The scourge of low interest rates looks likely to be confronting investors for at least a little longer after Washington’s budgetary shenanigans delayed the Federal Reserve’s plans to taper quantitative easing.

Over in the more sedate surroundings of Helsinki, this is keeping the pressure on the investment policy of Varma, a €36-billion ($49-billion) Finnish pension investor. Mikko Koivusalo, Varma’s investment director for capital markets, agrees that “it is far from easy to handle continued low interest rates as we need to hold on to government bonds for liquidity purposes”.

Finland’s “bond-orientated solvency-formula” regulations have also contributed to Varma retaining a 34 per cent fixed-income allocation. Nonetheless, the equity allocation has continued to rise in 2013, reaching 36 per cent at the end of June.

A strong preference for alpha-generating hedge funds and private equity has been another key for Varma in keeping its returns ticking along in the low-rate environment. A 7.7 per cent return on assets in 2012 was followed by 3.2 per cent growth in the first half of 2013.

Nothing wrong with hedges

A 13 per cent allocation in hedge funds – an asset class Varma has been invested in for over 10 years – is relatively high compared to the fund’s peers. It also exceeds Varma’s real estate allocation of 12 per cent.

“We have enjoyed good stable returns of around 7 per cent per year with hedge funds with low volatility,” explains Koivusalo enthusiastically. The returns are of course a particular boost in the current low-interest rate environment.

Varma deploys several different hedge fund strategies, which are roughly split into market neutral and opportunistic components.

Koivusalo attributes the investor’s experience with hedge funds to being extremely selective with the aid of the “very good resources and partners” that a fund of its size brings. “You have to do a lot of work and do plenty of due diligence to find some very good and disciplined hedge fund strategies,” he explains.

While he acknowledges that many institutional investors may have experienced disappointments with hedge funds as “it’s a huge universe and quality varies dramatically”, Koivusalo reckons “there is a very strong institutional part to the industry these days and there are certainly advantages because of that”.

Varma’s private equity allocation – a fifth of the fund’s total equity exposure – meanwhile offered stellar returns of 13 per cent in 2012, helped by brisk activity in US financial and acquisition markets.

Fixed income changes

“We have added a lot of corporate bonds to the fixed-income allocation as that moderates the impact of low interest rates a little bit,” Koivusalo explains. Government bonds now amount to 9 per cent of total assets and are spread chiefly around European governments. Varma mitigates its European government bond exposure with the help of some of Finland’s non-eurozone Nordic friends, with Swedish and Danish bonds making up 16 per cent of its sovereign allocation.

Finnish pension funds have been seeking some help from their government on the low-interest rate dilemma, and a government committee is discussing possible changes to the solvency regulations. Koivusalo says “this has been a help”, but it will apparently likely not result in any changes until next year.

Varma’s current equity allocation of 36 per cent is testament to its “belief in equities in the long run”. A five-year chart in Varma’s latest annual report shows equity investments have dramatically increased – at least fivefold – since 2008. Koivusalo argues this jump is misleading, though, and is due to the emergency measures the fund took in that year of tumult.

Strong Finnish

Varma maintains a 50 per cent exposure to Finnish equities in its listed portfolio. This is part of a proud commitment to its domestic economy that even sees the fund have representatives on the boards of many companies. “Finnish companies are very internationalised, despite our economy having many challenges, just like other countries,” says Koivusalo.

He points out that the private equity and hedge fund investments go a long way to mitigating the home bias, in particular with the strong US exposure of these alternatives. He also suggests a further international diversification of the portfolio is a strong possibility in the future.

Varma has a “low” emerging market exposure as part of a 10 per cent allocation within listed equities to “other countries”. Poor performance in emerging markets this year has therefore had little impact on the fund, Koivusalo stresses.

Varma generally hedges most of its currency risk along with making a 5 per cent investment in inflation-linked investments.

A cornerstone of Varma’s investment philosophy is investing internally whenever possible to gain cost efficiency – it boasted overall investment charges as low as 0.06 per cent in 2012. The private equity and hedge fund mandates are, however, run externally. “They are expensive,” Koivusalo says, “but you generally get good returns. If not, you would fly away from there.”

Koivusalo will clearly be happy to keep it that way to ensure Varma retains its rosy health. With the fund’s solvency ratio peeking above 30 per cent in 2013, things are in excellent shape for now, whatever the challenge posed by global interest rates

There is no way to predict whether the price of stocks and bonds will go up or down over the next few days or weeks. However, it is quite possible to foresee the broad course of the prices of these assets over longer time periods, such as the next three-to-five years.

These findings, which may seem both surprising and contradictory, were made and analysed by this year’s laureates, Eugene Fama, Lars Peter Hansen and Robert Shiller. Read the winning paper of the 2013 Nobel Prize in Economic Sciences, Trendspotting in asset markets.

“There is very little pure alpha” said Henrik Jepsen, chief investment officer of ATP, at the Fiduciary Investors Symposium in Amsterdam when reflecting on the giant Danish fund’s experiences with the return class.

The DKK 624-billion ($114-billion) ATP decided to merge the alpha and beta platforms of its investment portfolio earlier this year. This wound back a 2005 decision to create a designated separate alpha unit – in effect a hedge fund subsidiary.

Jepsen explains how ATP’s views on the alpha/beta divide shifted during its great efforts to generate alpha. He thinks any alpha generated after the 2005 split was always a form of smart beta. “We probably reduce alpha now, but by accident,” he says. “I’m not ruling out the existence of alpha but it’s very difficult to extract, particularly on a large scale.”

