Investors: Where credit is due
A look at four pension funds’ credit investment strategies
• National pensions buffer fund
• Location: Stockholm, Sweden
• Total assets: SEK348bn (€36.4bn) (end June 2017)
• Fixed-income weighting: 33% (end June 2017)
• Corporate bonds and private debt sit in different sub-portfolios.
• Active investor in corporate bonds with minimum rating of investment grade
• Current AP funds mandate does not reflect Europe’s growing private debt market.
Sweden’s fourth national pensions buffer fund AP4 invests in both corporate bonds and private debt, with these two types of fixed-income assets sitting in different sub-portfolios.
Corporate bonds are seen as important investments within the pension fund’s fixed-income portfolio, while private credit sits with its alternative investments team.
However, the allocation of capital to private credit investments comes from AP4’s fixed-income portfolio.
The pension fund invests actively in corporate bonds, and has a minimum rating for these ‘investment grade’ assets. The exposure to private credit is small, but as a result of regulation rather than the fund’s view on the merits of the asset type.
“This is due to the current AP Funds Act – now under review – which does not reflect the growing private debt market in Europe,” says Tobias Fransson, head of strategy and sustainability.
Fransson explains AP4’s main considerations when finding credit suitable investments: “Every investment is assessed based on if it contributes to the long-term risk-adjusted return of AP4, and as a consequence benefits the Swedish pension system and our retirees.
“We invest in corporate bonds, financial bonds and green bonds, and all investments sit in the same portfolio and are assessed based upon expected return and risk,” he says, adding that the same requirements apply to all investments for the pension fund.
In private credit, AP4 invests indirectly and does not negotiate deals itself.
The outlook for corporate bond spreads relative to the general interest rate level is difficult to assess, Fransson says. “The more recent increase in general interest rate level has been accompanied by even tighter corporate bond spreads,” he observes.
AP4’s investment specialists continue to find private credit attractive in the current low-interest-rate environment.
Fransson says: “Increased exposure will depend on the current review of the AP Funds Act and if this will enable us to increase our exposure to private debt.”
In July, the Swedish finance ministry announced a number of draft changes to the mandate governing the investment of the four main national pensions buffer funds, AP funds one to four, including a new 40% ceiling on illiquid investments in place of the current 5% cap on unlisted instruments.
• Sovereign wealth fund manager
• Location: Oslo, Norway
• Total assets: NOK220bn (€23.5bn) (end of June 2017)
• Fixed-income weighting: 40%
Includes corporate bonds from Norwegian, Swedish, Danish and Finnish issuers
• Corporate bond holdings diversified by quality and duration
• As a long-term investor, fund can weather volatile markets
Norway’s Folketrygdfondet, which manages the Government Pension Fund Norway (GPFN), the domestic and Nordic counterpart of the giant Government Pension Fund Global (GPFG), invests in corporate bonds as part of its bond allocation.
The strategic weighting to bonds is 40%, against a 60% weighting to equities.
The corporate bonds it invests in are from Norwegian, Swedish, Danish and Finnish issuers or by issuers whose equity is listed on
a regulated marketplace in these four countries.
Folketrygdfondet can also invest in securities that are not included in the index and can take positions in issued corporate bonds with all credit ratings.
By the end of the June 2017 the fixed-income portfolio had invested as follows:
• Government debt 22.3%
• Other government related debt 3.6%
• Covered debt 26.9%
• Bonds issued by banks and financial institutions 18.8%
• Subordinated debt 4.3%
• Corporate bonds with rating BBB- or higher (investment grade) 23.7%
• Corporate bonds with BB+ or lower (high yield) 5.3 %.
The manager’s investments in corporate bonds are stipulated by the mandate and through the benchmark defined by the ministry of finance.
“Since we are an active manager, we will make investment decisions that deviate from the benchmark index, subject to the limits laid down by the mandate,” says Håvard Engøy, a financial analyst at Folketrygdfondet.
He says the fund manager tries to generate excess return relative to the benchmark
from a differentiated exposure mainly to corporate bonds, which is diversified in terms of quality (credit rating), and length (spread duration).
Folketrygdfondet also tries to create excess return from liquidity premia, he says. This means it invests in corporate bonds that are less liquid than the benchmark index.
“As a long-term investor we have less need for short-term liquidity and are able to sit through more volatile markets with a counter-cyclical approach,” Engøy says.
The GPFN’s relatively wide mandate allows it to have a diversified portfolio with exposure to different companies and sectors with higher spreads compared with the benchmark.
