The $46 billion Norwegian DNB Livforskiring has a conservative strategy but it should not be confused with a static approach. The fund revises the investment strategy of its defined benefit offering on an annual basis.

 

Norwegian pension investor DNB Livforsikring is set to stick to a conservative investment strategy due to continued regulatory pressures, according to Tom Rathke, DNB’s head of wealth management.

The NOK 285 billion ($46-billion) fund, the largest in Norway’s private system, faces a tough funding requirement. It has to set aside returns of around 3.4 per cent every year to meet guarantees on its defined-benefit offering, with parent company DNB’s shareholders picking up the bill for any negative returns.

“There is no symmetry and no claw back in Norway, as if we return above our 3.4 per cent target the extra goes straight to our policyholders. That’s why we have a very, very conservative strategy, which has become more conservative over the past few years,” adds Rathke.

Events away from the idyllic fjords and forests of Norway seem also to be conspiring to keep the strategy’s cautious bent in place.

Despite being one of a handful of countries to have resisted the allure of joining the European Union, Norway is still subject to Europe’s new Solvency II insurance regulations.

Solvency II should further reinforce the strategy status quo at DNB Livforsikring after its likely introduction in 2016, says Rathke.

“Low interest rates and volatility in equity markets also brings us to being conservative,” Rathke points out.

Some 9 per cent of the defined-benefit fund is currently invested into equities, 16 per cent in ‘current’ bonds, 18 per cent in money markets, 41 per cent in hold-to-maturity bonds and 14 per cent in real estate.

It is the hold-to-maturity bond bucket, which currently grants a yield of 4.9 per cent, which is the key to matching liabilities, explains Rathke. This consists mostly of Norwegian Krone-denominated credit bonds rated A- or better, typically issued by insurance companies.

The fund’s 9 per cent equity weighting, while low from an international viewpoint, is typical by Norwegian standards.

“A few years ago all the Norwegian insurance-style investors were at the upper end of the 20s for equity exposure, and now we’re all between 5 and 10 per cent,” Rathke explains.

 

Conservative but nimble

DNB Livforskiring’s conservative strategy should not be confused with a static approach.

Far from it, as it revises the investment strategy of its defined benefit offering on an annual basis, something which will be useful for the fund’s efforts to navigate through the changing regulatory environment, Rathke says.

The increasing burden of longevity, coupled with the need to meet guarantees every year have also necessitated an annual strategy review. “Building up a cushion for longevity risk is one of our main focuses,” stresses Rathke.

Derivatives and overlays are frequently deployed to take positions on asset classes. “The use of derivatives is very important for us as we don’t want to have the risk management on top,” says Rathke.

 

Low-interest challenge

Low interest rates have naturally also been a challenge for the fund.

But some shelter has been provided by the fund largely avoiding government paper.

Unlike many institutions with conservative strategies, DNB Livforsikring has only a “very limited” exposure to low-yielding government bonds – mostly from Norway, Sweden, Germany, Belgium and the European Investment Bank.

Norwegian government bonds have been seen as a safe haven in markets over the past few years, making Rathke more enthusiastic about short duration Oslo debt.

Duration in itself is a hot topic for the fund, with the likely impact of Solvency II is making DNB Livforsikring assess duration across its credit investments.

DNB Livforsikring aims for 20 per cent domestic exposure within its equity investments, and as much as 66 per cent of bond investments are made within Norway. Any overseas credit investments are converted into Norwegian Krone to avoid any foreign exchange exposure.

As the defined-benefit fund’s strategy has moved into ever-more conservative territory, the real estate allocation has been lowered from 17 per cent in 2011 to 14.3 per cent today.

“Solvency II also makes it better to hold government bonds rather than real estate,” Rathke points out.

DNB Livforsikring keeps its direct real estate investments close to home, holding them purely in Norway and Sweden, it has also accessed international funds indirectly.

The conservative stance has notably also kept DNB Livforskiring’s defined-benefit offering away from any big moves into alternative assets. It does have a small (2 per cent) private equity bucket, but Rathke confesses “infrastructure will not be a direct part of the future of the investment strategy due to the harsh capital charges on it under Solvency II”. There could be some space to get involved in infrastructure loans though, he adds.

Rathke would “definitely say” that the conservative approach is working in meeting the tough liability requirements. He is able to point of “healthy returns” in 2013 of 3.6 per cent up to end of the third quarter of 2013 (above the 3.4 per cent target).

