Strong listed equity returns have seen the €15.8-billion ($20.8-billion) Finnish State Pension Fund, VER, increase the asset class to 40.3 per cent of its portfolio, up from 36.4 per cent at the end of 2011.
Timo Löyttyniemi, chief executive of VER, explains that the fund made net equity purchases of $74 million in 2012 while the values of its equities grew by 16.8 per cent, and another 7.4 per cent in the first quarter of 2013. “Equities are a wise long-term asset class in comparison to fixed income securities and government bonds in particular. Looking across the possibilities to diversify and bearing in mind negative real rates, there is a possibility that global economic growth will pick up,” Löyttyniemi says.
He also acknowledges a systemic shift from a prolonged bond boom to a new equity era is a possibility but says “the timing has been postponed” by central bank actions.
“Talk of low return expectations from fixed income has been around the financial community for a number of years already. Central bank actions and the real rate being negative have intensified this talk,” he explains. “But in an environment where the growth in the world economy is not there and [with] the Japanese central bank taking intervention into the next phase, there might not be room for a great rotation yet as long as central banks are aggressive in their policies.”
VER’s new equity allocation is “neutral” compared to a strategic allocation of 40 per cent, but marks a definite change of emphasis following an underweighting of equities and overweighting of fixed-income in 2011 and 2012. VER’s fixed income investments have been downsized from 56.6 per cent at the end of 2011 to 52.2 per cent at the end of March 2013 – and they returned just 0.2 per cent in the first quarter of 2013.
Few continental European funds run strategic equity allocations as high as 40 per cent. Löyttyniemi explains that VER’s freedom to run higher volatility and a longer investment horizon than solvency-bound corporate funds allow it a relatively high risk profile.
Sticking with Europe
The majority of VER’s sizeable equity investments are targeted at Europe and the Nordic region, some 62.5 per cent in all. VER was slightly overweight on its European strategic target at the end of 2012, with a 33.3-per-cent holding compared to a 32.5-per-cent target. Löyttyniemi says he is happy to continue a strong focus on the continent.
While Finns have been some of the most vocal critics within the eurozone of sovereign debt-troubled economies, Löyttyniemi emphasises that VER’s focus on large-cap European equities is intended to gain it exposure to global growth. “I’m a true believer that there are different challenges for international European companies and European governments,” he says. “And the divergence between corporate and government performance may be large.”
Another overweight can be found in VER’s emerging market equities portfolio. This has built up over the years to a 17 per cent share, currently exceeding the US equity holdings in the name of diversification. Half of the fund’s emerging market equities are invested in Asia and half elsewhere.
Keeping control of fixed income
VER’s equity portfolio is largely managed externally and close to half is run passively. It has opted though to control close to 75 per cent of fixed income in-house and runs it nearly entirely on an active basis.
This has enabled the fund to position away from certain sovereigns in the European debt crisis and make a play against bank debt. Löyttyniemi notes: “We have run a quite large underweight on financials in the past five years. Some times it has proved a good choice, at other times we have been hurt but it has helped manage total portfolio risk.”
VER was close to matching the size of its underweighted European sovereign debt holdings (35.3 per cent of fixed income) with its slightly overweighted corporate bond position (30.8 per cent) at the end of 2012. There is also a chunky 18.9 per cent in money markets and 15 per cent in emerging market debt, while the fund also runs a tactical high-yield position.
“We have enjoyed being with high yield and increased the credit side over the last five years,” Löyttyniemi says. Nonetheless, he speaks of low spreads between government bonds and corporate credit – resulting in continued debt opportunities for companies such as Apple’s record-breaking $17-billion offering – as “raising the warning signals” for investors.
Löyttyniemi is remaining watchful as a consequence. “We will not increase our strategic weight to credit and our high-yield side gives us a nice pick up, so we will be happy to stick to that to some extent”, he says.
Gentle alternatives growth
VER is also sticking to a plan to increase its alternatives holdings from their current level of 7.5 per cent to 10 per cent. “We were planning to make this increase more quickly, but the financial crisis forced us to be more cautious and we are now looking at good opportunities to make this increase if possible,” Löyttyniemi says.
Its most significant alternative investment position is in real estate, followed by absolute return. VER invests in absolute return funds that run a variety of strategies and has unsurprisingly experienced varied returns – the best performers in 2012 being credit strategies and the poorest quantitatively modeled commodity trading adviser funds.
The entire alternatives proportion is currently invested in external funds. The Finnish ministry of finance has prohibited VER from making direct real estate investments, but Löyttyniemi confesses that a more direct route for its $131-million infrastructure investments is a future possibility.
While VER’s status of a buffer fund allows it to run a more traditional equity position, Löyttyniemi indicates it is interested in the art of gaining excess returns and says the fund’s Sharpe ratio (2.3 at the end of 2012) “will become more and more of a yardstick for our performance”.
VER’s Finnish investments range between 10 to 20 per cent of the portfolio, Löyttyniemi says, and he is perfectly clear about the fund’s primary role. VER was mandated by the Finnish government to focus purely on performance – it is asked to contribute 40 per cent of the country’s state pension costs every year and work towards a target of providing 25 per cent of the state’s total pension liability.
“Over the last 10 years I have been doing a lot of work to assess the impact of an institutional investors’ absence from a domestic economy and overall it is usually quite weak. As a country, it doesn’t matter where investment is coming from – an internal source or an international institutional investor,” says Löyttyniemi.
In the same sense you imagine Löyttyniemi’s eye for the markets will keep VER ready to seize opportunities, wherever they are, for years to come.