Finnish pension fund manages market volatility

The $46.17-billion Finnish pension fund Varma has maintained positive returns for the first half of this year and maintained mandated solvency levels, despite facing a steep market downturn both at home and abroad.

Varma’s investment director, Mikko Koivusalo (pictured), says that while the fund has been exposed to the debt crisis in the Eurozone through its equity portfolio, it has managed to avoid peripheral European debt.

“We have for quite a long time had very low risk exposures in terms of our government bonds,” Koivusalo says.

“This has been concentrated in Finnish and German bonds for quite a long time. So in this part of the portfolio we have avoided the European debt crisis. But, of course, the debt crisis, and the effects comes mostly through the equity prices.

“We have seen a lot of volatility, especially in the last month.”

In its latest half-yearly report, Varma reported investment returns of 1.3 per cent for the six months to June 30 this year – down from 3 per cent in the first half of last year.

It also maintained a strong solvency position as required under Finnish law, with more than 2.2 times the mandated solvency limit that regulators demand. This compares to 2.3 times the solvency limit in 2010.

The Finnish pension system is similar to that of its neighbour Sweden. Approximately 70 per cent of pension funding comes from worker salaries and 30 per cent from funds exposed to some level of market risk.

There is a first tier of basic national pension, which is funded through taxes and employer contributions. The second tier of the Finnish pension system – an employment-based, earning-related pension – is provided through employer and employee contributions managed by funds such as Varma, which provide a buffer-type role similar to the Swedish pension system.

Koivusalo says Varma typically invests between 30 and 40 per cent of its overall portfolio in Finland, predominately in government and corporate bonds, equities and directly owned property.

While the Finnish stock market outperformed many of its European counterparts for the last decade, it has fallen sharply during the recent volatility.

The Finnish stock market is down around 22 per cent compared to the same time last year.

The fund has around 35 to 40 per cent of its listed equities invested in Finnish companies listed on the domestic stock exchange.

However, these Finnish companies usually are export orientated, with up to 80 per cent of their revenue coming from abroad.

The Finnish stock market has been going down more than the US or European market; the Finnish equity market has been very volatile and not a great place to be the last six months,” Koivusalo says.

But he says the fund has managed to keep its returns in positive territory due to a long-standing policy of diversifying its portfolio.

The fund has strong exposures to alternatives, with 10 per cent allocated to hedge funds and 6 per cent to private equity.

“Considering market circumstances this year, these are pretty decent numbers but, of course, they are lower than last year, which was quite good investment-wise,” he says.

“In a volatile environment, it has demonstrated our quite good risk management, and diversification has been working well in the first half of the year.”

Private equity was one of the fund’s best performing asset classes, returning 7.9 per cent, compared to 11.1 per cent during the same period last year.

“We have been in private equity for a very long time and we have a very international diversified portfolio,” Koivusalo says.

“There is quite a strong emphasis in the United States with about half of our private equity exposure there. That has been performing better than the European private equity market. In private equity we also have quite a strong Scandinavian exposure and this market has been strong over the long run.”

“Most of our private equity is in buyout orientated upper mid-market exposure. Also there is some exposure in a little bit bigger funds, but very little venture capital.”

In its other alternative assets of commodities and hedge fund investments, Varma achieved a combined 5 per cent return, with its hedge fund investments accounting for 3.7 per cent.

Despite the volatility in markets, Koivusalo says the fund has not made major changes to its asset allocation during the first half of this year.

“The target is to keep strong solvency and a strong buffer, especially if there is strong fluctuations in equity markets,” he says.

“The solvency position at the end of June was stronger and gave us room to keep risky enough allocations during the weaker times.”

Equities (including private equity and unlisted equity) have remained at about 40 per cent of the portfolio, real estate makes up 13 per cent and fixed income has edged up from 32 per cent to 34 per cent of the overall portfolio.

During the year starting July 1, 2010 the fund moved 6 per cent of its portfolio into equities, predominately listed equities, mainly from the fixed income section of the portfolio.

“Historically, Finnish funds were strongly orientated to bonds, but that has been changing over the last 10 years,” Koivusalo says.

“If you compare US or Anglo Saxon funds that typically have around 60 per cent in equities and you compare to some European funds that typically have very strong fixed income positions, I think we are between that.”

Hedge fund and commodity exposures were also decreased from 15 per cent of the portfolio to 13 per cent.

Koivusalo says the fund manages about 80 per cent of its assets in-house with just its overseas equities, private equity, hedge fund investments and some small allocations to emerging market equities handled through external mandates.

Due to it holding around 40 per cent of its equity holdings in Finland, its overseas equities are in larger, more liquid index-type exposures, says Koivusalo.

Most of its property holdings are domestic, directly-owned real estate.

Some of its more significant investments in Finland include the construction of a spa hotel on the shores of Lake Saimaa in Lappeenranta and a shopping and service centre being built in Hyvinkaa.