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Does small mean beautiful?

André Heimrich
Head of asset management and deputy CIO
BVK
Germany
• Invested assets: €53bn
• Members: 1.6m
• Hybrid: DC with guaranteed minimum interest return
• Average solvency ratio: 104% (Dec 2010)
• Date established: as BVK 1995, the oldest Versorgungswerk dates back to 1916

BVK comprises 12 different Versorgungs-werke - the pension schemes responsible for professions regulated by a chamber - plus two external Versorgungswerke and each of those have their own asset allocation.

On average, BVK has around 7% invested in equities but individual Versorgungswerke can have an exposure of up to 12%.

BVK invests in equities via a German Spezialfonds structure and issues equity mandates to external asset managers. It is up to the asset managers to select their respective equity benchmarks. But internally BVK uses Eurostoxx indices.

Around 95% of BVK’s equity investments are in active portfolios - the only remaining passive pure equity mandate currently is in the US large-cap space because it is difficult to achieve an outperformance there. In the past we also had a sizeable passive exposure to European large-caps. This was cut during the downscaling of European equities.

Around a quarter of the average 7% equity exposure is invested in small and mid-caps. This figure has increased substantially over the last 18 months. During the course of the financial crisis, we were unsure to what extent small-caps would be affected by refinancing problems. However, after the initial worries faded, small-caps started to look more favourable than large-caps because they do not contain large bank stocks, which have contributed to the recent slowdown of the stock market.

Our quantitative analyses indicated a better risk/return profile of small and mid-caps. With regard to small and mid-caps, we have positioned ourselves globally. Since 2010, we have also had an emerging markets small-caps exposure although those markets are yet to have a clear separation between large, mid and small-caps.

Hedging small and mid-caps is difficult, which can undermine the asset class because internal guidelines often instruct pension funds to be able to quickly take the risk out of their investments. For us the only difficulty is to strike the right balance between the size of the manager and his performance as it is often difficult for smaller managers to achieve a similarly good performance with more assets.

We are in the process of funding some new small and mid-cap mandates. This will be the only action in this segment for 2011 because we think this year could be more favourable for large-caps.


Ramon Tol
Fund manager, equities
Blue Sky Group
Netherlands
• Invested assets: €13.4bn
• Fiduciary manager of several Dutch pension funds including those of KLM
• Funding level: KLM ground personnel scheme 122%, cabin crew scheme 122% and pilots scheme 135% (Dec 2010)

Across all our clients we currently have an average strategic equity allocation of around 35%. As equity benchmarks, we use primarily MSCI but also Russell indexes, depending on the asset or sub-asset class.

For most asset classes, including US small-caps, we offer both passive as well as active solutions.

Some institutional investment managers consider small-caps to be part of broader mandates - usually it is part of their large-cap mandates. However, we believe that small-caps are a niche area, which is often driven mainly by the domestic economy. On the contrary, large-cap companies are more exposed to exports. In terms of manager selection, we believe small-caps require a different skill set.

In the past we have made use of consultants for our small-cap portfolio. During the last couple of years, though, supported by our two external manager databases, we are more aware of the external managers in this space.

Currently about 8% of our equity portfolio is invested in small-caps, which is - based on ALM and diversification studies - split equally between European and US small-caps. Mid-caps are part of the large-cap portfolio - we do not distinguish between them. Due to the relative outperformance of small-caps compared to large-caps the portfolio has grown in recent years. Small-caps have outperformed large-caps for quite some time, so the question is whether to cut positions. Valuations are stretched, especially against large-caps. But assuming that the economy continues to recover, small-caps may well continue to outperform their larger counterparts for another one or two more years. However, the low US dollar exchange rate is a benefit primarily for large-caps.

Two years ago, we started to restructure both small-cap portfolios and hired a couple of new managers who are, in our opinion, better able to deal with the current market volatility and market dislocations. As in the large-cap space, active small-cap managers have struggled, but probably even more so because volatility and extreme sector and style swings are even greater in the small-cap space.

Our global emerging market managers are allowed to invest part of their allocation in emerging small-caps. Taking into account the limited number of emerging small-cap managers, we have decided to incorporate emerging small-cap exposure into our large-cap mandates.

Christina Kusoffsky Hillesöy
Head of communications and sustainable investments
AP3
Sweden
• Invested assets: SEK208.6bn (€23.3bn)
• One of five Swedish national pension buffer funds
• Mandated by parliament to deliver high investment returns at a low level of risk
• Date established: 2001

Around 53% of our total portfolio was invested in equities as of 30 June 2010. Of these, roughly 48% was listed equity, with the remaining 5% made up of private equity.
Although our equity allocation has varied with regard to allocations to different regions, the total allocation has, over the last few years, remained relatively stable, ranging from 50-60%.

We mainly use regional variations of the FTSE indices as our large, mid and small-cap benchmarks. Moreover, for emerging markets equities we apply an MSCI index and for Sweden, the SBX index.

Our equity portfolio is a mixture of passive and active. However, the passive part has increased over the years. If expected returns are high enough, we will choose active management but, generally, passive portfolios are cheaper to run and provide the most cost-efficient way of investing.

Small and mid-cap positions make up around 10% of our portfolio. Almost 70% of our equity mandates are managed externally. We undertake the investment analysis and selection of managers internally.

The majority of our small and mid-cap mandates are passive. We have one small and one mid-cap external mandate for North America and another small and mid-cap external mandate for Europe.

At the end of June, we only ran one active small-cap mandate in Europe with SEK1.368m in invested assets, which dates back to 2003.

We had six emerging markets mandates - four active ones, an enhanced one and a passive one. The passive mandate is managed internally, while the management of the others is outsourced. While most of the mandates are of a large-cap nature, they can also contain small and mid-caps.

The challenge with regard to active small and mid cap portfolios lies in the stock-picking because you tend to receive less information about those companies. Their liquidity is also less than it is with their large counterparts but as a government state pension fund we are long-term owners so liquidity is not usually an issue for us.

While the other AP funds also have a tendency towards passive management, some of the other corporate pension funds in Sweden have a lot of small and mid caps in their domestic portfolio, which they run actively.


 

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