This March, nearly three years after the Buffer Fund Inquiry was announced, the Swedish government confirmed that it would push ahead with the closure of two of the AP buffer funds, leaving significant uncertainty over the future existence of the first four funds (AP1-4), as well as AP6, the domestic private equity fund, all of which manage assets totalling SEK1trn (€113bn).

In taking the decision to retain three funds, the government has consciously avoided creating a single consolidated vehicle like the Norwegian Government Pension Fund Global, France’s Fonds de Réserve pour les Retraites or the Irish National Pensions Reserve Fund.

“This was, and has been for a long time, a political issue in Sweden,” says Erik Thedéen, deputy to Peter Norman, now minister for financial markets, and a former head of AP7. Thedeén points to fears from the conservative side of the political spectrum that the AP funds could seek to influence, or even control private companies. This stems from proposals from the then Social Democrat government in the 1980s for AP funds overseen by trade unions – although this proposal never materialised.

“That was one of the reasons why we had four funds in the first place – five, if you include AP6 – in order to minimise the risk of the government to call the manager of just one fund and get a political investment.”

Of course, the risk of government intervention to control a company was addressed in the current system by implementing strict quantitative investment guidelines that restrict a fund’s total ownership of Swedish listed companies and cap the overall unlisted investment of each fund at 5% – excluding AP6, which is devoted to Swedish private equity investments.

These quantitative investment guidelines were singled out in the inquiry – chaired by Mercer and Goldman Sachs Asset Management veteran Mats Langensjö – and deemed archaic. The OECD said at the time that the restrictions could result in “sub-optimal portfolios and over-exposure to certain types of assets”.

Most of the inquiry’s recommendations have been accepted. However, the board also signed a letter recommending more radical reform – the consolidation into a single fund, an option not considered by government. Thedéen says there was simply no majority for any further change in the Pensionsgruppen, the parliamentary cross-party group that will decide on the reforms recommended by the Buffer Fund Inquiry. “It’s a classic political compromise.”

The points of principle agreed by the Pensionsgruppen allow for the introduction of a principal as the ultimate asset owner, similiar to the model employed by the Canadian Pension Plan Investment Board.

Thedéen, who prior to his appointment in 2010 spent time in finance in the public and private sectors, becoming deputy director general of the debt management office, Riksgälden, and president of Nasdaq OMX in Stockholm, says the prudent person approach should introduce flexibility into the system.

He says the new approach should allow for greater infrastructure and real estate investments and speculates that the liberalisation could lead to increased returns. This is despite all but AP6 having exposure to real estate and some to farmland – AP2 has jointly acquired US properties alongside the KRW425trn (€290bn) South Korean National Pension Service and in 2011 committed $250m (€177m) to an agricultural land joint venture with the $564bn TIAA-CREF.

“It’s actually an anomaly, the whole setup today,” he says when asked about real asset holdings, which he describes as more costly investments. “Generally speaking, compared to some other funds, they have a lot in listed equity and a lot in high-liquidity bonds. That’s why I think we will have more of a shift to less liquid assets.”

The Pensionsgruppen proposal allows for one of two potential reforms, he argues. “One is to have three exactly similar funds, that could organise the costly investments between them in some kind of co-operation,” he says, citing the current joint ownership the SEK 87bn real estate company Vasakronan as an example, albeit imperfect. “They could own a joint vehicle for taking care of the cost of investment.

“The other alternative is for two of the funds to have exactly the same mandate, they cannot invest in things other than listed equity and bonds, and the third fund should be devoted to the costly investments – infrastructure, real estate, private equity – direct investment in companies,” Thedéen says.

The introduction of a reference portfolio as a way of a collectively benchmarking returns – rather than allowing the five funds to have individual targets – is also an area lacking in detail, but the state secretary says that it should be “specific enough to evaluate their investment, but not so specific to basically steer the investment on an indexed term”.

He also says that government could retain an element of control – even in a new system that would see the principal sitting within Pensionsmyndigheten, the Swedish pension agency – through what would be an overall investment cost ceiling imposed on the system.

“If they only wanted to go for real estate, that would be extremely costly – if they have a cost ceiling, they can’t do that, they’d have to go back to the authority or the government and ask for that,” he says. “So that makes it possible to have some steering from the higher level to say that we’d like to have these funds very lean and mean, or we would like to have more innovation, more cost.”

Thedéen says the CAD201bn (€136bn) Canada Pension Plan, which delegates investment responsibility to the Canada Pension Plan Investment Board, could be one “good example” of what he sees an extensive operation – with a properly-calibrated reference portfolio allowing for “a more flexible, and maybe, more innovative” buffer fund system.

The core message of Langensjö’s recommendations – which Thedéen hopes to have legislated for within a year and implemented in two – proposing an overarching goal for whatever remains of the current system, was certainly received by the government.

“We found it very hard, and also Mats Langensjö found it very hard, that we should have four different targets for the same task, “ he says. “It is one pension capital, for one pension system, for one Swedish people, basically.”