Nordic Asset Allocation: Finding the answers from within
The increased use of internal investment resources by Nordic investors is a challenge for asset managers, according to Albert Løchte Jensen
Nordic investors are faced with a number of external factors, which, in combination with their general preferences, have a strong impact on how they organise themselves and manage their investments. This has been highlighted by the Kirstein Nordic Inteligence 2016 report.
Regulatory structures and changes are at the top of many investors’ agenda and the investment implications are profound. Together with the competitive landscape, this regulatory pressure has led to consolidation among pension funds, where smaller investors are merging with larger entities, if not entirely then at least in administrative or investment setups.
These external factors and organisational changes, along with increased investor sophistication, are changing the ways investors conduct their investments. This applies not only to asset allocation but also, not least, to the ways investments are being structured and how operational management is carried out.
Looking at the overall asset allocation of the Nordic investors at the end of 2015, the allocation towards equity investments is more or less on par with the previous year and accounts for close to one-third of the total regional assets. This relatively high level is in line with a continuously overall high interest in traditional equity products across the region.
Furthermore, as Nordic investors continue to reduce allocations to fixed income in favour of higher yielding asset classes, the relative share of alternative investments continues to increase. The increasing allocations to alternatives accords with the large number of funds registered in the asset class and can be explained by investors’ increased search for yield.
Norwegian and Swedish shifts dominate
On a country-by-country basis, the most notable changes to asset allocation occurred in Norway and Sweden.
Among Norwegian investors, equity allocations increased by seven percentage points to reach 31% of total assets, which was led by non-life investors reducing their exposure to fixed income.
In Sweden, the most noteworthy change was found within the allocation towards alternatives, which has increased by seven percentage points since 2014 to a current level of 19% of total assets. This increased allocation towards alternatives was highly affected by the AP funds moving away from traditional asset classes.
Among Danish investors, the allocation to equity investments decreased in favour of alternatives. This fall was led by several industry-wide pension funds and life insurance companies reducing their exposure towards equities. Finnish investors did not account for any significant changes in terms of asset allocation. As of last year, the Finnish investors have 25% of their assets tied up in alternative strategies, whereas the allocation towards fixed income remains low at 43%.
From the asset managers’ points of view, it is of utmost importance to be able to identify the share of accessible assets. Investors who look attractive, due to both size and asset composition, may in fact be irrelevant, since all assets are managed internally or because the entire portfolio is passively managed. In-depth interviews and survey data from our research suggest that more than 60% of the assets in the Nordic institutional investor market are managed internally, and this share will increase.
The Kirstein research suggests that internal management is increasingly preferred due to lower costs, increased transparency, higher control and a more holistic approach to investments where portfolio biases can be balanced. It is, and has been for some time, common to manage what are considered ‘plain vanilla’ assets – such as domestic fixed income and equity – in-house due to the low resource requirements.
Within alternatives, in-house management is not as widespread. This is primarily due to the substantial resources these investments require. However, more investors have ambitions to increase internal resources in this area, which has resulted in some, especially larger investors, building significant in-house teams to manage alternatives.
The Kirstein Nordic Intelligence report found a clear correlation between an investor’s size and the proportion of internal management. In particular, the larger life insurance companies, industry-wide pension funds and public pension funds in Sweden and Denmark tend to have a higher level of internally managed assets. The focus on fees is still the key reason why internal management has become popular among these larger investors.
“Investors’ need to reduce costs, in some instances, has led to higher levels of passive or rule-based management which is easier to manage in-house compared to fundamental active management”
When looking deeper into the different asset classes, we find that, internal management has increased in equity in recent years, as investors’ need to reduce costs, in some instances, has led to higher levels of passive or rule-based management which is easier to manage in-house compared to fundamental active management. The high degree of internal management is visible in local equity, as investors have easy access to the market and the resource requirements are lower. Global strategies, however, have a higher degree of external management since these strategies require greater resources. Nevertheless, the emergence and popularity of rule-based management has affected the increase in internal management, which is visible among several large investors from the public pension sector to life-insurance companies and occupational pension funds, which manage large passive and rule-based portfolios internally.
The highest share of internal management is found within fixed income. This is related to the fact that a high share of local fixed income is managed internally, as many investors feel comfortable in this area. Investment-grade corporate bonds are, unsurprisingly, managed internally, not least by the largest investors. The use of internal management in other credit products is dependent on the asset class, since there are differences in the complexity of managing products.
The use of internal management in alternative investments remains moderate yet, ambitions are high. Several large institutional investors are engaged in setting up internal teams with the purpose of investing in single funds, direct investments or co-investments. This movement towards funds and direct investments has been supported by lower fees. Investors who have limited resources will often invest on an ad-hoc basis, often in co-investments or through funds-of-funds. Across the Nordic region, we find that there are key regional differences, which are described in our most recent study.
The increased internalisation of Nordic assets has shifted the dynamics of clients and what they are looking for. Asset managers need to be able to illustrate the extent to which they are a valuable addition to the investors’ internal management across asset classes.
Therefore, it is fair to state that the increasing use of internal management among Nordic investors is a somewhat challenging trend that the asset management industry should be highly aware of. In our Nordic Intelligence 2016 report, we have identified a number of parameters from implementation to management to service, which are important to carefully consider.
Albert Løchte Jensen is an investment consultant at Kirstein Intelligence. The Kirstein Nordic Intelligence 2016 report is available from firstname.lastname@example.org