

Fixed income investments outside the euro-zone by Finnish pension funds have been increasing over the past years and now make approximately 39.7% of the average portfolio, according to TELA.

At several Finnish funds, volatility in the euro-zone has prompted fund managers to boost their exposure to emerging market debt. VER, for example, has increased its investments in the asset class from 10% to 14% already in 2012.

Increasing exposure to emerging market debt has also been on the agenda at Etera Mutual Pension Insurance, Jari Puhakka, chief investment officer of the €5.57bn firm, says.

Ilmarinen has also boosted its exposure to emerging market debt and has 10% of its bond portfolio allocated to the asset class. “The euro-zone crisis is speeding up pension funds investing in emerging markets overall,” Ritakallio says. “This was an upcoming trend prior to the crisis, but volatility in the domestic market is strengthening fund managers’ decisiveness.” Ilmarinen has, over the past year, increased both its debt and equity investments in emerging markets.

“We decide on our emerging market exposure to a given country on the basis of its economic prospects,” Ritakallio adds. “At present, Latin America seems to have a lot of potential and high oil prices make Russia an interesting investment target. Little by little fund managers are also becoming more interested in the potential African markets offer.”
Löyttyniemi notes VER has “a clear bias” in terms of emerging market equities. “We prefer Asian equities – that is our long-term priority. We are also researching what kind of role we should give frontier market equities,” he said.

VER used to invest 5% of its portfolio in emerging market equities before the crisis. At the moment, 17% of its equity portfolio is invested in emerging markets. “We have no concrete plan to increase our exposure to emerging markets but there is a vision this will be the case.”

Veritas’ Sevon agrees the euro-zone debt crisis has created new opportunities with cheap equity valuations but adds that these also include more “exotic” areas like private lending. Veritas picks emerging market funds by using an external database combined with internal resources to create a long-list, which is then evaluated. The shortlisted managers are then met by Veritas’ selection team. “We are agnostic concerning the question of single-country or global/regional managers, but we tend often to favour managers with feet on the ground,” Sevon says. “In many emerging markets, you cannot simply read the research – you must also evaluate the grin of the person writing the report.”

Ritakallio notes that Ilmarinen is looking to grow its investments in private equity and infrastructure funds. Ilmarinen had made a plan to invest 5% of its portfolio in private equity before 2015, but has now revised this to 6%. “We are also increasing our exposure to infrastructure investments, where we have been investing for several years already,” Ritakallio says. “Both direct investments and funds are on our cards, and this is a good way to bring balance to the portfolio as inflationary pressure grows.”

Löyttyniemi notes the growth of VER’s infrastructure investments depends on the flow of new projects. “We have invested in eight infrastructure funds since 2006 and have a positive bias towards UK funds as the infrastructure market tends to be bigger. Because of the crisis we have not made any new infrastructure investments. But in the long term our allocation to these projects can grow depending on the availability of new projects as well as the loan markets,” he adds.

Veritas, on the other hand, is in the process of revamping its hedge fund portfolio after negative results. The firm’s 0.4% exposure to hedge funds yielded a negative return of -14.4% over the first six months of the current year, and -15.3% in 2011. “We are restructuring our hedge fund portfolio and letting go of older, less promising investments. We look set to soon reinvest through an outsourced solution with the resources needed to be able to select a diversified portfolio of hedge funds. Part of our hedge fund investments have been of an explicitly hedging character in markets that have done well. So in part, and indeed to a very small extent, the performance can be explained as a so called insurance cost,” Sevon said.

Etera’s Puhakka adds the changes in the solvency framework may impact the attractiveness of hedge fund investments in Finland. Etera invested 2.5% in hedge funds over the first half of 2012, an allocation that generated a healthy 4.5% return. “At the moment, we believe in a quite concentrated number of managers, with whom we have good co-operation,” Puhakka adds.

Ritakallio notes that the crisis has taught Finnish pension fund managers a new approach to asset management. “The crisis trained us to act more rapidly and manage assets in a more dynamic manner, making  prompt decisions on risk durations. These skills are coming into use, as volatility in the markets is continuing.”