Working within constraints
Norway’s pension funds are highly regulated, at least as far as funding and investments are concerned.
Kjell Taftø, managing director of the Trondheim Kommunale Pensjonskasse, says that the need to produce an minimum annual level of return restricts investment freedom. “I would like to see fewer regulations, particularly in the investment area,” he says. “The demand for risk capital is the biggest problem, because you have to have enough to cover the losses.” The better the funding level is the more risk that can be taken.
He adds: “There needs to be a better accordance between short-term requirements and our long-term objectives. You have to report on a short-term basis but the payments to the pensioners are long-term liabilities. You have a problem there.”
In terms of the degree of regulation Tore Eilertsen, corporate treasury manager at Det Norske Veritas Pensjonskasse, feels comfortable, on the whole. “We are able to live within these rules fairly well but with a different set of rules we would perhaps have taken more risk.”
Det Norske Veritas provides another example of the direct influence of the level of risk capital on investment strategy. “We have a fund which is well equipped with buffer capital to cover the pension commitments and also to take what we feel is the necessary amount of risk to achieve a good return on the fund,” says Eilertsen.
He adds: “there are several funds in same position as us but the level of risk capital has much to do with whether the sponsor is willing and able to put risk capital into the pension fund. That varies a lot.”
The relatively comfortable position of Det Norske Veritas in terms of risk capital is clearly borne out in the asset allocation. “We are very close to the limit of 35% of assets invested in equities,” says Eilertsen. “We have money market bonds, investment grade and also high yield.”
Eilertsen explains that allocation to the different asset classes has been relatively stable. “We gradually move away from domestic focus to a more international focus both in terms of equities and bonds. It is particularly a question of diversification; the Norwegian equity market performed very well in 2003, and also so far this year, but it is small and more volatile than other markets. The same comment can be made about the bond market.”
Det Norske Veritas is also looking into alternatives and real estate, also for the purpose of diversification.
The Det Norske Veritas fund returned between 5% and 6% in the first six months of this year. “We are very satisfied,” says Eilertsen. The long-term objective of the fund is to achieve good capital growth. We take a long-term view and have been willing to accept some bad results.” he adds.
“After a good 2003 pension companies in Norway take on more risk in their portfolios. That will build up some reserves again after the awful results of 2002 and 2001. There has been some activity in alternatives; I think that is due to the need to diversify and achieve higher returns with interest rates so low.”
Following the merger of Aker and Kvaerner in 2002, the merged company has consolidated its Norwegian pension plans.
The Aker Kvaerner Pensjonskasse is a good example of a fund that is maintaining a conservative approach. Berit Mørck, managing director at the Pensjonskasse agrees. “The assets of the Norwegian pension plan are currently invested conservatively. Following several years of poor equity markets performance, the pension plan will need to restore ability to take on more risk (volatility). In general, the pension funds in Norway have a low allocation to equities due to regulations.
“Only 5% of our portfolio is invested in equities” Mørck says. “The rest of the assets are in bonds with quite a significant proportion in hold to maturity (HTM) bonds. The average interest rate of HTMs are close to 7%. HTM bonds helped us secure our short-term financial returns,” she says.
She adds: “Our strategic asset allocation is set to match our liabilities within the current regulatory framework. However, we actively apply tactical asset allocation to reduce risk and add incremental returns over time. We currently have a cautious outlook for the equity markets. Over time as our ability to take on more risk improves, we will look to add more equities. For incremental returns, we are also looking at hedge funds, real estate and private equity, but the initial allocation will be small.”
In the year prior to the merger, the fund returned over 12%. Clearly this will not be the case going forward in the current interest rate environment.
The new merged company established its own asset management operations last year. “Aker Kvaerner have used time and effort to find good people,” Mørck notes. “The company needed and wanted better control and advice and now that we have the advice closer to us we can work on a daily basis with the management and pay much more attention to it.”
About 30% is managed “in-house” which consists of both bonds and equities portfolios. Most of what is not “in-house” is the money market placements.
The regulatory required rate of return has been reduced to 3% for all new premiums paid in from 2004. “The Finance Ministry have talked about introducing the same with already paid-in reserves but we will oppose that,” says Mørck. “Over time, I think many companies will move away from DB plans if such changes were implemented.”