The long and the short of it

How are you managing interest rate and credit risk?

APK Pensionskasse
Christian Böhm

• Invested assets: €4bn (including Vorsorgekasse)

• Participants: 100,000

• Both DB and DC

• Funding level: varies according to pension plan from 100-108%

• Established: 1989

The most expensive asset class at the moment for us are the highest-rated government bonds, which is why we have reduced our allocation to them and shortened our duration in the ones we are holding.

The highly rated government bonds we invest in are benchmark-free. In other words, we do not invest in them according to a benchmark.

We have also diversified our fixed-income portfolio further than it was before.

This means we are now overweight all types of corporate bonds. We also have a higher exposure to high-yield bonds.

In addition, we increased our equity ratio and moved further into alternative asset classes.

But the shift was most significant within our fixed-income portfolio.

We believe this trend will continue into 2014 but with different points of emphasis. Due to the low spreads available, we are already more cautious with regard to investment-grade corporate bonds. We are also analysing whether they have become similar to government bonds from a risk perspective.

We undertake active duration management in-house and at present our duration is well below the level set by the benchmark.

We do not expect to make any dramatic changes to our fixed-income portfolio in the near future, as we do not anticipate a rise in interest rates but rather a persistent low-interest-rate environment. The risk, of course, lies within the slightest bit of upward movement of the interest rates.

We also have mixed feelings about floating rates. Floating rates only make sense for us when the real interest rates are reasonable. But because of the current financial repression and the lack of inflation forecast for the near term, we are staying away from them for now. Instead, we are looking for appropriately evaluated credit risks and as few real and nominal interest rate risks as possible.  

The challenge remains to generate decent returns from the fixed-income portfolio.

Today, investments are influenced by news flows from central banks and political developments; during the financial crisis we were still sometimes able to make presumptions of market movements and returns based on macroeconomic data.


Blue Sky Group
Arjan Stubbe
Senior fund manager, fixed income

• Invested assets: close to €17bn

• Fiduciary manager of several Dutch DB pension funds including that of KLM

• Participants: 80,000 participants and pensioners

• Established: KLM pension fund for ground staff 1932; pilot pension fund 1947; cabin crew pension fund 1978

• Nominal funding ratios for the KLM pension funds range from 118-129% fund 1978

Government bonds are probably the most overvalued asset class for us at the moment.

For that reason, we have been underweight sovereign debt, particularly European sovereign debt, for the large part of 2013.

We replaced that allocation at the top level by adding to our equities exposure.

Although we are underweight bonds overall, we have also allocated the extra capital that resulted from the reduction in sovereign bonds to our return portfolio which consists of credits, high yield and emerging markets. We are particularly overweight high yield and emerging market bonds.

Going into 2014, we have reduced the overweight in equities. In fixed income, our outlook is muted. Interest rates could rise somewhat but rates will be capped by low inflation, moderate growth in Europe and low central bank rates. We will continue to be overweight hard currency emerging market bonds and to a lesser extent local currency. We will reconsider the overweight in high yield but will likely still be somewhat overweight. Our investment grade credits will remain neutral.

Because we want to benefit from the fact that long yields are very low, we have also decreased our interest rate hedge somewhat.  

One of the main challenges for the coming year will still be low yields in government debt and tight spreads in investment grade credits. High yield could still be attractive on a relative basis. Emerging market hard currency and, particularly, local currency bonds could be hurt by FED tapering as we have seen earlier in the year.  

The equity portfolio presents another challenge, mainly due to the positive run equity markets had in 2013. Margins and/or sales volumes would have to improve to justify another 2013-like year for equities, but for now a lot of positive news is already priced in. On a relative basis, equities are probably still a better play than bonds.

We plan to shorten the duration of our matching portfolio somewhat in 2014 and to invest more in credit type products rather than government or inflation-linked bonds. The latter currently make up 50% of our overall bond portfolio.

Sparinstitutens Pensionskassa
Stefan Ros

• Invested assets: SEK23bn (€2.6n)

• Participants: 176 employers and 39,000 beneficiaries

• 99% DB, 1% DC

• Funding level: 154%

• Established: 1944

In view of the Swedish mark-to-market valuation of pension liabilities since 2006, the most overvalued asset class we have is fixed income.

Given our liability perspective in the management of our assets, it has always been good to be very long in duration because of the 25-year-plus length of our liabilities, but in December 2012 and April 2013 we significantly decreased the interest rate duration of our fixed-income portfolio in anticipation of an end to falling interest rates and the introduction of a new valuation curve by the Swedish FSA in December 2013.

The ultimate forward rate introduced in the new valuation curve will reduce the volatility of our pension liability by 50% which, together with the temporary interest rate floor, filled us with confidence that we could substantially reduce our duration.

On a relative basis it is still overvalued but not as bad as it used to be prior to the cuts.

If we still want to do some liability hedging, swaps will be very useful, given the construction of the new curve. Floating rates could be of interest once interest rates start rising again.

During the summer of 2013, we began looking at our asset allocation strategy. We decided that we would undertake a major overhaul of our entire strategy and diversify the portfolio into other asset classes in this low-yield environment because the new valuation curve is more stable and we can take on more risk. Until now, we have only invested in equities and Swedish fixed income.

Credit, for instance, has thus far not played a big role in our portfolio but it is looking relatively attractive to us now. And, from now on, in this new world, Swedish government and SEK-denominated covered bonds will have to compete with any other asset classes on a risk-return basis.

Until now, it always seemed to be a good idea to be very long in Swedish government bonds because we had good protection from a liability-hedging point of view. This is no longer the case.

There are more upside than downside risks in rates – we will have to bear this in mind when we change the fixed-income portfolio.




Interviews conducted by Nina Röhrbein


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