Too close for comfort?
On the face of it Finland’s tightly regulated pensions market, constrained by funding issues, might seem to offer rather infertile terrain for dynamic asset management. But while Finnish asset managers find their hands tied in certain respects, they and their clients are forging closer relationships. Too close for comfort, some might argue.
One of the main bugbears of Finland’s E83.5bn pensions industry and its asset managers is the solvency rule, whereby assets are classified according to their perceived risk, and the more risk that is attached to an asset class the more solvency capital is required by the fund. This system is the result of the decision taken by the authorities to align pension funds to the EU Life Directive.
The problem is that certain asset classes are perceived as being more risky by the regulator than they are by asset managers and their pension fund clients. “These categories are not measuring the risk but measure the way assets are managed, which is irrational,” says Esko Torsti, president of Pohjola AM. “We need to have the possibility to be flexible in our asset management in order to provide the best value-added services. Take our new commodities fund which uses derivatives, where the solvency rule places an irrational restriction.”
He adds: “Solvency margins are lower than they were five years ago. Funds should be able to carry more risk but the solvency margins won’t allow this. This is counter-cyclical.”
But changes are afoot to amend some of the alleged inconsistencies, the most notable of which concern hedge funds. From January, it is expected that funds of hedge funds will be moved to a lower risk classification provided there is a minimum of 20 funds and a track record of at least two years. Funds of hedge funds will be required to provide information about historical volatility.
This last point is good news for Martti Saikku, head of institutional business at Gyllenberg AM. “It sounds like the smart way to do it,” he says. “You can’t put the black box products into a low risk category.”
But there is some disagreement among the managers as to how hedge funds should be classified. Of the view that hedge funds are currently in too high a risk class, Mikael Simonsen, investment strategist at Ilmarinen, notes: “That is what the hedge fund marketing people would say. There are a lot of fees in the hedge fund business so there are strong muscles to lobby for this. The hedge fund industry is in constant change and funds have had to increase risk taking. Pension funds have been brainwashed.” Ilmarinen is a mutual pension insurance company that also manages assets for other pension funds, totalling around E20bn.
In addition to the solvency requirement pension funds have a required rate of return of .5% which has to be met each year. “This is more than the return that can be obtained in the fixed income market,” says Gyllenberg’s Saikku. “So we seek returns to optimise towards risk and solvency.”
He adds: “When you had large buffers you didn’t need to focus. Now the horizon is much shorter; you can’t formulate your strategic allocation with 10-year averages. You have to focus on achieving the absolute minimum funding rate each year. ”
The impact of the solvency requirements and their increasing stringency can be seen in the growing popularity of corporate bonds. “They are attractive at the moment to pension funds because of their risk-return/solvency profile,” Saikku notes.
Ilmarinen has responded to solvency issues by setting up a new tactical asset allocation (TAA) overlay team. “Previously we had one yearly asset allocation which hasn’t been fluctuating very much over the years,” notes Simonsen. “Last year we were unhappy when the markets had gone down for a third consecutive year and everything looked very black; our solvency wasn’t good enough for us to rebalance; we therefore had to rebalance using options. So next year we will go into a more active environment taking more active bets on different equity and bond markets. A more dynamic approach around the benchmark will probably lead to more efficient solutions.”
While size is beneficial to large institutional asset managers like Ilmarinen, it also poses problems in a small market like Finland. “We have an equity portfolio of around E4bn,” says Simonsen. “We cannot do a meaningful trade on the Helsinki stock exchange without ruining the market in that company. So our Finnish stockholdings tend to be buy and hold.”
The same applies to real estate. Simonsen says: “We have E2bn of real estate and so own a large part of the commercial real estate in Finland which is a huge risk.” ICECAPITAL AM, which is somewhat smaller than Ilmarinen, is exploiting the need to diversify. “We have launched a fund to provide our clients with an easy way to get exposure to the European listed property market,” says Jyri Viskari, ICECAPITAL’s managing director.
As pension plans increasingly seek to diversify their portfolios so the tendency to outsource management is becoming more established. “The needs of Finnish clients are quite international these days,” says Viskari. “They have internationally diversified portfolios and now also buy portfolio management from outside Finland. That is why we have chosen outsourcing as a key principle here.”
He outlines the structure: “The core contains index funds and is very stable so a large part of the asset allocation decisions are made here. Where the satellites are concerned we realise that we are based in Helsinki and not London or New York, and we have to be realistic about what kind of capabilities we have. So here we take the outsourced route where the global TAA is provided.” The use of the core satellite approach is now widespread among asset managers in Finland.
Evli IM takes a similar approach; it has a network of 17 asset managers worldwide. “We manage assets like domestic equities and euro fixed income, while with international equities for example we would use the best managers that we can identify,” says Maunu Lehtimaki, managing director at Evli.
A major development in the Finnish market has been the strong growth of the multi-manager approach. Jauri Häkkä, CIO at Kaupthing Sofi, says: “In recent years quite a few pension funds were disappointed with the performance of their chosen managers and realised that the process of hiring and firing managers is time-consuming. Finnish pension institutions need help because they haven’t always got the resources in their own organisations to screen managers and allocate funds to them.”
Gyllenberg has also been witness to this development. “The trend from direct investments to multi-manager fund portfolios is the strongest trend we have seen in the market,” says Saikku. “There is no end to it, and we have been adding resources in fund evaluation both internally and on a global basis.”
The strong growth in multi-management is one factor that has brought asset managers and their pension fund clients closer together. Another has been the gradual development of a consultancy relationship between asset manager and pension fund client. “The asset manager is helping with the asset allocation to help the whole pension plan meet its liabilities,” says Lehtimaki.
So doesn’t this produce a conflict of interest? Lehtimaki says: “There is a degree of conflict. It is a bit of an issue, but less so for us because we only provide part of the product ourselves.”
Matti Rantalainen, head of asset management at Opstock, says: “The bigger pension funds know what they want and just ask us if we can deliver. With the smaller and medium sized firms there is some semi-consultancy in between.”
This development is due to the very small size of the consultancy industry in Finland. Lehtimaki explains: “The main reasons for this are the very difficult regulatory environment and the limited potential of this small market for the international consultants.”
The potential for conflicts of interest gives cause for concern. Finland’s pension funds have their work cut out to monitor their asset manager