More in-house management means lower costs, risks for Finnish fund Ilmarinen

HelsinkiThe €21.7 billion (US$28.7 billion) Ilmarinen Mutual Pension
Insurance Company is adopting a ‘back to basic’ approach to investment and relying on its internal investment team to steer it through unprecedented equity market volatility. Deputy chief executive, Timo Ritakallio, talks to Kristen Paech about the virtues of in-house management.

“The name of the game is back to basics,” says Timo Ritakallio, deputy chief executive and head of investments at Ilmarinen, when asked how the fund plans to navigate its way through the current market volatility.

“Plain vanilla, and instruments which are transparent and liquid; nothing new and nothing special. I trust that we can make a good investment return by investing in these kinds of instruments. Of course, [share] prices are at a very low level and at some day in the future we will increase again the amount of equity investments in our portfolio, but today it’s too early.”

This investment philosophy “of keeping it simple” helps explain why Ilmarinen opts to manage the majority of its equities portfolio, and part of the hedge fund portfolio, in-house.

Ritakallio says that actively managing around 80 per cent of the fund’s equities investments internally lowers the fund’s investment costs and allows it to control the level of risk in the portfolio.

So successful has this approach been for hedge funds, which represent about 2.7 per cent of the total portfolio, the fund has decided to scale back its external management even further. Timo Ritakallio

“We are using external hedge funds but we also have a special team which is managing the in-house hedge fund operation,” Ritakallio says.

“This team is using similar strategies to many hedge funds and from our point of view, this part of the portfolio is very liquid and it’s very transparent. We know our risk level and therefore it’s a good way to manage [hedge funds] and in the future, we will continue to decrease the amount
of external hedge funds but at the same time increase the risk limits for the in-house hedge fund operation.”

Ilmarinen allocates roughly 27 per cent to equities, with around 40 per cent of that invested in Finland.

Given the significant home country bias, Ritakallio says it makes sense for the 65-person investment team to use its knowledge of Finnish and Nordic companies to manage the investments themselves.

But there are other areas where he believes external management can add alpha. In the US, for example, Ilmarinen uses exchange-traded funds (ETFs) while in Asia and the emerging markets mutual funds are the preferred route.

For real estate, the fund invests directly at home, and indirectly abroad, with 2-3 per cent of its 12 per cent allocation invested in overseas REITs.

“We are using only mutual funds in areas where our investments are quite small and we think that in these markets it’s possible for somebody to make more alpha,” Ritakallio says. “In the US we see that the market is so liquid and so deep that ETFs is a good choice.”

Founded in 1961, Ilmarinen is the oldest mutual insurance company in Finland, and claims about 33 per cent of the market share.

The nature of the fund allows its corporate members to borrow money “known as corporate financing” and pay it back within three to 10 years. 

While this has historically represented only a small part of the portfolio, Ritakallio says the banking crisis saw an up-tick in corporate financing in 2008 as the fund’s corporate members struggled to borrow money from the traditional lenders.

“At the beginning of 2007 the amount of this kind of corporate financing or corporate lending was 4 per cent of the total assets, and at the end of last year it was 12 per cent,” he says.

“Today these loan receivables are worth 14 per cent, which means the bond portfolio is smaller than it was a year ago, but the low risk loan receivables amount is higher.”

Falling interest rates have had a negative impact on this part of the portfolio, however Ritakallio believes the rapid growth of corporate borrowing is now over.

“The growth rate was so high because for corporates it was so difficult to borrow money from banks after the global financial crisis, but now I see the demand already going down,” he explains.

Another major change over the last year has been a dramatic reduction in the equity weighting within Ilmarinen’s portfolio from about 40 per cent at the start of 2008 to 27 per cent today.

Geographically, three quarters of the portfolio is invested in either Finland or elsewhere in Europe, however Ritakallio says the international nature of Finnish companies means this is not a problem for the fund.

“If I take the top 40 companies on the Helsinki Stock Exchange, 50 per cent of their turnover comes from abroad,” he says.

“They are very international companies; it’s international business risk. [For example] the biggest company on the Exchange is Nokia. Less than 1 per cent of Nokia’s turnover comes from Finland. There isn’t any country risk from our point of view.”