Six major pension investors chart the risks and opportunities ahead as the world moves into a recovery phase

The beginning of a massive vaccination campaign in Europe in the final days of 2020 means that the end of the COVID-19 pandemic could be in sight. Assuming a successful rollout, a continued slowdown of infection rates and little damage from a potential third wave, this year the hope is that economies will start to grow more strongly and consistently following the wild swings in economic activity in 2020.

While by no means certain, a secure trajectory would bode well for institutional investors, whose portfolios show limited damage from the market crash of March 2020. Markets recovered steadily thanks to massive stimulus packages by central banks and governments, even if asset prices have raced ahead of economic fundamentals. 

Indeed, market valuations would suggest that the recovery from the crisis will be exceptionally strong. As policymakers carry on in their quest to support the real economy, investors are left to their own devices in determining whether markets are overconfident and where opportunities and risks may lie.

In this extended version of our ‘On the Record’ feature, IPE asked six prominent pension investors to comment on how their strategies are changing as they enter a crucial phase of the recovery process. 

This requires reflection not just on the market environment, but also on the broad impact of the pandemic and the role of investors in bringing about a more sustainable future. Investors also raise questions about the health of the financial system, after years of cheap money fuelling a sharp growth of the global debt-to-GDP rate.  CSM

AP1Dynamic and liquid

• Location: Stockholm, Sweden 
• Assets: SEK355bn (€33bn) 
• National pension buffer fund 

Key points

  • Kept increasing exposure to equities significantly since the pandemic 
  • A constructive view of 2021 based encouraging macroeconomic indicators
  • Cautious on illiquid assets, aims to maintain a liquid portfolio 
  • Divested from fossil fuels in liquid portfolios, intends to transform make private equity allocation sustainable 

Första AP-fonden (AP1), one of Sweden’s national pension buffer funds, was in a neutral risk position at the beginning of 2020, having enjoyed particularly strong results for 2019. “We saw an appetite for risk in the markets, and thought we would be compensated for taking more risk, albeit at a lower level historically,” says Mikael Angberg, AP1’s CIO.

“We also approached 2020 with an ambition to focus on dynamic asset allocation, which means we were prepared to react and make investment decisions based on changing market conditions.”

Angberg says that the fund had been cultivating a dynamic asset allocation approach but last year it was planning to ramp it up. That was facilitated by AP1’s strong liquidity profile at the time.

“Then the pandemic hit, and those preconditions served us well in terms of mitigating the drawdowns. We were also able to buy back risk according to a pre-defined gameplan, when we felt that it was reasonable to do it,” says Angberg.

Mikael Angberg

The CIO says that the main scenario the fund was contemplating was a w-shaped correction. As the correction took ‘v’ shape very quickly, the fund bought back the equity risk it had sold before the pandemic hit.

Angberg says: “Since then, we have been getting gradually closer to our risk budget by buying mainly equities. We bought the capital equivalent of 20% in equities, which is an unprecedented shift. As a result, we have had a very good return for 2020.”

The figures have not been made official, but the CIO says he is satisfied with the overall return for the fund.

Having started 2021 with a high allocation to equities, the fund will continue to focus on being dynamic and liquid.

This year, the AP1 board is likely to raise the long-term risk budget, partly reflecting the upcoming changes to the AP funds’ regulatory framework. But Angberg says that the fund holds a constructive view of the near future as well.

“Clearly, there are challenges ahead. The current dislocation between markets and the real economy is a conundrum, which forces us to maintain a strong liquidity profile.

“The macroeconomic indicators that matter are improving, in terms of their absolute levels, but we keep a close eye on second-derivative effects.

“However, the macro data point to a strong recovery from a growth perspective. That is our base case, despite the uncertainty,” says the CIO.

In contrast to many institutional investors, Angberg is cautious about private markets. He says: “I am really starting to question the wisdom of piling into private markets. That is partly due to our need to maintain liquidity. We keep a portion of the portfolio illiquid, but we need to be able to react swiftly to changes in the liquid markets.”

“I am sceptical about the size of the liquidity risk premium available in private markets. Furthermore, the fact that private market assets are not marked to market could potentially hide the actual portfolio dynamics.”

For the longer term, Angberg echoes the sentiment of many in the industry who fear that global debt levels are unsustainable. “We keep borrowing from the future, just like we have been doing since the financial crisis, which is why our long-term capital market assumptions do not read well at all,” he says.

Angberg says that the COVID-19 crisis did not lead to changes in AP1’s sustainability strategies, which was well advanced. But 2020 was an eventful year for the fund in terms of responsible investment.

