Consensus could wreck the chances of effective reform to Sweden’s buffer funds, writes Pirkko Juntunen

Sweden’s much publicised and debated Buffer Fund Inquiry (see panel) is now being reviewed in parliament and government as well as the pensions industry. Answers will take time and most observers seem inclined to think not much will change.

The inquiry, chaired by industry veteran Mats Langensjö, proposed reducing the number of funds from five to three, replacing the quantitative investment rules with the prudent person principle and improving governance – separating owner from manager, and creating a new authority overseeing the funds Pensionsreservstyrelsen, or the Pension Reserve Board (PRB).

Even before the report reached Peter Norman, the financial markets minister, labour market participants were up in arms about any suggestions of reducing the number of funds. The old chestnuts of ownership concentration and political interference were cited as reasons. Sometimes their arguments seem stuck in the past or perhaps just preferring the status quo.

Sweden is famous for its socio-economic model of a social welfare state with a free economy, and this is perhaps the perfect illustration of the consensus-based decision-making process that the country is known for.

Indeed, this type of decision-making process runs deep in Swedish society. While it engages a larger number of participants with varied view points, critics say decisions are often compromises leaving everyone dissatisfied. Another famous notion is the Goldilocks-like concept of ‘lagom’ which loosely translates as ‘just right’; not too much or too little.

Compromise – or ‘lagom’-style changes – is the likely fate for the recommendations of the inquiry which was initiated by the country’s centre-right government in order to bring the country’s buffer funds, the AP funds, up to modern financial standards.

Langensjö was given the mandate to find the optimal solution for the management of the buffer fund capital so that it would benefit the national pension system. However, there was a caveat as the government at the same time stipulated that the number of funds could be no lower than three, thereby making a single-fund solution impossible from the start, whether or not this would have been the optimal solution.

This resulted in seven out of the nine special advisers, the inquiry board members, working with Langensjö, criticising the final outcome and proposing an alternative, single-fund solution. Because of the disagreements, not just among the special advisers but in Swedish society there is a big risk that the proposals will be diluted.

The seven all said in a statement that while Langensjö was following the mandate given, the inquiry proposals would not lead to an optimal solution. Two of the nine, Thomas Nielsen and Brita Hammar, both working at the Swedish ministry of finance, remained loyal to the inquiry.

The group argued that the optimal risk management and asset allocation could only be achieved through a single fund and that the high level of competence required to run pension reserves makes spreading them over different funds counterproductive.
The seven believe that their proposal is in line with established research and international experience. They also rebuke the historic arguments that several funds are better equipped to counter political interference, and that the sheer size of the funds, some SEK900bn (€104.5bn) in total, would have too great an impact on Swedish listed companies. They point to other countries such as Denmark and Norway, which have opted for single fund solutions, with funds even larger than all the AP funds together. Their argument is that the world has moved on from a decade ago, when the current set-up was created, and that one fund would not become as dominant.

They also point to analysis by Ernst & Young, appointed as an adviser to the inquiry, on costs relating to the funds AP1-4, which clearly shows the cost benefits of a single entity.
Langensjö understands the criticism but says the inquiry proposal is the best possible within the limitations. He argues that the issue of the number of funds is of less importance than those of governance and removing the restrictive investment guidelines, a point emphasised by the OECD.

Kerstin Hessius, CEO of AP3, said at a recent debate at the Kungliga Ingenjörsvetenskapsakademin (IVA) the Royal Swedish Academy of Engineering Sciences, that the only necessary change would be the removal of restrictive investment guidelines. She argued that the rest of the proposals were going too far, leading to a concentration of power by creating the PRB in the first place. The AP funds, and other relevant parties, will hand in their views on the inquiry proposals to the government by 30 November 2012.

Erik Valtonen, former CIO of AP3, now working as an independent consultant advising the fund on technical issues, comments: “The crux is about the savings that may or may not be achievable, but whether a bigger unit size enables a better management of the capital. I believe that this is the case, in particular, in the area of alternative assets. What might be optimal for the buffer capital as a whole might not be optimal for a single AP fund. Therefore, good investment opportunities could be overlooked if the capital is divided between too many units. Relaxed investment rules opens up the possibility of making direct investments without financial intermediaries. By concentrating the resources in fewer bigger players there is a better chance of building world-class teams, with presence possibly also outside Sweden,” he said, adding that in the management of public assets there will be scale benefits: “For example, it doesn’t make sense to build four in-house teams for passive equity investing.”

ATP’s Lars Rohde has been the most vocal about his arguments for a single fund solution as well as the importance of defining the fund objectives and risk capacity. Rohde joined ATP in 1998, when the fund owned approximately 8% of every domestically owned and listed company. This has over time come down to today’s 1-2% because of global diversification and assets today being owned by a broader range of entities and investors, a case which he argues demonstrates that the old arguments against a single-fund solution no longer hold.

Rohde, who will take up the reins as governor of Denmark’s Nationalbank, on 1 February 2013, also believes in specifying precisely what the fund objectives and risk capacity are. He shuns broad definitions such as ‘achieving the highest possible return for the lowest possible risk’ and agrees with the inquiry recommendation of creating a sponsor or asset owner that is separate from the fund, which oversees and sets the objectives and risk parameters.

The most likely outcomes after the lengthy political process are that AP6 will be swallowed into the other funds and it is also likely that the investment guidelines will be relaxed. In particular, it is widely expected that commodities will enter the investment theatre.

Because of the differing views with many people still believing that the current system is the best one, wide ranging changes and a complete governance overhaul are unlikely. It is expected that many people with various agendas will do their best to water down the proposals, possibly reflecting their status quo bias or their genuine beliefs. One sure thing is that in another decade another review of the buffer funds will be proposed, conducted and opposed.