CIO Richard Gröttheim downplays his fund’s recent stellar performance, explaining that conviction in strategy should always trump short-term gain. Pirkko Juntunen reports
In today’s low-equity-return and low-interest-rate environment, most institutional investors would be shouting from the rooftops about an annual risk-adjusted return of 30% over the past three years. But Richard Gröttheim, chief executive of AP7, the default option in the Sweden’s PPM defined contribution system, takes a more cautious approach.
At a glance
- Assets at SEK265bn (€28.3bn) as of end-Feb 2015, compared with SEK253bn at year-end 2014.
- Returned 31.1% in 2014 (34% in 2013).
- Annual return since inception 9.4% compared with 6.2% for the PPM.
- Sustainability within private equity will be AP7’s inaugural ‘theme’ until 2016.
He is naturally happy about the returns but emphasises the importance of focusing on the long term. “As a long-term investor, we are here to add value over to the savers over a long time period and not just a few quarters or years. We work towards optimising returns and we continuously evaluate whether the strategies work. Part of being a long-term investor is accepting times of underperformance as long as the strategy works and we know the reasons behind it. So expecting more than 30% per year is not realistic in the longer term. If we are able to achieve 8-9% per year over several decades, we are happy.”
It is inevitable that annual returns above 30% get much more attention from the media and rivals but Gröttheim is aware that the same is true for years of muted performance. Irrespective of returns, he is cautious when commenting on quarterly and annual numbers, arguing that the market will inevitably work against them sometimes. The short-term focus of the media and quarterly reporting cycles are not always helpful, he adds, which is why he tends not to blow his own trumpet.
During 2014, the SEK265bn (€28.3bn) fund returned 31.1% for its main equity portfolio, having returned 34% the year before. The fund employs derivatives to boost performance by using up to 50% leverage. “Our base is a global equity portfolio, and using leverage, instead of the traditional asset allocation, is a smarter way of achieving long-term returns,” Gröttheim says.
Apart from OTC derivatives, mainly total-return swaps, the fund’s active securities-lending programme through its custodian, Bank of New York Mellon, also boosted returns. The main building blocks of AP7 are the equity and bond funds in the Såfa default fund option. The proportion of equities and bonds are automatically adjusted as the saver ages, with the allocation to equities falling over time.
Premium pension system reform
The Swedish premium pension system is now approaching its 20th anniversary. Since its launch there has been much debate about reforming it.
Members continue to lack the skill or interest to select funds and, with AP7 outperforming the majority, some wonder whether it might be a good idea to let CIO Richard Gröttheim and his team manage all the assets in the premium pension system.
Stefan Engström was commissioned to investigate the system and what could be improved. In his report published in May 2013, he came up with two alternatives for change which address three main issues: the wide discrepancy in returns of the funds in the system; the large number of funds (more than 800); and high costs.
The first alternative was to leave the current number of funds in place but emphasise the default fund, AP7, as a good option for those who cannot or do not want to make a choice themselves. In addition, cost and risk limits would be introduced that could lead to a reduced number of funds, a tighter range of returns and less inequality in pensions, the result of a lack of financial knowledge.
The second alternative would be a radical overhaul, with up to 10 selectable funds with internal and external asset management capabilities.
These funds would have uncorrelated risk levels and investment focus, and be selectable by the individual savers. The default option would remain. Should the returns between different individuals vary to such an extent as to be considered a problem, there is the option of having one giant fund.
The first alternative emphasises freedom of choice, but the drawback is higher costs and inequality in pension returns. The second alternative would address the three above-mentioned issues but without freedom of choice.
Engström’s proposals went out for industry consultation and were debated by the five-party Pension Working Group (Pensionsgruppen). In July 2014, the government commissioned a report on what reform would mean. As a result of the election in September 2014, there was a change in government, with the centre-right alliance losing out to the left-of-centre red-green block, and all progress has since stalled.
Såfa returned 29.3% in 2014, compared with the 15.1% returned by the privately managed funds within the PPM. Since inception, the fund has returned 9.4% annually. The cumulative return since 2010, when AP7 adopted its current strategy, is 103.1% compared with 46.1% in the PPM.
In 2014, AP7 decided to focus on specific themes each year. The inaugural theme was sustainability within private equity, which will be the focus until 2016. The fund invests 3% in private equity, and Gröttheim concedes that sustainability within the asset class lags that of listed equities. “AP7 wants to be at the forefront in the field to increase openness and transparency.”
All the AP funds in Sweden have an ethical and environmental focus, and AP7 is no exception. In particular, it has been working on how its investments can contribute to lowering carbon emissions.
Currently, one-fifth of AP7’s private equity investment is in cleantech stocks, and it aims to increase that to one-third. “We see the potential for this sector in the future,” Gröttheim says. “So far, it is a nascent industry, so performance has yet to show consistency. But we are convinced this is a future industry that will grow and eventually become one of the drivers of the equity market as others adopt their technologies.” Investments include Tesla, the electric automobile manufacturer, and Solar City in the US.
By focusing on a few themes at a time, the fund believes it can get a more in-depth insight into complex areas relevant to the fund’s investments. The themes are selected based on their relevance to AP7’s portfolio, whether the fund can make a difference in the field and whether it is able to find appropriate partners.
The themes influence the fund’s priorities and have consequences for its active engagement and voting. They also increase co-operation with other actors to influence standards and norms within a specific area. Each year, a new theme will be added, with three themes running parallel from 2016 onwards.
In 2014, AP7 also set out to create a more efficient organisational structure. Gröttheim put in place four distinct management and co-ordination groups with responsibility for asset management, risk management, administration and strategy. Particular focus was placed on compliance and risk, with the fund implementing a new risk-management system that will facilitate the development of alternative strategies within active and tactical asset management.
That same year, AP7 also terminated mandates for Mesirow and Carnegie, which managed long/short equities for the fund. It is currently going through a five-year review of its global equity managers State Street Global Advisors, Handelsbanken and Northern Trust Global Investments, which manage the fund’s global equities, which total 90% of the assets, on a passive basis.
Gröttheim takes pains to emphasise that the tender process is part of a regular review and in no way suggests that AP7 has any issues with the current managers, all of which have been invited to re-tender. “It is good to look at competition and what is out there,” he says. “We expect to make the appointments after the summer.”
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