SWEDEN - A report has been published by an independent think-tank from within the Swedish Ministry of Finance suggesting the country's first four pension buffer funds should be merged into one, to achieve scale advantages and potentially boost assets by SEK1bn (€958m) annually.

The think-tank report, written by Malin Björkmo, now head of the Insurance and Investment Fund department of the Swedish regulator Finansinspektionen, argued the Swedish state pensions system could save some SEK300m in reduced costs reduced as well as increase returns by SEK700m annually if it were to merge AP-Fonden 1-4 and scrap its quantitative investment restrictions in favour of the prudent person rule.

Björkmo claimed quantitative investment restrictions had the potential to prevent cost-efficient management of the buffer fund, as she argued: "Qualitative-oriented regulation would create better conditions for more efficient fund management than the existing rules."

In particular, Björkmo said she would like to see the limit on private equity investments removed along with the prohibition on commodities investing - something which many of the funds have been lobbying for for some time.

That said, any removal of the limit on private equity would also render AP6 redundant. So the report's author suggested these assets be incorporated into the bigger pool rather than keeping what Björkmo described as a "somewhat odd" separate asset pool which made governance more difficult and which may account for its poor results.

The report also stated that three out of the four main principles under the four separate funds were created are no longer valid.

At the time of the Swedish pension reforms a decade ago, government officials decreed it was better to create four buffer funds instead of one large one, as it was thought this would any counter any negative market impact, because of its size, and therefore impede efficient fund management.

However, Björkmo, who acted as an independent consultant before joining the regulator in October, argued this was now a moot point because financial markets have developed during the 10 years, and in turn created new instruments and strategies.

She pointed out that even if funds were merged into a SEK750bn (€71.9bn) fund, it would still be overshadowed by the likes of APG, Calpers and Norway Pension Fund-Global.

Another reason for creating four identical funds at that time was the belief that this would diversify management risk. However, this latest report pointed out that contrary to what was envisioned, the competition between the funds have resulted in very similar portfolios and a herd mentality which, in turn, has increased the total risk within the pension system.

Similarly, the creation of separate buffer funds was supposed to enable competition, in order to achieve a downward pressure on costs and improve results, but Bjrörkmo argues this has not materialised either.  She said management performance does not appear to have improved as a result of competition and added despite the pressure on costs, the results from active management has been poor in all funds.

Bjrörkmo was keen to stress that she does not believe there should be a forced move to force passive management, however, she recommended the new structure be flexible enough to adopt which ever style suits the investment environment, bearing in mind the long-term nature of pensions.

While three of the four key reasons for setting up separate funds appear to have been challenged, the one point that may still be valid, according to the report, is maintaining four separate and independent funds would reduce the risk of possible political influence on the governance of Swedish enterprises.

Yet the four-fund solution does not eliminate the problem, according to Björkmo. Instead, she suggested any concerns about too much government control over companies could be reduced if the funds were allowed to take indirect holdings of Swedish equity, either through investment funds or derivatives.

"This way, the fund can profit from the return of the equity market without execising the voting rights," she said in her report.

The report also claimed that the governance of the funds should rest with an authority under the parliament, rather than the government, through the establishment of a council empowered to elect the board of the buffer fund.

"The council would have one specified duty, while the government has plentiful [duties]," Björkmo said in the report.

Other proposals set out in the study include a suggestion to scrap the member nomination of labour market social partners and instead place more emphasis on ensuring board members selected have the relevant competence to fulfil their duties. A nomination committee, with relevant investment expertise, could instead recommend candidates, according to the think-tank report.

It was also suggested that the number of board members be reduced from nine to seven but their remuneration be increased in order to attract the right candidates, including those from overseas.

Björkmo said she was well aware that the proposals would require extensive work and a lengthy investigation of the Swedish constitution and legal framework and many changes to the existing laws, making it uncertain when such changes could be established. However, she argued that starting the process urgently is better than uncertainty, which in itself could increase the costs within the Swedish pensions system.

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