Warren Buffet shapes AP4’s “contrarian” investment approach

Sweden’s SEK175.7 billion ($24.9 billion) AP4 is planning to introduce active management to its global equities portfolio and is investing in people with the hope of driving better investment performance. Kristen Paech talks to chief executive, Mats Andersson, about the merits of being contrarian and why AP4 is standing by active management despite historical poor performance.

Mats Andersson, chief executive officer of the Fourth Swedish National Pension Fund (AP4), is the first to admit that
active management has not delivered for the fund over the past few years.

Take 2008, for example. The return on the portfolio of actively managed listed assets was -22.3 per cent, before
expenses, and active management added -1.1 percentage points to the total portfolio.

The Swedish government launched a review in May of the AP funds’ costs management, including the use of active management, after an evaluation of the buffer funds’ performance found AP1-4 and AP6 had collectively lost SEK194 billion ($27.5 billion), or -21.6 per cent in 2008.

Furthermore, since the second half of 2001, active management is said to have represented 25 to 50 per cent of the AP funds’ overall $1.05 billion costs, yet it lost them $1.2 billion.

However the first six months of the year were encouraging for AP4, says Andersson, who maintains that active management can add value over the long term – provided the right people are in charge.

Since joining the fund in 2007, Andersson has replaced 50 per cent of the fund’s internal staff, and reviewed the use of
active management, which is currently employed across 60 per cent of the portfolio.

“I strongly believe that active management will bring value over time if you have the right people doing it,” he says.

“We have had trouble historically in performing in active management, however the first six months of this year we
achieved [excess return from active management] of 100 basis points on our quoted assets, and that’s hopefully due to the process of reviewing our way of managing money that we have been doing for the past two years.”

Last year, AP4 hired a new head of fixed income and foreign exchange, Bengt Lindfeldt, and a new head of global equities, Bjorn Kvarnskog, who Andersson says has proposed a new way of handling active management.

“Externally we have gone from having six or seven active management mandates [for global equities] to, since the beginning of the year, only beta mandates, however that’s not the way we’re going to do it going forward,” Andersson says.

“We will not do it by internal management, we’ll use external forces, and this will be implemented in the coming two
years.”

The fund already uses active management for domestic equities, fixed income, FX, tactical asset allocation and private
equity, but will extend this to global equities and “probably use a more dynamic process going forward,” Andersson says.

By this, he means the fund will have the liberty to increase the use of active management when it believes there is
better chance of achieving alpha, and reduce it in periods where it believes less risk is required.

In addition, the board of AP4 has put aside a “substantial pot of money” for investment in alternatives, which Andersson classifies as “assets that are in between asset classes”.

“It could be senior debt, opportunistic real estate investments, it could be public equity via a private equity fund,”
he says. “We have committed above SEK1 billion so far this year, and we see very good opportunities in this area still, but I think it’ a window of opportunity we have now after the financial crisis last year.”

On the back of disappointing performance in 2008 (the fund made a net loss of $6.2 billion, or -20.8 per cent), AP4 is
planning to adopt a more contrarian approach to investing in future, and try to avoid the market’s herd mentality.

Andersson says Warren Buffet provides a good example of how being contrarian can pay off handsomely.

“The best way to earn excess return for a fund like ours is to be a bit contrarian,” he says. “Since we’ve got a mandate that’s pretty unique, a time horizon of 40 years, it means that we don’t need to act that fast, we don’t need to react or act according to the herd. If you were a contrarian in the last 10 years – if you look at a guy like
Warren Buffet, what he’s done is to be contrarian and that’s something which
we’re trying to do.”

There are, however, some investment restrictions which AP4 and the other AP funds are required by law to abide.

These include that the funds must have at least 30 per cent of their assets invested in “safe, liquid bonds”; they are
forbidden from having more than 5 per cent invested in unlisted assets; they cannot invest in commodities; they must not have a currency exposure of more than 40 per cent; and 10 per cent of their assets must be run by external
managers.

In addition, they are not allowed to own more than 1 per cent of the Stockholm Stock Exchange (although Andersson points out they could legally own 100 per cent of the Norwegian Stock Exchange), and they cannot own more than 10 per cent of a listed company.

While intended to prevent market extortion, these restrictions pose real barriers to investment for the funds, many of
which have argued they are in fact preventing the diversification that having four funds was originally intended to provide.

“After eight years it probably makes sense to at least go through and see whether it still makes sense to have these
regulations,” Andersson says. “I think some can be taken away or at least altered. It’s not my call…but when
you compare the asset allocation of the funds, we are pretty similar and if you want to achieve diversification, which was the idea of having four funds, you’re missing the point by having the restrictions we have today.”

Fund snapshot:

The Fourth Swedish National Pension Fund (AP4) is a government pension fund, which manages a part of the buffer capital set aside to offset temporary fluctuations in pension system contributions and disbursements.

The fund’s mission is to generate optimum returns through long-term risk-weighted management of investments, and the vision is “Financial security for Swedish pensioners”.

AP4 can invest in most types of assets, but the portfolio mainly consists of equities, fixed income assets and real estate. AP4 has SEK175.7 billion ($24.9 billion) in assets as at June 30, 2009.