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Right asset mix ensures continued outperformance

Gildi, Iceland's third biggest pension fund with €2.8bn under management entered the IPE Awards because it believes its portfolio management and excellent performance make it the small nation's best pension fund. The judges agreed.
"At 23%, our annual performance was the best for 2005 among pension funds in Iceland and we also topped the league with our five-year rolling result of 15%," the seafarers' and blue collar industry-wide scheme points out. Gildi says specifically the way it constructs its portfolios, manages the relationship between its assets and liabilities, and has integrated a successful currency overlay programme are the main reasons for its ongoing success in the past five years.
"We have put a lot of work into our portfolio construction and drafted our investment policy carefully in relation to the risk the investments carry," says Gildi. "In five years we have outperformed our benchmark by 2% per year and a real return equivalent to 6.5%," it adds. Thanks to this exceptional performance, Gildi's board decided to increase benefits to members by 7% last year.
Gildi says it was not only one of the first Icelandic pension funds to implement a portfolio strategy based on an asset/liability study, but also to incorporate currency overlay. "Asset/liability studies are an important tool in determining the investment strategy that best fits the fund," the scheme comments.
Gildi's target is to select an investment strategy that adds value to the asset/liability ratio over the full investment cycle. It takes into account the returns and volatility of selected asset classes as well as the growth of liabilities.
The fund's portfolio construction is based on the fundamental structure and characteristics of the fund. "This means we consider the law, age distribution, future cash flow, funding levels and the benefit/contribution ratio," explains Gildi.  These factors are then measured against the risk budged to assist Gildi construct the optimum long-term strategic asset allocation it requires.

Gildi estimates how different strategies affect asset/ liability ratios, maximum drawdown and risk. It then calculates the funding level for a given portfolio by running simulations. Gildi says the nature of the scheme gives it a competitive advantage. "The fund is fully funded at the moment with strong cash-flow and young membership. That gives us flexibility to explore different investment strategies," it argues. "The fund can tolerate historical volatility in the markets and meet expected maximum drawdown. The importance of asset/liability management should not be underestimated."
The way Gildi has elected to construct its portfolios has created a certain discipline and professionalism in its approach to investments. "We came to the conclusion that the optimal strategy was 50% in both domestic and foreign bonds, 40% in equities, again Icelandic and international, and 10% alternatives. We believe this strategy will continue to generate 6.5% real returns per year with 4.4% standard deviation of portfolio risk for a full investment cycle," the scheme says. In addition, it uses monthly reports into the investments' performance which determines tactical allocation.

According to Gildi, its currency overlay programme has also given it an edge over its peers. "Currency overlay has lowered the risk in the portfolio and enabled us to generate excess returns. Furthermore, we hedge a large part of our foreign currency against the Icelandic krona, because that is the currency our liabilities are valued in," it says. Gildi manages its currency hedge ratio on a daily basis and takes full advantage of the yield difference between Iceland and other countries. "This helps lower the risk profile at the same time."
The return from Gildi's currency overlay programme was 0.7% last year and 5.9% over five years. But it's not just nominal returns that keep Gildi ahead of its rivals. The fund has shown good performance through both bear and bull markets, with excess returns reaching 3% in 2005 and a cumulative 15% over the past five years. 
Also, throughout 2005, Gildi undertook an overhaul of its 30-year-old scheme rules and procedures, including the schedule of benefits it commits to, which has led to new articles of association and a revamped structure for the accumulation of pension benefits which takes full account of demographic trends. "The accumulated liabilities are to be balanced against the assets every year to ensure the scheme remains fully funded and our commitments respect our risk budgets," Gildi says. "We believe the main reason for our successful performance is portfolio management coupled with strategic decision-taking," it concludes.

Highlights and achievements
A strong sense of the right asset mix to match the characteristics of the scheme has kept Gildi at the head of Iceland's pension scheme tables. This takes into account demographic changes, the changing nature of benefits pension funds now offer and other actuarial assumptions. Gildi understands the impact and importance of managing these risks efficiently with its financial risk.
With a young membership, Gildi can afford to be flexible. The results speak for themselves, not just in the short term but in the long term as well, the way Gildi has constructed its portfolios has ensured it consistently outperforms its peers.

 


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