As many investors face the current uncertainty gripping world markets, ATP chief investment officer Henrik Jepsen says the Danish fund is well positioned to handle the current volatility.
Jepsen (pictured) says the fund is keeping a watchful eye on proceedings in Europe and the global economy generally but has tried to position the portfolio to handle a variety of scenarios.
“We try to be not too dependent about having a central forecast on how things are going to go, and we try to have an approach where we will cope with things no matter which way things turn,” Jepsen says.
“Right now it is fair to say that there are fat tails in the potential distribution of where things could end up.”
The strategy results in ATP using two main portfolios – a hedging portfolio and an investment portfolio – and this allowed the fund to maintain funding levels of more than 120 per cent in the 2008-09 global financial crisis.
During that period it was also able to increase pensions by 2 per cent and had a 19 per cent return in 2008.
For the first half of this year the fund has grown its total reserves by 8.1 billion krone ($1.42 billion). The investment portfolio achieved a 2.9 per cent return and the hedge portfolio lost 1.4 per cent.
The fund is regarded as one of Europe’s most innovative investors and Jepsen explains that total assets are split relatively evenly between the two main portfolios.
The hedge portfolio is designed to hedge ATP’s pension liabilities as efficiently as possible to offset changes in interest rates.
“ATP has very long-dated pension liabilities and they are mark-to-market, which means they are very sensitive to interest rates such that if interest rates go down by one per cent our liabilities go up by 75 billion krone [$13.2 billion],” Jepsen says.
The portfolio is mainly comprised of interest-rate swaps and long-dated government bonds.
The aim of the hedge portfolio is to ensure that the fund can guarantee a life-long pension to its members, says Jepsen.
But to ensure the long-term purchasing power of pensions paid to members, the fund uses its investment portfolio to achieve better returns.
Most of the assets in the investment portfolio are held in a so-called beta portfolio, which is divided into five risk classes.
These consist of:
- Equities, including both public, private and venture capital investments.
- Credit – mainly corporate and emerging market debt.
- Inflation, which focuses on price trends and includes inflation-linked bonds, real estate, infrastructure and timberland.
- Interest rates, which includes government and mortgage bonds.
- Commodities, where the focus is on oil.
Jepsen says the fund has tried to do a risk allocation rather than a conventional asset allocation. This allows the fund to gain returns with lower risk than a conventional asset allocation model that sees much of the risk concentrated in equities.
“We want a portfolio that will do well in lots of different scenarios,” he says.
“So we have tried to be very conscious that the risk allocation between different asset classes, or we call them different risk classes, should be fairly even.”
As of June 30, 2011 risk was allocated 35 per cent to equities, 20 per cent to interest rates, 10 per cent to credit, 25 per cent to inflation and 10 per cent to commodities.
The beta portfolio achieved a 2.9 per cent return for the first half of the year, with all but equities achieving a positive result.
There is also a second much smaller alpha portfolio that consists of an actively managed equity portfolio. This portfolio returned -0.7 per cent for the first half of the year.
“This [beta] portfolio gives us a good mix because it has something that will do well if the economy is on the upswing – such as the equities, credit and maybe even oil – and we have something that does well when the economy is trending down, such as the interest rate and indexed bond part of the portfolio,” he says.
“We also have inflation-protected assets – so basically we have tried to split our portfolio so it will do well in most scenarios.”
Jepsen says that during the spring, the fund reduced its risk exposure but its mix of assets has not changed markedly over the course of the year.
“We are trying to run a fairly well diversified portfolio at all times. We didn’t do it [take less risk] because we thought equities would fall in particular, but more because we were uncertain about how well investors would be paid to bear all risk,” he says.
“So what we did in that case was to lighten up on all types of exposures – not just equities but credit and so forth, so we are running well below our maximum portfolio risk.”
In terms of asset allocation in the investment portfolio, at the end of 2010 this was: 42 per cent in bonds and fixed interest, 13 per cent in credit, 14 per cent in equities, 26 per cent in inflation-protected assets and 5 per cent in commodities (mainly oil).
The fund chose to invest in oil as the main exposure in commodities because it gave the best diversification device for the fund, says Jepsen.
He says the fund also has a tail risk hedge portfolio to protect the fund against extreme losses.
“Basically we use put options – so the trigger is to buy put options that are fairly deep out of the money,” he says.
“So it is buying a put option that is, say, 30 per cent out of the money when you buy it. The trick is that you should buy it in peace time because it is like fire insurance – it is very difficult to get a good price on insurance when your house is burning down.”
Instead of using benchmarks to measure its performance, ATP uses an absolute return target that is linked to the liabilities of the fund and goals set at the start of the year to increase pensions at least in line with inflation.
The approach differs from conventional benchmarking that can tend to overemphasise risk in relation to a benchmark and not focus enough on the risk in relation to reserves.
Not being bound by benchmarks allows the fund to be more nimble in its asset allocation, and in 2008 it could look to take opportunities during times of financial turmoil.
ATP has also taken its innovative investment approach beyond Denmark and has recently launched a UK arm.
It is the fund’s first foray abroad and aims to take advantage of reforms in the British pension system that will see consolidation of the UK’s more than 46,000 defined contribution schemes.
Titled Now:Pensions, ATP’s UK pension arm will be an independent, multi-employer fund.
UK members will have access to the same suite of investments as the current 4.5 million members of ATP.