Austrian APK smells equity opportunities

Austria’s APK Pensionskasse is poised to increase its allocation to equity in response to buying opportunities that have emerged in recent months. Chief executive Christian Boehm says the multi-sector pension scheme is “taking a closer look” at different regions and sectors.

About one-third of the fund’s €5.5 billion ($6.3 billion) portfolio is invested in equity, although this sits at the low end of its trading range. In 2017, the trading range oscillated between 21 per cent and 41 per cent for equities, and 42 per cent and 64 per cent for bonds, APK’s annual report states, in a strategy shaped by constant surveillance and reaction to the capital markets.

“It is a little bit too early to start increasing our equity exposure, but we may in the second quarter if markets go down,” says Boehm, who also expects technological developments, particularly in the auto sector, and political uncertainty around Brexit and the US-China trade spat, to affect markets and present buying opportunities. He cautions, however, that he will wait to make any decision if there is “too much uncertainty”, noting as a key risk the pension fund’s exposure to the euro via its large European portfolio.

Although APK decides its own asset allocation within the equity portfolio, along with the passive/active split, all active equity management is outsourced and Boehm favours specialist managers. About one-third of the equity portfolio is passive; Boehm plans to increase the fund’s active management further in response to buying opportunities.

“In this environment, we believe active investment can make a lot of sense due to the changing underlying composition of the indices,” Boehm says. For example, he sees varying opportunities in the financial sector, where some European banks are healthier than others and better able to withstand enduring zero or negative interest rates.

“This is just the type of environment where active management works,” he enthuses.

The success of APK’s strategy has been reflected in its status as best performer in the mid-risk segment of the Austrian life-cycle model over three, five and 10 years, based on Mercer analysis. The consultancy tracked the performance of all six of the country’s multi-employer Pensionskassen over the three time periods.

The Pensionskassen offer funds in five different risk levels within the Austrian life-cycle model – defensive, conservative, balanced, active and dynamic – all defined by their equity exposures. For the conservative segment (with an equity quota of 16-24 per cent) APK came first over the three-year, five-year and 10-year periods. Investment strategies are selected either by the company for its employees or by the beneficiaries themselves. APK targets a return of between 2 per cent and 6.5 per cent, Boehm says. If the target isn’t met, the pension fund cuts its benefits. “We are always fully funded,” he says.

Inside alternatives

Assets in APK’s 10 per cent allocation to alternatives comprise private equity, real estate, hedge funds and private debt. In recent years, Boehm, who has been with APK since its creation in 1989 and became chief in 2002, has scaled back the hedge fund portfolio to “a single-digit allocation”, dropping fund-of-funds strategies in favour of single strategies dedicated to specific environments like equity long-short and certain arbitrage and distressed strategies.

“The single fund strategies we have implemented have been positive for our allocation,” he says.

In contrast, APK has increased its allocation to private equity incrementally, funded via a reduction in public equity. Boehm aims for private equity to replace about 10-15 per cent of the public equity exposure.

“This change has not been massive but has been increasing over time. Our public equity bias increases volatility, which you don’t get in private equity. We would never substitute the whole public equity portfolio, but [this reduction] does make sense in an environment like today,” Boehm explains.

The private debt allocation, which he describes as “useful in the past” has become increasingly expensive in today’s crowded market. The current challenge in this area is moving the needle as a small investor.

“As a small investor, you have to keep in mind the real investment case,” he says. Boehm also advises checking where the return is coming from in alternatives, particularly in private debt.

“Is it an alpha product dependent on manager skills and trading strategies or is it a strategy with a real investment case. Private equity has a real investment case but many other investments in the alternative space, where predicting the market isn’t possible, are often just pure trading strategies,” he says.

Fixed income

APK’s fixed income portfolio accounts for 50-60 per cent of assets under management. The portfolio is diversified, with allocations to European government bonds, investment-grade corporate bonds and high yield. Boehm has favoured investment-grade corporate bonds and high yield over low-yielding European government bonds for a long time but he is increasingly concerned about over-valuations in both high yield and investment-grade fixed income today.

“I am concerned about the volatility of high yield compared to equity,” he says. “It is a question of whether the spread is priced fairly or if there are over-valuations in these markets.”

The fund increased its allocation to investment-grade corporate bonds a couple of years back but took profits in 2018 because the spreads, especially in investment-grade European corporate bonds narrowed. Today, Boehm is concerned whether corporate bonds in the financial sector, like the fund’s equity stakes in financials, accurately reflect the risk of some banking names.

“After the financial crisis, the risk was priced into the financial sector. Europe’s financial sector is in better shape than it was seven years ago but not every bank is in good shape,” Boehm says. “We don’t want to be invested in one of those banks that are struggling. If there are extreme risks and this is undervalued, then it might dissuade us from investing altogether.”