New portfolio dividing lines

Storebrand Investments, the asset management arm of the giant Norwegian insurer Storebrand, is one of the first major financial institutions in Norway to reorganise the management of its assets along lines of alpha and beta strategies rather than equities and fixed income.
The asset management splits its asset management into two operations: a beta operation organised as single group with separate duties, and an alpha operation, made up of six teams, each responsible for a Luxembourg-based fund.
The man behind this move is 41-year-old Hans Aasnæs, the former chief investment officer of Storebrand Investments, who was appointed managing director a year ago.
The move was a response to the needs of its main client, the parent Storebrand insurance company, which accounts for some NOK140bn of the NOK200bn (e25bn) assets under management, Aasnæs says. “As a part of an insurance group, one of the main things we have is a set-up to run large portfolios on a very large platform.
“Three years ago we had an old-fashioned, mixed mandate. But over the last two years we have had a mandate with a well-defined beta portfolio and an alpha mandate just given as a Value at Risk.
“The mandate we got from the life insurance company, which was a complete alpha-beta split, is a diversified investment mandate, where the client tells us the composition of the beta portfolio and then tells us how many million Value at Risks we are going to produce. This is a pure alpha mandate, and very few clients operate on that basis.
“So far, we have taken what we have already done and converted it into an alpha and beta, splitting the alpha and beta in existing products. This has given us a very much sharper focus on the value creation processes, with a specialisation both in fund and product.
Initial results from the alpha satellites have been mixed, he says. “It is a mixed bag. Some alpha products have done very well, some have done not that well. This was expected.”
Mixed results do not invalidate the overall approach, he says. “If you believe in the process and the people, you have a little more patience with them than if you don’t. But if you find that the process is wrong or the people are wrong then you shut it down.
“Going forward we shall be looking for new teams, new processes and new portfolios to add to the ones we already have in place.”
He does not specify which processes or portfolios. “When you separate alpha from beta you are not concerned about where the alpha comes from, so long as it has a low correlation with all the other alpha generators you have. Whether it’s trading a sector or a region, or what instrument you use, doesn’t matter as long as it has a low correlation and a high return.
“One of the big mistakes that a lot of people are making is connecting alpha too much to the beta. The question is how do the alpha portfolios play together. The reason for choosing an alpha process is that it gives the right correlation to the rest of the portfolio and its expected performance.”

Generally, this approach has worked well, he says. “The alpha-beta split has been very successful from a risk control perspective. And as a general platform for running big portfolios, it has been definitely been a success.”
Some impressive evidence to support this view emerged last November, when Gjensidige Forsikring, a leading property and casualty insurer, awarded Storebrand Investments a NOK25bn mandate to manage the bulk of its investment portfolio. The mandate is the largest that has been put out for open tender in the Norwegian market, and has doubled the total of Storebrand Investments’ external assets under management to more than NOK50bn.
Aasnæs sees the mandate as a vote of confidence in Storebrand’s new approach to asset management. “Gjensidige has the same way of thinking as us, and the mandate confirms that our asset management area represents high business quality.”
Gjensidige Forsikring is now Storebrand Investment’s largest external customer. Other external institutional clients include municipalities, pension funds and charity foundations.
The new platform is also open to external managers, says Aasnæs. “Any client that wants to use an external manager for a particular kind of product can use the platform too. That makes it a good structure for running big portfolios.” Storebrand Investments’ choice of whether to manage assets internally or externally will depend on how much information is available, he says. “We are not out there to gather information. We are out there to use information.
“The business schools say you have to be in the US to manage US equities, in Europe to manage European equities, and in Japan to manage Japanese equities. I think that is wrong because the world has become global and information has become globalised.
“All the blue chip companies today are global companies and there’s not exactly a lack of information out there. Rather it’s an overload of information.
“As a general rule we outsource asset classes where the information flow is restricted, such as emerging markets and small cap equities. We do not want to be players in the less analysed, less efficient markets.”
He concludes: “The player who wins this game in the future is the one who is best at getting the information and using the information right.”
The exception to the information rule is the home market. Storebrand Investments manages Norwegian equities, Norwegian bonds and Norwegian money markets. There is no attempt to split the management of Norwegian equities into alpha and beta. “That’s very much an illiquid, small cap market,” he says.
There are no hard and fast rules about the use of external managers. If external managers can do the job better than the internal teams, Aasnæs says he is prepared to give it to them. “Obviously with the alpha-beta split we put our head on the block, and if our alpha product doesn’t deliver, then that has its consequences.
“Also if we can’t manage the index part of the portfolio, cost efficiently, that too is open to external managers. For example we use derivatives to produce a credit index, but we don’t do it ourselves. An organisation of our size can’t produce an indexed beta product efficiently enough.”
Management of the beta portfolio is kept simple, he says. “So far we have done very little enhancement. On the equities side we do an optimisation, and on the fixed income side, we do cash flow mapping.”
Handling beta mandates in-house suits Storebrand for several reasons, he says. “One reason is the cost of production. The cost of producing it is less than we could buy it for.
“Another reason is that Storebrand has a lot of SRI restrictions on its investments. To get a beta mandate set up as a separate mandate with this exclusion on top of that to meet the life insurer’s separate need for SRI criteria is obviously creating a product that is more expensive.
“That’s certainly our experience when we’ve tried to do get people outside Storebrand to do it. But if an external manager comes to me and says they can manage it cheaper I am more than willing to accept that.”
Storebrand Investments has a symbiotic relationship with its largest client, the Storebrand life insurance operation. Their respective areas of responsibility are well defined, says Aasnæs. “The life insurance company is responsible for the investment mandate and the total risk-taking in the portfolio. If something dramatic happens in the market and they want to adjust the portfolio then that is their responsibility.
“For our part, we are responsible for everything to do with the market view, and all market operations. But they draw heavily on our resources – for example, in optimising expected return in the market. Generally we are quite strongly integrated with each other’s operations.”
Recent developments in Norway’s pension system are likely to lead to increased business for the insurer. Storebrand already has a dominant position in the market, with 42.6% of the market for private sector pensions provided by the insurance sector.
Its share of public sector pensions is far smaller and now stands at 5.8%. This market is dominated by the former monopoly provider KLP, with an 85.6% share. Although the public sector market was opened to competition in 1997, local municipalities have been slow to take advantage of this.

This is primarily due to KLP’s plans to change its ownership structure, aborted last year, which persuaded many municipalities to stay with KLP to see what their shares would be worth. However, the potential of the market is considerable, says Aasnæs.
“Historically the public sector has been the fastest growing part of the market, due to very good pension schemes in the sector. Today they get 66% of salary at pension age. If you consider the wage growth and the growth of the public sector in Norway you don’t have to be a mathematician to know that is a very good business.”
Pensions in the private sector are also expected to grow, with the arrival of the compulsory group pension.
“Most of that, if not all of it, we expect to come in the form of defined contribution. That definitely will make that part of the market grow faster. On top of that there are the recommendations of the Pensions Commission that people will have to retire later, or reduce their pension, or save more. That will probably create a lot of savings and pensions business.”
A new insurance law, which comes into effect at the beginning of 2008, will also have an impact, he suggests. The law will change the system of pricing of the defined benefit pensions.
“Today we get paid by sharing the profit. In the future you have to pay that price up front. We expect that will speed up the growth of DC rather than DB pensions.”
Against this changing background, Storebrand Investments’ decision to sharpen its asset management act looks particularly well timed.