Which way to go?

Nina Röhrbein spoke with Eddie Dahlberg, who is responsible for Volvo’s pledge to provide pensions

Corporate pension funds in Sweden are a different species to those in most of other European countries.

A Swedish pension fund is a pledge for the company’s promise to pay pensions to its employees. That means the fund has no liabilities and no members – those remain with the sponsoring employer. In order to keep the pledge viable a special law regulates these funds.

This puts the pension plans in a unique position as demonstrated by the pension foundation of energy company Vattenfall, which was dismantled in late 2012 and returned to the company’s balance sheet.

This could in time also be a possibility for the SEK7.5bn (€876m) pension foundation of truck manufacturer Volvo AB, a DB fund for the company’s approximately 25,000 Swedish-based white-collar workers.

Regulatory developments in Europe, such as the new occupational pensions directive proposed by the European Insurance and Occupational Pensions Authority (EIOPA), set to follow in the footsteps of the Solvency II insurance regulation, could result in more investments restrictions, which might lead to the fund’s closure.

“One big issue is the increase in bureaucracy surrounding our financial activities, particularly as we are a small organisation, consisting of four staff and three additional people who are responsible for the accounting,” says Eddie Dahlberg, managing director at Volvo Pensionsstiftelse.

“Therefore, there is a limit on how much we can do, otherwise we would have to hire more people, which would significantly increase our costs. The bigger threat, however, is the restriction on our business as a result of the new regulations. Under the regulations, our investment returns might be so low that it would be better to put the assets back into the company. After all, before the creation of the foundation, the pension assets were a debt on the sponsor’s balance sheet.”

However, with the Swedish Pension Fund Association lobbying, Dahlberg hopes that the new rules will not apply to pension funds in Sweden.

Another option, the pension fund has looked at is enhancing its resources and undertaking more of the management in-house, with the exception of hedge funds and private equity.

“If we look at the fees we are paying to managers, it is quite a substantial sum of money,” says Dahlberg. “It is enough money for us to be able to hire four, maybe five additional people. In addition, the results of external managers have often proven to be unreliable whereas we have been consistent and a lot of things we have done ourselves turned out to be better than what the managers have produced.”

The pension fund’s investment strategy is to have two portfolios – a tactical and a strategic one. Four-fifths of overall assets are in the tactical portfolio, in which the pension fund tries to make asset allocation decisions on a short-term basis, which are often implemented through derivatives. The remaining 20% is within the strategic portfolio.

Volvo introduced the split in 2009. Prior to this, the split was about even. “We wanted to be more active in our asset allocation activities but realised that in order to do this we needed one part of the portfolio to be more resilient and less volatile,” says Dahlberg. “Therefore, we took the decision to split our portfolio into 80% tactical and 20% strategic. It allows us to move our assets around fairly quickly.”

The current target for the tactical portfolio is 20% Swedish equity, 15% emerging markets equity and 5% international equity. The remaining 60% of the portfolio is in fixed income including domestic, high yield and SEK500m of international bonds. The only target in the bond part of the portfolio is between short-term and long-term investments, with the target for short-term paper standing at 10%.

The targets for the portfolios are revised every quarter and at times the current allocations can vary considerably although they more or less always return to an even split.

The financial and euro crisis did not largely affect the asset allocation of the pension fund, says Dahlberg. However, the pension fund has, over the past three years, sharply reduced its exposure to government bonds from 30% to 15% of the bond allocation.

“We try to find fixed income opportunities mainly in the European corporate or financial sector, for example through perpetuals issued by banks,” says Dahlberg. “However, the spread of those papers versus European government bonds has narrowed sharply.”
In the strategic portfolio, the pension fund undertook its first real estate investment four years ago. Today, the strategic portfolio consists of three equal parts – real estate, private equity and hedge funds with real estate expected to increase at the expense of the others in the future.

One of its real estate investments is a co-operation called Vacse, created by Volvo Pension Funds with six other pension foundations – Apoteksbolaget, Atlas Copco, Sandvik, Skanska, Stora Enso and Ericsson. “In a small country, co-operation with like-minded partners who share the same interests and goals as us is a good idea,” says Dahlberg. “Investing through Vacse reduces the normally quite large fees in real estate investments. In this case, the co-operation has undertaken all of the investments by itself, meaning it saved quite a lot of money. The amount invested through Vacse is set to increase further.”

The co-operation has bought into properties that are let to government agencies, in other words stable tenants with long contracts. The district courthouse of Attunda, in the northern suburbs of Stockholm, is one of the examples of Vacse’s investments. The judicial administration has a 20-year rental contract. Vacse also owns the jail building adjacent to the courthouse.

However, Volvo has so far abstained from investments in infrastructure.  “We have not yet invested in infrastructure because it is slightly tricky to do these investments,” says Dahlberg. “Due to the lack of track record on this type of investments, we do not yet know the outcome of such investments. The political risk for infrastructure investments is also greater than other asset classes.”

Volvo has been an investor in private equity for over a decade – and it has always invested through Scandinavian private equity houses.

The majority of assets – around 60%, namely fixed income and Swedish equities – are managed in-house. The rest is outsourced. The pension fund undertakes its own due diligence.

Volvo Pension Fund only chooses asset managers with an investment policy that takes socially responsible investment (SRI) issues into account. However, the pension fund does not invest in SRI funds. And, unlike other Nordic pension funds, Volvo does not have an exclusion policy. “Not investing in SRI funds does not mean that you are investing in a socially irresponsible manner,” says Dahlberg. “We check that potential mangers have a policy on SRI matters that is compatible with ours before we invest with them.”

In the past, Volvo Pension Fund had a required rate of real return of 5.5%. However, in 2012 the rate was lowered to 4%. “The required rate of return naturally decides the mix of assets that is forecast to give us that return,” says Dahlberg. “In recent years, the pension fund has struggled to find low risk assets with a decent return, which is why we had to lower the rate. Maintaining the 5.5% real rate would have meant taking on higher risks in our portfolios.”

“Obviously when you lower the required rate of return, more investments become viable,” he adds. “If you have a required rate of return of 5.5% and inflation is at 2%, a return on real estate of, for example, 7-9% no longer appears that attractive. If we can accept lower returns in certain investment classes that are a pretty reliable source of return, such as real estate, investments in the asset class are a lot easier to justify.”

The length of time the required rate of return will remain at 4% is uncertain as the board reviews it on an ongoing basis. It is certain though that the strategic portfolio is set to expand with time.

Since 1998, annual nominal returns have averaged 6.5%. Over the last five years, average returns amounted to 4.5% in nominal and 3.3% in real terms.

With regard to risk management, the pension fund undertakes a worst-case scenario calculation at every board meeting, as well as an analysis of the risks if the chosen asset mix behaves differently than expected in relation to the required rate of return.

But the worst-case-scenario test has to date been only hypothetical. “We have never been near the worst case scenario, so we never had to react to our worst-case scenario assumptions,” says Dahlberg.

The investment committee, which includes some external experts as well as in-house staff, meets prior to every board meeting and formulates a broad recommendation on how to allocate the assets. This proposal is then presented to the board, which will make a decision on it. The investment committee in turn picks and chooses the markets and stocks within that broad target.

The board – which consists of two company representatives, two trade union representatives and an independent chairman – meets every quarter, or more frequently if necessary.

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