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Impact Investing

IPE special report May 2018


Plus ca change

One of the aims of arranging that the first four of the six AP buffer funds in Sweden have the same initial strategy was that putting the eggs in four baskets was considered less risky than putting them all in one.
Three-and-a-half years on, a study published by the ministry of finance in May has found almost total correlation between the individual strategies of the funds and a declining divergence from their respective strategies, indicating a low level of risk taking. Consultants Wassum are responsible for evaluating the funds’ performance.
“Four funds were set up partly for diversification purposes but the result is no diversification at all,” says Nicklas Fahlström, senior consultant at Wassum’s office in Stockholm. “The diversification purpose originated from the fact that the investment problem was not well known from the beginning when the AP-funds were restructured to fit in with the reformed public pension system. The reason for the similarity of the investment strategies is that the AP-funds have so far interpreted the investment problem in similar ways.”
“It’s absolutely crazy to give identical mandates because they will come up with the same reference portfolios,” says Mikael Nyman, editor of Swedish pensions journal Pensioner & Förmåner.
What makes matters worse is that the ALMs that have been carried out by some of the funds have produced answers that are quite similar in terms of strategy to those yielded by the initial ALMs.
“We are four funds with the same amount of money and the same objective,” says Ossian Ekdahl, head of strategy and corporate governance at the AP1 fund. “It is natural that in an ALM study that we will reach the same conclusion.”
He adds: “If the government had wanted to have a lot of diversification they should have given us different objectives.”
Swedish MP Bo Könberg, liberal party representative in the cross-party pensions implement group notes: “There is some value in that argument.”
But that doesn’t conceal the fact that system as it stands is very inefficient: the total cost of managing the four funds is around SEK800m (f86.7m) a year. “They have their own offices, they are extremely costly for what they deliver,” says Nyman. “You could easily just make one fund and sack the people in other ones saving three quarters of the cost.”
He cites the aim to encourage competition among the four funds. “But what happens is that they all deliver the index. If you really wanted index return you could buy it from State Street, costing us nothing. They say they will beat the index by 0.5% but is that sustainable?”
But while the costs of the system are a concern there are other underlying principles that need to be preserved. Crispin Lace is senior consultant at Watson Wyatt in Stockholm. “The whole point of these funds was to set public money aside and reassure people that its purpose is for old age pensions. A future government may say that it’s a bit short of cash and use the funds to build a couple of roads. It is much easier to do this if an internal department of the government is running than if it’s an external fund run by an independent group of people.
As for the issue of efficiency, there is no doubt that problems exist. “The funds have started to suck talent out of the market,” says Lace. “They’re all creating their own areas of expertise in a limited talent pool to create the best solution to the same problem.”
He adds: “Because of the talent issue they’re all looking over their shoulder, so it’s not surprising that we can see peer group behaviour. It’s horribly inefficient. We’ve seen this
in other markets so maybe we should have foreseen it in this one. So would it not be more efficient to pool
those resources and create a single solution? It’s obvious when you look back now but I wouldn’t have foreseen it then.”
What makes things worse is that a formal report that appears each year compares the performance of the funds and explains any differences in performance. “Because of that there’s a temptation to start doing something a bit similar to what the other funds are doing,” says Lace.
He adds: “Furthermore a fund may be loath to go out on a limb and try something different because if the strategy undershoots the index there might not be much understanding from the customer as to the reasons.”
Lace would like to revisit the original reasons for setting up the fund. If the objective is a hedge against the domestic economy and the Swedish economy happens to outperform the global economy, the fund will suffer successive falls in value.
“The fund has been doing exactly what you wanted it to do but the headlines are going to be screaming,” he says. “Vast amounts of government money are diminishing, while we would have been much better off if they had invested it in this country.
“I think that the strategies that they are following are broadly appropriate for the objectives of the fund.”
He adds: “I think the idea of the AP funds is very valid. I have a lot of sympathy for the government.”
Wassum is planning to discuss in detail possible solutions to this issue with the ministry of finance shortly. “We also encourage everyone involved, the ministry of finance, the AP funds and the national social insurance board to sit down and talk about this,” says Wassum’s Fahlström. “We want an open discussion.”
For now at least the issue of cost is being addressed. “Some authorities have questioned whether costs are reasonable,” says Könberg. “The demand that costs be reduced will be made more explicitly.”
Is this reassuring? Nyman is sceptical about the prospects for meaningful change. “Pension reform cannot be altered by parliament,” he says. “Nothing can be altered unless they agree totally so they are sitting in the committee having but nothing is changed.”

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