Scandinavian pension funds face many of the same costs challenges as their international peers face. Transparency and scrutiny have improved, while lower return expectations make costs a more important element of performance just as funds are forced to get creative by shifting portfolios away from traditional assets into more illiquid – and more costly – strategies.
The Swedish AP funds are probably the most high-profile example in the region of how both political and public attention around costs have affected investment strategies. They have slashed active management and brought a lot of investment in-house. However, the focus on costs across the whole pensions industry has probably been the most pronounced in Denmark.
“This pressure is certainly there,” says Anders Schelde, CIO of Nordea Liv & Pension in Denmark. “But over the five-year period [since I joined Nordea], we have brought down costs significantly and are starting to reach levels where it’s difficult to lower them further.”
Danish pension companies must adhere to common guidelines set up by the industry body Forsikring & Pension on how to disclose both administrative and investment costs, which are publicly available. This has facilitated comparison and put real pressure on commercial entities like Nordea Liv & Pension that compete for clients in an open market.
“I think it’s very fair when clients ask us to come down in costs,” says Schelde. “But in the media, the debate is sometimes a bit too simplistic and too focused on costs and too little on what you can gain from added costs.”
Jan Østergaard, CIO of Industriens Pension, also believes that the public discussion has sometimes been too one-sided.
“I think there has been too much focus on costs in isolation,” says Østergaard. “You have to take both returns and costs into account. At least in some situations, that’s not what has happened so it’s a challenge and could present a reputational risk.”
Østergaard recognises the need to be sensitive about numbers. “We have to take into account that our 400,000 members could become less happy with us if they saw in the newspaper that we’ve spent a lot on investments,” he says. “While our board has decided to continue with our strategy of active management, private investments and tactical asset allocation, we also continuously focus on our cost level and how it compares to our peers.”
Jens Christian Stougaard, director at PensionDanmark, points out the positives of all the scrutiny. “It makes [pension fund managers] more accountable,” he says. “You need to justify it when choosing expensive funds and managers. From our perspective, openness and transparency about costs will help pension funds discipline themselves.”
Gaining economies of scale is one way to exert that discipline, but while Danish funds have undergone mergers and taken more assets under internal management, external active management still plays an integral part in many investment strategies.
Industriens Pension invests almost exclusively with active managers, but Østergaard says that, in theory, it could bring more of its equity portfolio under internal management. It currently has one person managing its Danish equity portfolio.
“We have discussed this, but the question is, can we attract the right people?” he says. “Most of our peers that have internal management tend to see that as a cheap way of having a passive portfolio but we wouldn’t stop being active.”
Nordea Liv & Pension only uses external managers and has a fairly high allocation to alternatives. “We took some heat in the public space for high investment costs and of course we had to take note of that,” says Schelde.
As a result, it renegotiated its external management agreements but also changed its equity strategy from being predominantly actively managed. While part of its portfolio is now passive, it has also been looking for active managers that can provide more alpha. Schelde mentions its shift to small-caps two years ago as an example.
“We selected a number of small-cap managers that on average are a bit more costly,” he says. “In order to make this cost-neutral we put a bit of the portfolio into a small-cap index.”
A similar scrutiny around ensuring that money is only spent on active managers that really deliver alpha – whose returns cannot be accessed in any cheaper way – can be found at SEB Pension, also in Denmark. Its focus on risk premia and systematic ‘alternative beta’ strategies has led to a shift away from both active management and hedge funds.
“Nowadays we replicate the major part of our equity exposure via passive instruments and we have scaled down our hedge fund exposure,” says portfolio manager Nils Lodberg. “We can replicate a lot of the things that active managers and hedge funds are doing in a cheaper form.”
He adds, however, that this is not a crusade against active management, but in favour of spending the fund’s risk budget more efficiently. SEB Pension therefore prefers to use active managers for alternative strategies like distressed debt and senior secured loans.
The crucial thing is making sure the costs focus does not compromise investment beliefs. Schelde at Nordea Liv & Pension notes that costs could have been brought down significantly just by getting rid of private equity and direct real estate. “It was important not to succumb to this cost pressure to the extent that we ruin our investment strategy,” he says.
Nordea Liv & Pension made the strategic decision to also offer passive versions of the whole range of its market-rate products. “It’s a way for us to provide clients that are very cost-conscious with a choice, without us having to change our investment strategy and what we believe in,” Schelde says.
The same point could be made at Unipension which, while it manages 50% of its assets in-house, is outsourcing its real estate exposure in order to realise its strategic goal of internationalising its portfolio. CIO Niels Erik Petersen says Unipension is focused on maximising returns after costs but admits that some of the real estate funds are quite expensive.
“We’ve sold more than half of our direct domestic real estate portfolio over the past year and are building up an international portfolio of US and European real estate funds of the same value,” he says.
However, while the recent focus has been on bringing costs down, a more challenging investment climate could reverse this trend.
As Jesper Langmack, managing director of PFA Kapitalforvaltning, the asset management arm of pension company PFA, points out: “It’s inevitable that the pension industry’s increased focus on alternatives and credit at the expense of traditional investments in government bonds will increase investment costs.”
However, Langmack adds that there are still ways to hold costs in check, by avoiding investment structures with multiple layers fees, and making direct private equity investments in your domestic market, for example.
While private equity fees indeed make up a large share of most pension fund investments costs – Industriens Pension notes that they are about half of its total investment costs – few other investors appear willing to take the direct route for their private equity exposure.
Cutting out middlemen through direct investments and co-investments has, however, been a distinct trend for investments in real assets.
“The fees for co-investments are close to zero, so you save a lot of money doing it that way. And for us, size is not a problem,” says Østergaard.
PensionDanmark aims to put 20% into infrastructure and real estate, so increasing its internal capacity to avoid expensive funds has been crucial to keeping costs down. While part of its infrastructure investments are done directly by its internal team, it helped establish a separate fund company, Copenhagen Infrastructure Partners, as a supplement to its in-house team.
This set-up has also benefitted the seven other pension funds that recently committed to its second fund and as a result they enjoy fees set at around half those of a traditional fund. Stougaard similarly mentions PensionDanmark and Danish pension fund PKA’s acquisition of half of Denmark’s largest offshore wind farm as another example of pension funds coming together to cut costs. This could be the way forward for an industry that recognises the sensitivity around investment costs – but wants to preserve the integrity of their long-term strategies.
Special Report, Fees & Costs: Winds of change
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Special Report, Fees & Costs: Coming together to cut costs