AP3 gets dynamic about risk

Just days before the Swedish AP3 releases its annual results, Amanda White spoke to head of asset management, deputy chief executive, Gustaf Hagerud, about the fund’s new dynamic approach to allocating risk.

The SEK208 billion ($32 billion) AP3 is coming to the end of its first year under a new asset management regime. Now a dynamic asset allocation model means that investment decisions are based on preferred levels of risk and expected returns between seven different asset categories, and investment staff have the authority to make those decisions.

Gustaf Hagerud, the fund’s head of asset allocation and deputy chief executive, says the new investment process gives the staff more freedom than other pension funds in changing the allocation. While a by-product rather than a key driver, this freedom does give staff ownership, which in turn leads to a more motivated team.

“Since we introduced the new approach and the freedom to move dynamic asset allocation we have had a big advantage. We have a 4 per cent real target and the staff knows that they are responsible for allocation decisions more than previously, it means they are more involved, and they have more ownership,” he says.

The fund allocates assets across the risk categories of equities, fixed income, credits, inflation, foreign exchange, other, and absolute return strategies.

About 65 per cent of the fund’s money is run in-house, with external mandates being slowly reduced over time. Hagerud says that will continue, as will the propensity to favour passive management for liquid equities and fixed income.

Having said that, within some risk classes there are a large number of actively managed external mandates – within absolute return, for example there are 30 mandates, 20 of which are managed externally.

While the staff’s outlook has been fairly optimistic since mid-2009 – which has been reflected in its risk allocation, with high exposures to equities and low exposure to currencies – equities have been reduced over the past year. In the first six months of 2010 it reduced equity weights from 58.2 to 54.8 per cent (from a risk point of view, equities still has about a 75 per cent share).

Within fixed income there was a trend towards domestic bonds, with the Swedish bond allocation increasing at the expense of Japanese bonds, and increased portfolio duration.

Hagerud says the asset allocation team of six meets every second week to discuss what to do with allocations (its capital and risk exposures differ due to the use of derivatives).

“The portfolio we have now is what we think is the best for the next two to three years, it depends on our outlook.”

He says 2010 was a period when equity markets depended on the fiscal situation in countries, and within Europe this meant a domestic bias.

“We have been overweight the Swedish, we were optimistic domestically compared to the international outlook. Sweden has been benefiting from a strong fiscal situation, weak currency and importantly a low interest rate from euro area. The short rate in Sweden, very dependent on what’s happening in Europe.”

While reluctant to give away portfolio positions, Hagerud says there is a trend away from liquid to other risk classes, for instance real estate which fits in the “inflation” risk bucket.

One of AP3’s overarching aims is to be a “leading asset manager” which means generating strong risk-adjusted returns with cost efficiency. Its total expenses, operating expenses plus commission expenses, for the first half were 0.16 per cent of assets. The equivalent internal expenses were half of this, at 0.08 per cent.

Hagerud says alpha/beta separation has been an important part of cost effectiveness.

AP3’s risk categories, June 30, 2010