While the defined-benefit offering is ticking along nicely on-target, a new NOK 33 billion ($5.4 billion) defined-contribution portfolio is giving DNB Livforsikring an unusual chance to make some risk ploys. Equity allocations have been set up to 30 per cent, 50 per cent and 80 per cent across different defined-contribution portfolios. Returns have been as high as 16.5 per cent in the first three quarters of 2013.

With the defined benefit offering closed “the focus going forward is only on defined contribution,” says Rathke. Keeping the defined benefit offering returning so dependably within its limited wiggle room will also no doubt require more good work though.

New research has found that if you have a PhD and work for a money manager your flows will be larger and your performance will be better.

This research in the US shows that the gross performance of domestic equity investment products managed by individuals with a Ph.D. (Ph.D. products) is superior to the performance of non-Ph.D. products matched by objective, size, and past performance for one-year returns, Sharpe Ratios, alphas, information ratios, and the manipulation-proof measure MPPM. Fees for Ph.D. products are lower than those for non-Ph.D. products.

Investment flows to Ph.D. products substantially exceed the flows to the matched non-Ph.D. products. Ph.D.s’ publications in leading economics and finance journals further enhance the performance gap.

 

To access the paper click here

Investors with a large proportion of educated female members have extra reason to take socially responsible investing seriously, but can possibly relax about poor returns. That is a fascinating finding of Rachel Pownall, an associate professor of Tilburg University, who has published groundbreaking work on the nuances of responsible investing.

Pownall, together with Arian Borgers another Tilburg University researcher, polled over 1,000 Dutch households, in order to gain their views on the topic of responsible investing and its values.

They found that close to 45 per cent of respondents were willing to give up a ‘substantial’ amount of pension income in exchange for a more responsible investing approach – a result that seems to challenge the return focus of investors the world over.

“It seems that educated females, and more females in general are more happy to prioritise responsible investing over maximum returns, no matter their own income,” Pownall says in summarising the key demographic results of her research.

While her research showed widespread support for responsible investing from pension fund members, this trend was intriguingly muddied.

Some 17.5 per cent of respondents to the survey preferred a non-responsible equity portfolio no matter the returns it delivered under a scenario as part of the survey. Pownall and Borgers believe this can be explained by poor financial understanding, but the implication seems to be that investors should strive to gauge their members’ potentially complex preferences on responsible investing.

 

Into the thick of responsible investing

Pownall had already observed before doing the research that within the somewhat fuzzy and all-embracing concept of sustainable investing there were clear opinions indicating what Dutch pension fund members expected of investors.

For instance, there has been clear pressure on Dutch pension funds to exclude investments related to the production of cluster bombs, a development “that really ignited the whole responsible investing debate in the Netherlands” says Pownall.

On the other hand, when a couple of large Dutch funds made big charity donations following the 2004 Indian Ocean tsunami, some criticism resulted of this overstepping their responsible investment mission.

These developments in the Netherlands have to some extent been mirrored elsewhere, but another key result of Pownall’s research is that social norms informing responsible investing actually seem markedly different in different societies.

“We have found that Europeans are much more driven by social issues when it comes to thinking about responsible investing and are less worried about the likes of gambling and alcohol,” explains Pownall.

This should naturally serve to steer any investors away from simply emulating a responsible investment approach of their international peers. “I think investors really need to find out what their members want when it comes to responsible investing,” she says.

Other preferences shown by the research are that smokers and drinkers are (perhaps inevitably) less concerned on the whole about their pension savings being invested in tobacco or alcohol companies. Good employee relations were meanwhile rated as the quality that the Dutch value most highly in responsible investing.

 

Responsible menu

“We also wanted to see if individuals are responsible and able enough to express their responsible investing preferences or should there be a top-down approach,” explains Pownall.

The results of some basic investing scenarios conducted as part of the survey indicated widespread misunderstanding – if not financial illiteracy – something that Pownall says is all too common when the public are tasked with hypothetical investment games.

Pownall reckons investors have a role in empowering individuals by offering responsible investing options whenever possible. She sees much more potential for that in the burgeoning defined contribution plans of the UK and US than the big benefit-promising funds of the Netherlands.

“Lots of people want to have a say in what they invest in, and a menu of investment choices would allow those how want to make these decisions to act,” argues Pownall. Large state-connected funds are probably best positioned to set a positive example in this, reckons Pownall.

Pownall feels responsible investing could also come under a wider financial education drive by governments.

A mindset shift from investors might also be needed, Pownall reckons, with the relative lack of importance that her research suggests members place on returns challenging conventional performance horizons. “It’s always a worry that pension funds could be part of the same game when it comes to the quarterly returns that investment managers obsess about, whereas there is a need to focus on the long run,” she says.