The fund implemented the board’s decision to divest from fossil fuels, which predated the pandemic. “We also launched an initiative to essentially transform our private equity exposure, towards assets and projects that have a positive sustainability impact. We do not necessarily like the industry connotation of the world ‘impact’, but we are effectively trying to create an impact portfolio out of our private equity allocation,” says Angberg.

“It is going to take some time, but gradually we will be investing the net proceeds in sustainable private equity projects.”  CSM

APG: No walk in the park

● Location: Amsterdam, Netherlands
● Assets: €560bn
● 4.7m participants 
● 7% 25-year annualised return 
● Participant owned pension manager serving eight Dutch pension fund clients ranging from the public fund ABP to APG’s own staff pension fund 

Key points

  • Three-stage approach to the pandemic focused on liquidity, portfolio adjustments and pipeline for illiquid assets
  • Working towards digital due diligence
  • 62 new investment professionals recruited in 2020
  • Gradual move towards fiscal policy expected to bring less focus on monetary policy

 APG Asset Management’s chief investment officer Peter Branner and his team took a multi-stage approach as the extent of the coronavirus hit. 

First off, this included ramping up liquidity and client communication; a second stage involved portfolio trimming and structural changes with all investment teams calibrating portfolios towards the expected outcomes from lockdowns and travel restrictions. The third part involved concerns about illiquid investments with measures to improve the investment pipeline.

This all happened in parallel with an extensive recruitment drive, boosting the investment team by more than 15%.

“I’ve been around, so I’ve seen many crises in my career and they all sooner or later turn into a liquidity crisis,” Branner comments. “We raised our liquidity cushion quite a bit to make sure we could accommodate our needs and we set certain thresholds for where the VIX should be before we would say we were back at normal levels and can take another look at liquidity.

“You can raise liquidity in many ways,” the CIO notes. “You have assets you can liquidate or like us raise liquidity via the derivative portfolio. Like all insurances hopefully you’ll never need them.” The VIX will remain a key proxy for market stress.

Other than building up liquidity, APG used what it calls “smart” balancing techniques during March and April 2020, which Branner says benefited the results substantially. 

The second stage involved a more extensive exercise with all investment teams to determine medium and long-term financial trajectories within scenario parameters and taking opportunities.

“Up until the second quarter many portfolio adjustments were made across all asset classes, from trimming to larger changes, and also to re-allocate to some companies that had been quite expensive before the crisis.”

APG’s clients (and owners) include the Dutch public employees’ pension fund ABP and others like BpfBOUW, the sector scheme for the building industry, and communication was paramount both during the initial phase of the crisis and during the summer.

After the summer Branner’s team, which manages about 72% of the assets internally according to the 2019 annual report, prepared extensive client reports, including detailed portfolio positioning.

Peter Branner

Emerging issues involved investing in illiquids, an area of increased focus for APG and its clients. Signature additions to the portfolio in recent years have included 2019’s acquisition of a 36% stake in Brussels Airport from Macquarie in a consortium with Australia’s QIC and Swiss Life.

Branner identified early on in the crisis that traditional due diligence would become problematic short term and didn’t really know how long that could last. “So our pipeline within illiquids was a worry for me,” the CIO says. 

“From the very beginning, and my colleagues are probably getting a little bit tired of me on this matter, but such an important part of illiquid investments is that you are in control of a fat pipeline so that you have opportunities to invest in. That was a concern and still is because our clients’ allocations are ramping up.”

For APG the focus has been on what Branner has termed DDD – digital due diligence – in recognition of the fact that significant parts of the investment process needed to be rethought given restrictions on travel and meetings. 

Naturally there has been emphasis on top-ups to existing structure and holdings, where due diligence has already been done, but other sometimes substitute solutions have been applied, such as asking trusted parties on the ground in different locations to perform certain tasks. 

“It’s an area that’s still evolving and the concern is not gone but I’m very pleased to see how responsive all investment teams have been to this challenge and in trying to mitigate the problems with more digital ways of doing things and thinking outside the box.”

Branner welcomes fiscal support packages in Europe, the US and elsewhere, not least as a mechanism to quell the risk of social unrest arising from the economic fallout from the pandemic. He says: “I think it’s really good in our economy to see fiscal policy starting to play a bigger role, and I also think that the new administration in the US may take some good steps in that direction.

“On the one hand monetary policy obviously has a risk of asset bubbles building. There has also been a lot of inflation concern among investors and these are of course sub scenarios in how we look at our overall risk picture of the world. There are certain risks but I would say that to expect a lot of inflation in our economy in the shorter term is not our main scenario.”