Portfolio managers are therefore free to pick issuers with different credit ratings, which requires thorough credit analysis of the issuer and the loan agreements.
Engøy says Folketrygdfondet emphasises the importance of sound credit research to avoid losses, and considers it an important part of the contribution to excess return.
“In the management of the Government Pension Fund Norway, the aim is to achieve the highest possible return over time and to achieve this goal Folketrygdfondet considers corporate debt investments to be an important part of our investment universe,” he says.
• Pensions insurance company
• Location: Helsinki, Finland
• Total assets: €38.5bn (end June 2017)
• Fixed-income weighting: 33% (end 2016)
• Invests in both public and private credit; larger share allocated to public credit
• Allocation to credit varies depending on market conditions
• Pensions insurer lowered fixed-income allocation in 2016 strategy review
Even though Finland’s second-largest pensions insurance company is strategically cutting its exposure to fixed-income investments, CIO Mikko Mursula stresses the importance of credit investments in the asset mix.
“Ilmarinen is an institutional investor with the aim of diversifying its portfolio by, for example, geography and asset classes, and we invest both in public and private credit with a larger share allocated to public credit – that is, corporate bonds,” he says.
“Investing in credit is important in forming an optimal composition in portfolio, therefore it may be seen to fit well in our portfolio. Of course, the share of credit varies over time depending on market conditions.”
At the end of June 2017, Ilmarinen’s holding of public corporate bonds amounted to €4.1bn or 10.6% of the institutional investor’s overall assets of €38.5bn.
As part of its updated investment strategy which was set out in 2016, one of the key changes Ilmarinen made to investment was to include a decreasing proportion of fixed-income investments, making way for increasing allocations to real estate, infrastructure and listed equities.
The allocation to fixed income had already fallen from 41.1% to 33% at the end of 2016, according to its annual report.
The proportion of corporate bonds within the fixed-income portfolio has also fallen slightly between 2015 and 2016. At the end of 2016, 65% of Ilmarinen’s fixed-income portfolio was in corporate bonds, whereas in 2015 corporate bonds made up 67.4% of the portfolio.
When negotiating credit deals or finding suitable investments to sit within this asset class, Mursula says Ilmarinen analyses credit opportunities to optimise the risk-reward ratio.
“We also take into account our views for forthcoming market trends and aspects for responsible investing,” Mursula says.
Looking ahead, Ilmarinen indicates it is positive about credit. “Credit has an important role in our portfolio currently. We do not generally disclose our views for markets but as long as the central banks maintain the low-yield environment and the general business cycle maintains its positive stance the credit market may be relatively well supported,” Mursula says.
On the outlook for interest rates, Ilmarinen sees a gradual change happening in central bank policies especially in the US as the inflation outlooks normalise.
Mursula concludes: “We do not expect rapid changes. The general interest rate conditions have an impact on our views on credit, but at the moment the outlook seems stable, at least in the short term.”
North-East Scotland Pension Fund
• UK Local government pension fund
• Location: Aberdeen, UK
• Total assets: £3.81bn (€4.39bn) (end March 2017)
• Fixed-income weighting: 12.4% (end March 2017)
• Awarded multi-asset credit mandate to Russell Investments in July
• MAN access higher-yielding parts of the Rucredit market
• NESPF does not envisage offering other credit mandates
The North-East Scotland Pension Fund (NESPF) took a step towards spreading its fixed-income exposure more broadly in July, when it awarded Russell Investments a mandate to run a £100m (€112m) multi-asset credit (MAC) portfolio. The investment was made through a pooled fund.
Graham Buntain, investment manager at NESPF, said the mandate enabled the pension fund to diversify its existing fixed-income allocations into more attractive higher-yielding parts of the market, as well as reducing our exposure to equities.
“We recognise the limitations of a single manager accessing the full spectrum of the opportunity set, and feel the multi-manager approach provides a better platform for success,” Buntain said at the time.
Other advantages of investing in credit using this method were the fact that the MAC fund gave access to an all-encompassing strategy at a competitive price, and that it involved only a low governance burden, Buntain said.
The MAC fund invests in a range of credit strategies through many specialist managers, and gives its investors exposure to personal, corporate as well as sovereign balance sheets, Russell Investments says.
At NESPF, Buntain says the pension fund feels that adding a credit allocation augments and diversifies its asset base within the overall portfolio, with the right return-risk profile.
But he says that the fund does not envisage offering other credit mandates in the wake of the Russell Investments deal.