While her research shows how decisions are probably best made with the particular environment of the fund in mind, Pownall feels that the Netherlands will continue to make a hefty contribution in pushing the responsible investment debate further. Strong media attention and a questioning public are particularly vital components in the helping the country to the forefront of the responsible investing movement, she says.

 

You can read Arian Borgers and Rachel Pownall’s paper, ‘Social Norms of Pension Funds’ here

 

Norway and Britain have both announced plans to buy carbon credits, giving the United Nation’s struggling Clean Development Mechanism a boost.

 

Sovereign institutions have thrown a lifeline to the United Nation’s struggling Clean Development Mechanism, CDM, set up under the Kyoto Protocol which awards tradable carbon credits to projects like wind farms or solar power that reduce emissions.

Norway’s Ministry of Finance has just invited submissions under its plans to purchase carbon credits from struggling green energy projects threatened by low prices for the offset they generate. In another development Britain says it plans to buy £50 million worth of carbon credits.

Norway plans to purchase UN Certified Emission Reductions, CERs, up until 2020 spanning the second commitment period of the Kyoto Protocol.

Initial purchases of up to 30 million CERs will be made via specialist fund the Norwegian Carbon Procurement Facility, NorCap, set up in October by the Norwegian Ministry of Finance and the Nordic Environment Finance Corporation, NEFCO, an IFI owned by the five Nordic countries that specialises in financing environmental projects.

“We have asked for authorisation from Parliament to spend up to 2 billion Norwegian Krone up until 2020. The 2014 budget appropriation, which is yet to be confirmed by Parliament, is about 316 million Norwegian Krone,” says Sigurd Klakeg, Deputy Director General at the Ministry of Finance.

“Buying these credits is not an investment by the Ministry of Finance. It is for compliance purposes,” says Tommi Tynjala, a senior advisor in carbon finance and funds at Nefco which has assets under management of EUR 230 million.

“It is about helping Norway comply with its Kyoto requirements and helping the carbon market by purchasing from vulnerable projects.”

The carbon market has floundered on oversupply of allowances and reduced emissions eight years on from the first credit being issued. Prices for credits have crashed to less than 50 cents from over 20 euros five years ago.

Under the agreement rich country governments buy the credits to count towards their emissions-cutting targets. Companies can also buy credits to offset the effect of their activities on the climate.

But government institutions are very rarely involved in buying and selling carbon credits. Instead they use the credits to cancel out emissions back home. The financial return comes in that it is often cheaper to buy carbon credits from international projects than reduce domestic emissions.

Klakeg says that Norway’s strategy differs from other institutions weighing in to support the market in that it specifically targets the most vulnerable projects. Those that are either at a standstill or “stranded,” and projects which have no other source of revenue but from carbon prices, he says.

Although 30 billion tonnes “is quite a small amount if you compare it to the total oversupply” and “won’t have any impact on carbon prices” Norway’s purchase is very important for the projects selected, argues Tynjala.

What can other states can adopt from the pension reforms at Rhode Island.

The most significant item from the pension reform at Rhode Island is the fact the Cost of Living Allowance (COLA) is conditional. Or in other words, the fund will only pay the COLA if it can afford to do so.

This simple reform alone, is monumental in the sustainability of the plan, according to professor of finance at Columbia Business School, Andrew Ang, who has just completed a case study on the reform.

“One of the biggest things here is that the COLA is contingent. A lot of COLA’s are automatic, or linked explicitly to inflation but that is incredibly expensive for employers. I’d like that too,” he says. “At Rhode Island there is some indexation, but there’s a formula. It is contingent on investment return above a certain threshold and funding above a certain level, it makes a huge change. If they can’t afford it they won’t pay it.”

In his report, “Saving Public Pensions: Rhode Island Pension Reform”, Ang outlines that Rhode Island’s new COLA is calculated as the five year average plan investment return less 5.5 per cent. It is subject to a 4 per cent cap and a 0 per cent floor, and only applies to retiree’s first $25,000 of retirement income.

Linking the COLA to investments of the fund, and not inflation, is a significant move, Ang says, highlighting similar provisions at the Wisconsin Retirement System, whose stability is due in large part to its treatment of COLA.

In addition to changes to the COLA, the Rhode Island reform introduced a defined contribution plan which would operate alongside the smaller defined benefit plan, with contributions for all employees split between the two.

“The hybrid plan is a compromise and it’s economically reasonable,” Ang says. “It has the buy-in of the workers, they have some skin in the game and have to contribute, but at the same time the taxpayers are not bearing all the risk. It means some of the benefits of defined benefit are retained in that workers know what they’re getting, but the employer is baring most but not all of the risk.”