The CIO sees accommodative monetary policy for the longer term. “In the spring, a lot of people got the equity markets really wrong because they forgot the power of the central banks. Take a close look at the central banks and if you think they’re going to change their policy dramatically you probably need a dramatic reaction in your portfolio. If you think they have a long-term approach to what is going on, you can probably do the same. And I am more on the latter.”

Somewhat counterintuitively, APG has added some 62 investment professionals to its teams across its offices in Amsterdam, New York and Hong Kong in the last year or so, many to support investments in illiquids. This has involved a conveyor belt of digital onboarding and Branner has online coffee breaks with all new joiners. One-to-one meetings have in some cases taken the form of walks outdoors.

Branner is keen to emphasise continuity with pre-pandemic trends, which include digitisation, also within portfolio management itself: “I didn’t have to do any sort of strategic changes in the way we look at the world and our clients also didn’t ask us to do that.”

Sustainability is also on a sustained trajectory that was set well before the crisis: “I do not have a single investment committed without an element of responsible investing as part of the decision matrix,” the CIO comments.  LK

Danica PensionStrategic and tactical

● Location: Copenhagen, Denmark
● Assets: DKK500bn (€67bn)
● 800 staff
● Commercial provider with both market-rate and traditional average-rate pension products

Key points

  • Expects economic upswing gathering pace in 2021 backed by vaccine rollout
  • Will stick with long-term strategy but focus keenly on steering liquid assets through the volatility
  • Looking to step up high-yield credit and equities weightings
  • ESG now a decision parameter in every investment

Denmark’s Danica Pension is expect ING 2021 to result in positive investment returns overall, in spite of the economic effects of lockdowns and pandemic-halting restrictions.

The Danske Bank subsidiary’s CIO, says the house view is that an economic recovery will pick up speed during the year, supported by the rollout of COVID-19 vaccines. 

Nevertheless, he says uncertainty remains and the coronavirus still has the potential to create a “really sour mood” in financial markets.The economic recovery could get stuck, according to Kobberup, if government-imposed restrictions around the world are tightened or lengthened.

Overall, Danica Pension’s investment plan is to stick to its long-term strategy while being focused – as it was in 2020 – on selection and managing the liquid part of the portfolio tactically.

“That’s what we learned in 2020, and that’s the way we came through that year quite well. The equity market is always volatile, but last year it has been more so between each sector, and it’s been very important to be able to move well.” 

Poul Kobberup

“We are a long-term investor and here for the long run, so we believe in our strategic allocation. And in fact what we found in our work with that process late last year, is that the expected returns from the different asset classes are pretty similar to what we expected the previous year – despite Covid,” he says.

Kobberup advocates sticking to an investment strategy that ignores the effect of COVID-19, while dealing nimbly with the short-term market volatility.

“You should be very focused on your liquid assets and especially your equities, where you need to look at the opportunities from COVID-19 and also ex-COVID-19,” he says.

The team is looking to make a slight increase in the portfolio’s proportion of higher-risk assets, probably high yield or equities, because of the continued low-yield environment.

“There’s really not much yield coming from the traditional fixed-income area, but you still need fixed income in your diversified portfolio to keep your risk levels similar,” he says.

Danica Pension has a portfolio consisting largely of directly-held domestic property assets, which Kobberup says performed satisfactorily in 2020.

“We haven’t made huge changes here. Next year we might look into opportunities abroad if they arise,” he says.

Kobberup says ESG in general is now playing a bigger role for Danica Pension’s investment operation.

“It is on our minds and a decision parameter for us every time we make an investment – things have moved a lot in the last few years,” he says. Danica Pension has targets to include further green investments in the coming years, having doubled its investments in the green transition in 2020 to above DKK20bn.

When he steps back to look at the bigger picture for investment prospects, Kobberup is confident, despite the challenges.

“In general I believe that things will get back into their stride, and I have quite a positive view about the coming years. With the right investment policies, you should be able to manage it,” he says.  RF

INARCASSALong risk, with caution 

● Location: Rome, Italy 
● Assets: €12bn 
● First-pillar pension fund for engineers and architects

Key points

  • Bought equities into the recovery after the March 2020 crash 
  • Has implemented a risk overlay strategies to manage the uncertain times ahead
  • Disconnect between markets and real economy represents a concern
  • Pushes through with plans to address sustainability of private markets portfolios

After registering particularly positive results for 2019, Italy’s Inarcassa approached 2020 in a defensive position, says CIO Alfredo Granata.

