Jan Willers outlines some of the key findings of a recent survey on Nordic institutional asset allocation and trends within equities


Although we have yet to return to pre-financial crisis levels, allocations to equities have
picked up again. Those pension funds that were not forced to sell off a large proportion of their equities during the crisis benefited from the rally in equity markets and have regained the majority of what was lost during the crisis. This is reflected in the increased overall allocation to equities in the asset allocation overall. In the Nordic region, Danish investors maintain a significantly lower exposure to equities, and many of the largest Danish pension funds still struggle to increase their equity allocation, in effect still operating with single-digit allocations to equities. The consequence has been single-digit returns.

In Norway and Sweden many pension funds managed to claw back the majority of the losses endured during the financial crisis. Many of these funds have experienced relatively high returns, and the allocation to equities is now closer to par, as compared to the proportion of equities in the total asset allocation prior to the financial turmoil.

Use of derivatives continues to be very common. During the financial turmoil, derivatives were used to reduce risk. Now, on the other hand, some investors use derivatives to increase the risk in the portfolio. As in last year's survey, the use of derivatives is infrequently reflected in the balance sheets, however, although our interviews confirmed their extensive use for tactical reasons.

At the Nordic level, the equity allocation has increased from 23% last year to 28%, distributed between local and international equities. Consequently, the proportion of local fixed income has dropped from 41% to 37%, whereas the share of alternative investments has been more stable, not least due to the illiquidity in this asset class where investors have been reluctant to engage in new commitments.

Some investors are still locked up in illiquid assets like hedge funds and private equity. Consequently, the changes in the portfolio have been limited, although investors still struggle to reduce risk. Due to regulations, local fixed income continues to dominate in Denmark and this asset class still represents close to 60% of the total portfolio.

In Finland, the pension funds' overall allocation to equity is getting closer to the average 2008 level. Large pension funds, in particular, have increased their equity holdings and are thereby major drivers of this trend. In general, tactical asset allocation has been very dynamic, with the use of derivatives as well as the selling and buying of equities, although this it is not all reflected in balance sheets.

In Sweden, the average allocation to equities is now just above 40%, making Swedish investors the largest equity investors. Local equity holdings in Sweden increased during 2009 due to strong performance and a significant homeland bias for some investors.

Like in all other Nordic countries, equity holdings in Norway increased during 2009. This trend was primarily driven by the large players in the market, while smaller investors showed more reluctance towards increased allocations to equity. Some of the company pension funds were supported by their parent companies during the crisis, making it unnecessary to sell off risky assets. Naturally, these funds have benefited from the pick up of the market in 2009-10.

The picture emerging from investors' individual replies is rather clear. More are now planning to maintain their allocation to equity and so fewer intend to increase their allocations. Most significant is the drop in Sweden where the share of investors indicating that they will increase the allocation to international equity has fallen from 60% to 16%. This reflects investors' increased exposure to equity during the last year partly due to price rises and partly due to net investments.

At the same time, a number of investors are unable to take on more risk in their portfolios due to the current solvency requirements in combination with lower reserves. One of the factors that adds to the problem is the rise in the longevity of pension fund members, which requires more basis capital.

Danish investors are still looking to internationalise their portfolios, albeit at a slower pace than last year. Norwegian investors, large and small, are looking to do the same and will increase their allocation to international equity. In contrast, Swedish investors have cut down on their plans to invest internationally, especially in equities. In Finland, pension funds are reluctant to make large changes to their portfolios due to the uncertain environment and the focus has been on investment structures and fine tuning of the strategies.

Generally, we are impressed by the fact that 41% of Nordic investors have indicated that they will increase allocation to alternative investments. Of course, this is a broad category, but nevertheless rather surprising, considering the experience from the financial crisis. We are looking forward to seeing what this will implicate on an operational level.

An important factor that occupied the minds of almost all pension funds in relation to the overall strategy was Solvency II and its impact on investments and investment organisations. The attitudes range from utter fear to a more relaxed attitude.

All investors agree that Solvency II will increase the complexity of pension management, which will have implications for investment structures and organisations, and some investors have established dedicated teams to deal with the issues. For small pension funds the challenges might be too big and external assistance, fiduciary management and even mergers may be the answer. Some investors have mentioned that Solvency II requires the establishment of an independent risk management unit, which cannot be accomplished in a small organisation.

In relation to equities, the conclusions from the Nordic study are rather clear: global equity and emerging markets are attracting the most interest. This is partly because some investors are moving from regional to global mandates, partly due to the fact that more investors are looking for active global satellites.

The trend towards global equity is broadly based and should be seen in connection with the changes in investment structures. In Sweden some of the large pension funds still prefer regional mandates and in Finland the large funds have also tended to retain regional mandates, although some may use global mandates as satellites.

Investors have for a long time been operating with core/satellite structures in different ways. Previously the core could be global equity supplemented by small cap, sector mandates or special regions.

It is important to understand that the concept of the core/satellite structure has changed significantly in recent years. Many investors look at the core as the assets necessary to fulfil the strategy - in other words beta. This is particularly the case for equities. Here, the core will be indexed or close to index (enhanced) to ensure that the strategy is in place, whereas satellites can be more active or specialised mandates. As an element of this we are seeing a significant move towards global mandates. Some regional mandates are converted to global and at the same time active global mandates are used as satellites in order to generate alpha in the portfolio.

Emerging market equity is still in focus and many investors have expressed strong interest. Some investors shy away from dedicated emerging markets mandates, however, and prefer that their global developed managers invest in emerging markets either systematically or opportunistically.

According to our survey, a number of interesting searches are likely to be coming up either directly or indirectly. One element is dissatisfaction with existing managers as many Nordic investors have had problems with global equity products from local managers. But other managers are also up for review. This should open the door for other (new) managers.

Jan Willers is head of department at Kirstein Financial Market Research

The Nordic Investor Survey 2010 can be purchased by contacting Jan Willers at jan@kirsteinfinans.dk or by visiting www.kirsteinfinans.dk. Subscription for the 2011 survey will take place in January 2011. The next survey from Kirsten Financial Market Research will be the Benelux Investor Survey 2011.