 

The power of facts and figures

Gina Raimondo took office as Rhode Island’s Treasurer in January 2011. She spent a lot of the first year looking at reforming the Employees’ Retirement System of Rhode Island because not only was it dangerously under-funded, the published numbers underestimated the extent of the problem. Figures, as it happened, turned out to be her friend.

In the seven years from 2003 to 2010, taxpayer contributions to the fund had risen from $129 million to $303 million and there were concerns that without pension reform that would rise to $1 billion a year within the next 10 years.

State employees were contributing 8.75 per cent of salary, teachers were contributing 9.5 per cent, and state contributions had risen from 5.6 per cent of salary in 2002 to 23 per cent in 2011. Overall 10 per cent of every state tax dollar went to fund pension benefits.

In discussing the problem with stakeholders – which included the governor’s office, taxpayers and unions – Raimondo spoke candidly and openly about these figures.

She had commissioned a report, “Truth in Numbers: The Security and Sustainability of Rhode Island’s Retirement System”, which became the songbook that all parties sang from. There were disagreements but they were based on facts and figures, not emotion and politics.

“This is her genius,” Ang says. “Everyone speaks to the same language.”

Raimondo used the facts as an important communication tool to engage with stakeholders about reform.

She travelled around the state, held in-person meetings at town halls, and spoke directly with unions.

“One thing that the Rhode Island case pointed out is that you need facts,” Ang says. “This problem can be solved by starting at a valuation basis, and everything is transparent. Also communication is really important for the government, taxpayer, workers, and unions.”

While Ang acknowledges that Rhode Island is “somewhat special”, partly because it is a small state and Raimondo was able to speak directly with taxpayers, also everyone knows each other so communication was widespread.

But he says the concept of reform, especially the contingent indexation and the hybrid plan compromise, goes well beyond that State.

 

Investment controversy

The investments of the fund, is a rather touchy subject for Rhode Island, with much criticism, and press attention of their alternative investments.

For Columbia’s Ang, the two issues have been collapsed and should be seen quite separately.

“One thing is to ensure the liabilities are paid, and the only way to do that is that the present value of the liabilities is equal to the money you have right now. Second, is the broader issue, of how you best manage the assets in a public setting.”

Ang says this latter issue is the same whether it is the Rhode Island pension fund, which at $7 billion is not that large, or a very large sovereign wealth fund.

There are a number of issues at play when there is public scrutiny, including the lack of ability to pay competitive salaries available in the commercial institutions, and that governance structures not robust because of political interference.

In addition some management and trustees at pension funds are not investment experts and “that would never happen in a commercial entity”, Ang says.

Ang considers the Rhode Island reform to be the first major public pension reform in the US that has been successful – it may not immediately but the fund in a good financial footing, but the process and reform is in place to lead to a sustainable fund.

“In the past it was piecemeal, not coherent and hacked away at the problem rather than tackling it full on, this is really a regime change,” Ang says.

“Hedge funds and private equity are appropriate in certain circumstances, but only if there is some money to manage. The second debate is about the appropriate strategy.”

Ang says the problem on the investments side is that a lot of funds are making investments without contemplating whether their own governance structure is appropriate, including whether investment decisions can be made without political interference.

“It’s discussing whether those investments are ok without the context of how decisions are made. If you do have the governance structure then alternatives may fit in,” he says. “But if there isn’t a good structure in place and decisions are being made to achieve return targets but there isn’t money in the pot to meet liabilities it’s like a paint job on a house that is falling down.”

 

 

Danish pension investor PFA is continuing a switch out of European government bonds in favor of global equities, but has begun reinvesting in Europe’s southern periphery.

DKK-350-billion ($63-billion) PFA announced a $900 million purchase of equities in April, commenting at the time that the crisis in Cyprus had increased the risk to its European bond portfolio.

Henrik Henriksen, PFA’s chief strategist, reflects that “you could say moving out of European bonds for equities been working well as typical European bond investors have lost money this year”.

Henriksen says the switch is ongoing despite some unease about high equity prices – with US equity prices increasing more than 20 per cent so far in 2013.

“You need to be prepared for some kind of reaction especially if growth news disappoints,” cautions Henriksen, adding “we also have to be aware that some of the equity value increase has been liquidity driven, and if the Fed were to withdraw that for the wrong reasons, there could be a real blow.”

“We have to see the US economy pick up next year if the upturn in equities is going to be supported.”