The €12bn first-pillar fund for engineers and architects had left ample room within its risk budget before the pandemic hit, which put it in good stead for the months to come.

“At the end of February, our equity allocation was between 15% and 20%, which is significantly lower than our strategic allocation of 28%,” says the CIO.

“We also had a quarter of the portfolio allocated to private markets. That meant that while we experienced drawdowns on our listed assets, our private markets were still offering positive returns, because of the time lag with which they are valued.”

After the March crash, the fund started buying into equities, gradually moving towards the strategic allocation. Granata credits Inarcassa’s board with the necessary efficiency of decision-making when it came to taking advantage of dislocations.

“As a result, our performance during 2020 was in line with our expectations at the end of the previous year, which certainly did not take into account the effects of a pandemic,” says Granata.

This is also despite the additional liquidity needed to provide assistance to members who saw their income plummet either through contribution holidays or actual subsidies.

After a positive conclusion to a difficult year, the CIO says that the fund has begun 2021 with a much more cautious perspective on things and, again, a defensive stance. However, since the risk budget has been used almost in full the fund had to implement other solutions. 

Alfredo Granata

“We are wary of the disconnect between financial markets and the fundamentals of the real economy.

I am sceptical that this disconnect can be resolved in a way that is favourable for investors,” says Granata.

“For that reason we have implemented a number of risk overlay strategies to protect us from future drawdowns. In particular, we hold futures on equity and other indices and to offset our exposure to currency risk. This way, we have significantly reduced our beta exposure.”

With regard to the disconnect between markets and the real economy, Granata envisions that macroeconomic data could surprise on the upside, particularly if successful vaccination campaigns avoid more lockdowns. However, he says that the likelihood of another market correction is high.

But Granata, like his peers, sees the pandemic as a boost to a number of structural changes in our economy. Sustainability is one of such key changes.

He says: “There may be market bubbles that are about to burst, but COVID-19 is speeding up change. There are businesses and individuals that will benefit from some of the changes, and it will be those that focus on sustainability, not just environmental but social as well.”

The fund continues on its sustainability journey. Its current focus is on engagement with investee companies in the liquid part. But Inarcassa is taking significant steps in addressing sustainability issues within its private markets portfolio, according to Granata.

Weeks before the onset of COVID-19, the fund also launched a new association, Assodire, which brings together like-minded Italian institutional investors. The aim of the association is to discuss and develop sustainable investment policies and initiatives.  CSM

KZVK-VKPB: The beginning of a new cycle

● Location: Dortmund, Germany
● Assets: €14.7bn 
● First-pillar pension fund for church employees and clergy 

Key points

  • The fund raised its allocation to equities, private equity and real estate
  • It maintains a strong liquidity position to deal with further volatility 
  • No allocation to illiquid credit assets due to the relatively low return profile
  • Sees sustainability as an evolutionary process

Staff at KZVK-VKPB were surprised by the speed of the recovery after the March 2020 crash, according to Axel Rahn, head of investments.

“Capital markets were looking beyond COVID-19 as early as April and thanks to the determination of central banks and governments in dealing with the economic fallout of the pandemic, markets recovered very quickly,” says Rahn.

“As long-term investors we do not seek to react particularly quickly to changes in the market environment or focus on single asset classes. Our investment process is gradual.”

However, we saw the crisis as the beginning of a new cycle, and decided to raise our allocation to equities to an overweight, which we did during the second half of last year, explains Rahn. 

He expects that the long-term effect of central bank and fiscal stimulus will be, on one hand, an indefinite extension of the low interest rate regime, and potential reflation on the other. 

“When the pandemic is over, people will want to shop, go to the cinema, eat at restaurants and travel again. That could cause reflation, which could put further pressure on bonds. That is why we are happy with our current overweight on equities,” adds Rahn.

For the same reasons, the fund has also raised its allocation to private equity and real estate. The fund favours these asset classes compared with illiquid credit assets, due to the more favourable return profile. 

Axel Rahn

Rahn says that while the fund is overweight in risk assets, it has simultaneously tried to ensure ample liquidity within the portfolio. 

“We handle liquidity as an asset class, and have decided to raise our exposure to it, to serve as a buffer during the liquidity crisis such as the one experienced by the bond markets in March,” he says. “We find that volatility spikes such as the March 2020 one, and the liquidity stress that they cause, have become more frequent over the past two decades.”

During those times, the usually negative correlation between bonds and equities inverts and it is essential to have liquidity available.

