PFA navigates corona storm

Under the stewardship of new CIO, Kasper Lorenzen, Denmark’s PFA has survived the first wave of coronavirus-fuelled market mayhem.

Lorenzen, who joined the $86.3 billion PFA, from the country’s statutory pension fund the $125.7 billion ATP six months ago, told Top1000funds.com the fund’s belief in risk parity and a balanced portfolio resulted in a “reasonable” risk-on allocation at the end of last year, and for the first two months of this year.

“Equities did fine, and rates kept dropping so a balanced portfolio did really well,” he says.

So well, in fact, by the end of February 2020 the portfolio had returned as much in the first eight weeks of the year as it was expected to return over the course of the whole year. That, combined with a belief that coronavirus was “more than flu,” and would have severe supply consequences for the world economy, led PFA’s investment team to take profit on some of the equity positions in its return portfolio.

“We scaled down risk,” says Lorenzen, speaking from the fund’s Copenhagen headquarters before the country was put in a virus-induced lock down along with the rest of Europe. “Sometimes you get it right, and sometimes you don’t,” he says.

With global equity markets experiencing a “big correction” and government bond yields crashing to historic lows, he is minded that a rebound may be in the offing. “This is too much, too quickly,” he says. “We’ve put on some short-term adjustments.”

That is not to say he doesn’t have a keen awareness of the long-term structural changes the virus could trigger should patterns in globalisation, already under pressure from trade wars, populism and “now this,” shift.

“The global value chain has been closed for a while and it’s probably going to get worse. Firms and individuals are being reminded that it is great to have parts of your production in other parts of the world, but this comes with risk,” he says. “This is not going to be over, even if there is a cure for the virus tomorrow. We are going to learn something from this and that could be a reversal in globalisation.”

Lorenzen also believes the fund’s response to the crisis has been helped by changes he put in place on his arrival.

When Lorenzen joined PFA six months ago, he restructured the investment organisation’s meeting structure. It involved re-jigging which members of the team are part of the decision-making process, and which are involved in management, leadership or fund management.

“How we meet, and the agenda, is the heartbeat of the investment organisation. We needed a structure that could execute, and work with strategy on a daily basis.” It’s an evolving process that will be adjusted and developed over time, he says. “It’s difficult setting up an optimal organisation from the beginning.”

He has also turned his attention to investment strategy, where much is running well at the pension fund he needed little persuasion to join, having worked at PFA as a portfolio manager before joining ATP in 2007.

The fund’s growing alternatives allocation is a particular jewel in the crown, overhauled in 2016 when it was just 2 per cent of AUM and comprising older fund commitments and a few direct investments, to now account for around 20 per cent of AUM and invested across private equity, credit and infrastructure. Investments include TDC, the Danish incumbent telecommunications provider and a stake in the Walney Extension Offshore Wind Farm, located in the Irish Sea.

“If we are presented with good deals, we might take our private markets allocation to 25 per cent. But if we don’t see anything we like, the number of deals will gradually expire, and the allocation might go lower. It all depends on what deals we are presented with.”

The unlisted allocation is run by an internal team of around 15 – where the focus is origination, execution and leadership – plus a select group of strategic external managers. Manager relationships are based on “good strategic dialogue” that ensure efficiency and transparency around co- investment. “Our investment process in private markets allows us to execute when opportunities arise and be fairly firm on how we communicate with some of our funds. They know what we are after, and have certainty around our appetite,” he says.

Risk parity

However, there is an important element of the portfolio he is keen to develop. Namely, introducing a framework across private and public markets that would allow the team to compare risk, an area PFA has already done much work, but where he is keen to push further.

Many risk-parity investors don’t apply the strategy to illiquid investments, but at ATP Lorenzen included illiquid alternatives (private equity, real estate and infrastructure) under a risk-parity umbrella in a structure that gave a common currency, or shared risk denominator, to public and private assets. It allowed the fund to dial risk up, or down, in what he calls a “very useful” way.

“At PFA we are now working to create a similar risk framework that will allow us to specifically compare the risk of public and private markets,” he says.

For example, the new visibility will allow the fund to act if it sees too much risk in private markets by hedging some of that in public markets.

“Alternatively, if we have a good, robust private markets portfolio we want to be in a position to take on a little more risk in public markets to capitalise on that diversification benefit,” he says, adding that building an alternative risk framework will involve looking at each individual private market deal in a bottom up approach within the organisation.

Building out risk parity in private markets is neither a dramatic new strategy nor a particularly long journey ahead. PFA already looks at its portfolio through a risk lens. It has a 15-year history of using derivatives and has long hedged its liabilities.

Instead, it’s more of a fine-tuning that speaks to all Lorenzen’s experience.

“I have bought a mindset to PFA that was established at ATP over the last decade and is now is in my DNA. It comprises separating the hedging and investment activity so that hedging in one metric, and investment risk is measured using a different metric. Not being too levered against reserves – and taking on the right amount of risk.”