He argues that should a withdrawal of monetary stimulus be made to avert a bubble before underlying economic strength returns, there will be a fallout impacting high-risk assets on the whole.

Henriksen explains that PFA’s sale of European bonds has taken place across its core portfolio. At the same time, PFA has exhibited renewed faith in the continent’s periphery adding to its holdings in Spain and Italy “in order to get a better carry with a decent risk/reward”.

Henriksen agrees that PFA has a more positive view on the Euro, although he jokes this is somewhat inevitable as “last year you were wondering whether the whole thing would collapse.”

The support of European politicians and the ECB for the currency has “reduced distrust, even if you can’t really say trust has been increased” in Henriksen’s view.

PFA has extended its renewed confidence in Europe to its equity weightings – going overweight on European equities along with US shares.

The Danish fund remains neutral on Japan, with Henriksen saying “we can’t figure out yet if the third arrow is going to fly” – in a reference to Prime Minister’s Shinzo Abe’s planned structural reforms.

 

Market-based freedom

While PFA’s cornerstone guaranteed product remains bond-dominated due to its tough solvency requirements, the investor is expressing much of its enthusiasm for equities in the approximately DKK-50-billion ($9-billion) ‘market-based’ product. The rapidly growing defined-contribution offering has a near 50/50 split between bonds and equities.

Despite its clear global investment horizon, PFA’s Danish equity returns have been particular strong in recent years. Henriksen explains that one reason for this is that the fund is happy to take clear positions on companies listed on the Copenhagen exchange.

Despite underperforming relative to their benchmark this year, returns of more than 20 per cent on Danish equities have still exceeded the gains from global shares. Liquidity needs have led PFA to shift somewhat away from its traditional preference for Danish equities, however – at least in the traditional guaranteed fund.

Like many global funds, PFA is in the process of increasing its alternative-asset allocation. A recent drive started with an increase ub the share of real estate assets in the market-based portfolio from 5 to 10 per cent, with an increase also planned for the guaranteed product’s relatively smaller real estate bucket.

PFA is looking to expand its real estate exposure internationally, in order to gain added diversification. It has been exploring the London and Hamburg markets with Henriksen saying it is browsing on a “case by case” basis to avoid possible overvaluations in these core markets.

Also in the alternative space, a recent joint venture purchase of Danish energy firm’s Dong Energy’s onshore wind business for around $140 million was a headline-grabbing new private equity initiative for PFA.

Henriksen is enthusiastic on the potential of wind power, saying “the return possibilities are better than they were a few years ago. If we lever it up we should be able to get double-digit returns from this investment.”

PFA has since made a 2 per cent stake in Danish government-owned Dong. Henriksen says PFA is considering further private equity and infrastructure investments – both directly and via funds. He is confident that the associate illiquidity risk can be controlled by the fund’s selective approach and long investment horizon, allowing PFA to reap good yields from its burgeoning alternative adventures.

 

Solvency squeeze

PFA fears that its ambitions in illiquid assets could potentially be halted in their tracks by the onset of Europe’s Solvency II regulations.

The investment strategy of PFA’s guaranteed offering will “certainly be affected” by the regulations, says Henriksen, with work to set the portfolio up for the new regulatory regime ongoing.

Relatively opaque and illiquid assets like infrastructure are set to be penalised under the regulations, meaning that “infrastructure investing could be very expensive and politicians might get less from pension investors than they hoped for.”

Other asset classes should benefit though from the new European solvency formula adds Henriksen, with investment grade credit likely to look particularly appealing.

PFA’s capital adequacy ratio was as high as 224 per cent at the end of June 2013 indicating a healthy funding state.  That is no cause to relax though says Henriksen as “a thing that’s working against us is that Danes are getting older”.

PFA’s larger guaranteed portfolio suffered an investment loss of 2.2 per cent in the first half of 2013. This was largely due to rising interest rates and a loss from hedging against further interest rate drops, says Henriksen.

“The best thing we can hope for is a slow and steady climb in interest rates rather than anything too abrupt, but things have improved somewhat in the second half of 2013,” explains Henriksen.

As a large investor in socially conscious Scandinavia, it is no surprise that PFA takes its responsible investing credentials seriously.

It went further than most though in drawing up guidelines on its government bond investments in 2012.  A small number of investments in Ivory Coast sovereign bonds were sold as a result.

While efforts to increase alternative assets will remain a focus, Henriksen is happy that PFA’s investment strategy is robust – something he feels is helped by the high level of competition among Danish pension investors.

“You have to make sure your strategy is good at all times and you really have to justify expensive investments”, he says.