On the sustainability front, the fund is going through an evolutionary process, says Rahn. The fund has appointed a head of sustainability and has integrated ESG reporting on all its portfolios. It has also started reporting on the carbon footprint of its portfolios. 

Rahn says: “We discuss ESG issues regularly and are trying to evolve as best as we can. However, we are somewhat frustrated by the fact that these days everyone is trying to get a foot in our door using ESG as a label for their products. And at the same time, there is much disagreement as to what ESG means.”  CSM

USSDry powder at the ready

● Location: Liverpool and London, UK 
● Assets: £66bn (€73.5bn) 
● DB/DC scheme for UK universities sector  

Key points

  • Took advantage of price dislocations in public and private credit markets in 2020
  • Adjusted exposure to equities when market was over-discounting negative news but remains cautious for 2021
  • Strategic allocation in place but with dry powder to invest counter-cyclically
  • Has increased its responsible investment efforts, announcing exclusions of tobacco, thermal coal and controversial weapons

The £66bn (€73.5bn) Universities Superannuation Scheme (USS), the UK’s largest pension fund, is undergoing its triennial valuation process in challenging conditions, to say the least. The higher education sector has been hit particularly hard by COVID-19, but the fund’s sponsoring employers have been asked to support the reduction of the growing deficit by raising contribution rates.

Mirko Cardinale

In the 12 months to March 2020, the fund’s deficit grew from £5.7bn to £12.9bn, due to the fall in interest rates, and last September, USS warned that the deficit could rise further.

Investment performance during the latest financial year was negative, but the fund’s highly diversified DB portfolio has returned 6.19% a year for the past five years. 

Mirko Cardinale, head of investment strategy and advice at USS Investment Management, says that last year the fund stuck to its long-term strategy, but tried to take advantage of price dislocations.

Cardinale says: “As a long-term investor whose sole job is to enable USS to pay the pensions that have been promised, USS Investment Management’s role was to look through the short-term volatility created by COVID-19 and focus on managing the assets in line with our long run objectives. 

“However, we believe that a long run investor must also take advantage of market opportunities when they present themselves. In fact, substantial value added can be generated by accelerating the timing of a planned allocation shift to take advantage of more attractive market pricing.” 

He says USS has focused on acquiring high quality credit assets in a coordinated effort across private and public markets. “We took advantage of much wider spreads in the wake of the COVID-19 shock but also considering that a build-up in credit exposure is consistent with the long-term evolution of our investment strategy,” he says. 

“We also took advantage of more attractive pricing to increase our exposure to global inflation-hedging assets, which helps better hedge one of the key liability risks. We also adjusted our equity exposure when we felt that the market was over-discounting the bad news but, that said, we have been cautious in our allocation as we recognise the long-term risks to equity holders posed by the new economic reality.”

Given the pressure on the funding ratio, USS has to avoid a pro-cyclical investing as much as possible. Cardinale says: “Our strategic asset allocation must be appropriately constructed to be aligned with long-term risk appetite set by the trustee, but we also ensure that we have enough ‘dry powder’ to selectively dial up as opposed to dial down risk in the bad times, when many investors can be panicked into overreaction.” 

That approach meant that during the COVID-19 crisis USS did not take risk off the table. “Instead we took gradual steps to increase our exposures in a counter-cyclical fashion, particularly in the credit space,” adds Cardinale. 

“Meanwhile we also behaved as good corporate citizens, providing help and support to our investee companies where we are direct investors, such as in our property portfolio. In this way we believe we can play our part in providing support towards a recovery.”

During 2020, USS also increased its responsible investment efforts. The fund announced a series of sector exclusions, where it believes returns will be heavily impacted by regulatory and societal change over the coming years. These include tobacco manufacturing, thermal coal mining and controversial weapons.

He says the decision to divest from thermal coal was justified by a belief that markets have failed to value adequately the potential risks coal mining companies face. 

Pricing pressure as a result of an industry-wide focus on emission reductions and a decrease in the cost of alternatives cannot be mitigated by engagement, says Cardinale.

The divestment process will be carried out over the next two years across both the DB and DC sections, but the exclusions will be kept under review, and may be changed or reinforced over time, according to Cardinale. 

He adds: “As part of our scenario analysis modelling we of course take into account ESG factors such as climate change. Investing responsibly has been a core part of our philosophy for decades. This includes maintaining high standards of stewardship for the assets in which we invest and also ensuring a broad spread of investments that chime with these goals.” 

Among USS’s climate-related investments is £750m worth of renewable energy assets, including on and offshore wind. The fund is also a significant investor in UK water utility Thames Water.  CSM

Special report: Covid response