Hedging pays off for Industriens Pension

Industriens Pension is one of very few pension funds globally to achieve a positive return in 2008. Kristen Paech talks to chief investment officer, Jan Ostergaard, about what drove the positive return, and the fund’s upcoming merger with two small Danish funds.

At a time when negative double digit returns are the norm, the DKK61.8 billion (US$11.33 billion) Bankpension, the Industriens Pension is the exception.

Taking into account the return on interest rate swaps used to hedge against interest rate risk, which is accepted practice for Danish funds when reporting investment returns, Industriens Pension posted a return of 4.4 per cent last year.

“We’re happy with that of course,” chuckles Jan Ostergaard, chief investment officer of the Danish industry-wide pension fund for blue collar workers.

“It’s among the best results in Denmark and I’m guessing globally as well in this market.”

The fund’s performance was largely down to a fortuitous decision made at the end of 2007 to hedge all of the interest rate risk within the portfolio.

Like most other Danish pension funds, Industriens Pension offers so-called interest rate guarantees to members, at a current rate of 2.5 per cent.

While the low level of guarantee means there is not a huge amount of risk for the fund, Ostergaard says the decision was made in the interest of prudence.

“We did hedge from 1 January 2008 and today, looking back, the timing for that decision was incredibly good because of the decrease in the long swap rates,” he says.

“So we earned a lot of money on those interest rate swaps, which have been used for the hedging of liabilities. That’s the reason for coming out of 2008 with a positive result.”

It also helped that Industriens Pension was underweight equities and credit bonds, and overweight bonds, having reduced exposure to shares at the beginning of 2007.

In hindsight, Ostergaard admits that was a little early, but adds “that’s not a problem today, of course”.

He remains bearish on the outlook for equities, believing it’s still too early to reallocate to the asset class.

“The financial crisis and threat to the system as a whole may be solved now but we are still, we think, in the first wave of a serious economic crisis so we’re not going to increase our equity exposure right now but we are increasing our risk in general and the way we’re doing that is we are investing in credit bonds,” he says.

“We have recently added 5 per cent of the total assets to investment grade corporate bonds, and we have increased our exposure to high yield and emerging market debt. The next step will be to increase credit bonds and that will come before increasing our equity exposure. I would be surprised if we were overweight equities at the end of 2009.”

Gilt-edged bonds, which make up almost half of Industriens Pension’s total assets, returned 6.9 per cent in 2008, boosting the return on the overall portfolio.

Danish equities were among the poorest performers, posting a return of -44 per cent, while international equities followed close behind with a return of -41 per cent.

Private equity, on the other hand, posted a return of -18 per cent, which while still poor, was significantly better than the return on listed equities.

In 2008, the pension fund’s members increased by 15,000 to 366,790, while pension payments totalled DKK6.4 billion.

However the number of members is due to rise even higher from January 1 next year as a result of a planned merger with Pensionskassen for rings og Nydelsesmiddelarbejdere (PNN) and the Pensionskassen for Hog Industri (PHI).

The merger, which comes on the back of a preliminary analysis conducted last year to investigate the benefits of the move, will see around 55,000 members added to Industriens Pension’s member base, and increase its assets under management by about DKK6billion.

Ostergaard says there will be no change to the fund’s investment strategy, but it may be necessary to make small adjustments to pension insurance and sales products, and add a few new staff on the administration side.

“Size does matter a lot, and it will be possible for them primarily to have much more flexibility in their strategy than they have had so far,” he says.

“It’s a merger with two funds that are a lot smaller but are in many respects very much like Industriens Pension. They are about the same age, the structure of the pension services is not that different, [and] so it’s not that difficult to merge the three pension funds. And, of course, it is expected to give more economies of scale for us at Industriens Pension and for the smaller pension funds it’s simply a question of giving the members the possibilities they’ll have in Industriens Pension.”

Industriens Pension is one of the largest pension funds in Denmark by members, and will soon add a further 55,000 members when it merges with Pensionskassen for Hog Industri (PHI) and Pensionskassen for rings og Nydelsesmiddelarbejdere (PNN) on January 1, 2010.

The Danish industry-wide pension fund for blue collar workers currently has around 367,000 members and assets under management of DKK61.8 billion (US$11.33 billion), as at December 31, 2008.

Strategic asset allocation:

Listed equities:   30%

Credit bonds:      10%

Private equity:   7.5%

Real estate:          2.5%

Infrastructure:   2.5%

Absolute return strategies: 2.5%

Gilt-edged bonds:   45%