According to Jepsen, the alpha portfolio was a definite success in constantly generating positive returns with little correlation to the beta part of its $66-billion investment portfolio. “The problem was that the returns were simply too low on an absolute amount”, he says, compared to ATP’s total portfolio. Nonetheless, he reckons that ATP has “retained a hedge fund platform of international quality”, while lowering costs by now reuniting the alpha and beta platforms in a single investment portfolio unit.

“Back in 2005, we saw the world consisting of two types of returns: beta as a sort of reward for carrying market risk over time, and alpha that could give you returns by outsmarting the market,” Jepsen says. ATP’s thinking these days is that “alpha is much smaller than what we thought and what is considered to be alpha is very often a kind of beta – in being a form of exposure against a systematic risk factor”.

ATP’s non-benchmarked return-seeking investment portfolio will continue to be divided into five risk classes: rates at 20 per cent of risk budget, credit at 10 per cent, equities at 35 per cent, inflation at 25 per cent and commodities at 10 per cent. The risk allocations are designed to ensure “all classes are meaningful but there is not any one dominating completely”. The portfolio is vital is generating cash flow to meet benefit commitments and Jepsen says it is designed to perform “more or less all the time” due to capital considerations. Some 85 per cent of the portfolio is invested in house.

Outside of the investment portfolio, a similarly sized hedging portfolio is invested 50 per cent in bonds and 50 per cent in swaps (both purely in Denmark and the eurozone. The purpose of the hedging portfolio is “to generate the promised interest rate, which is the accrual of our guarantees” as well as hedging interest rate risk, according to Jepsen.

Liquidity focus

A new liquidity-risk management model is identified by Jepsen as another key recent adjustment to ATP’s investment activities. “Liquidity is only a problem when you need it and we have seen how debilitating liquidity crises can be, so we developed an extreme focus in making sure we never get caught with insufficient liquidity,” Jepsen states. The fund has initiated a system of stress testing its ability to generate liquidity and liquidity needs to daily, weekly and annual horizons.

“As we have a very large portfolio of interest rate swaps, our business model is largely dependent on a well functioning banking system, and managing risks like that is a focus,” says Jepsen. A new need to post “a very large sum” of collateral for derivatives in European central clearing rules has also had an important part to play in increasing ATP’s focus on liquidity.

Cockroach approach

ATP’s investment strategy naturally faces the same demands as its international peers in navigating a low-yield environment, which Jepsen also argues is prone to shock. “One of my concerns is that we have all these statistical models that generally underestimate the number of big shocks that we have every five years or so,” he says.

ATP is aiming for robustness in this environment. Jepsen cites a thought from veteran Wall Street risk manager Richard Bookstaber that investors can learn from the cockroach. The cockroach has a very good risk management approach due to the wind sensors in its hairs, he explains. “If you’re a pension fund, you want to survive in the long run and you can maybe focus less on specific statistical models,” says Jepsen.

Maintaining a balanced portfolio and extending diversification to protect against shocks are also outlined as guiding principles for ATP in the current environment. Jepsen urges his fellow investors to focus on their comparative advantages and adds that patience is needed, as “no investment strategy will work at all times”.

Jepsen says ATP has been able to buck a trend for risk parity portfolios to underperform this year as “we have been much higher with our equity allocation than is usually the case”. That shows the importance of being adaptable, adds Jepsen, despite stating that ATP retains its long-term faith in qualities such as diversification and balance.

For years metals such as aluminium, zinc and nickel have been persistently oversupplied. The copper market, in contrast, has been much tighter, primarily because China needs to import the metal but is largely selfsufficient in other metals. This has seen copper trade at a premium to other base metals and be recognised as a good proxy for investors tracking China’s economic growth.

New chairman Ruston Smith’s inaugural speech at the United Kingdom’s National Association of Pension Fund annual conference in Manchester focused on building trust in the pensions industry. Talking about the need to create “pensions people trust to deliver a decent income, pensions people trust to be there when they retire and pensions people trust not to rip them off”, he set out the main themes that will govern his two-year tenure at the organisation that represents 1300 pension schemes with a  combined £900 billion ($1.46 trillion) under management.

As auto-enrolment promises to see between 6 to 9 million people start to save for the first time, so Smith’s focus will be on improving governance and regulation to protect savers, maximise retirement incomes and nurture confidence in pension saving. He promised more emphasis at NAPF on defined contribution, “the future of pension’s provision”, and more support with investment strategies and regulation.

In what he called “building on today for a better tomorrow”, Smith, who replaces outgoing chairman and former Barclays pension chief Mark Hyde Harrison, set out four “big steps” that the industry needs to take in order to adapt to the challenges of auto-enrolment, whereby every company in the UK will be obliged to offer all staff a pension. Staff will be automatically enrolled unless they opt out.

Quality mark

Firstly, he asks the industry to encourage savers by increasing awareness of the NAPF’s Pension Quality Mark, a tool to help people recognise more easily what quality schemes look like. Smith called to make pensions simpler by “junking the jargon” and encouraging “simple conversations” about them. Adding in a third point: “We need to develop more innovative and creative products and services to recognise pension savers’ changing needs, particularly at retirement. We need to recognise the need for products that reflect people’s retirement choices and life patterns when they get older. Linked to this, we need a more flexible pensions framework for individuals and employers. People’s lives and expectations have changed. So we need to face into that challenge together,” he said.

Smith also talked about the need to build confidence in saving to overcome pension apathy and cynicism. “This means we need trusted institutions. And it means we need to tackle the difficult questions and vested interests so that saving for retirement is something that works in the interests of the saver – and not against it.”

Top-shelf issues

An industry heavyweight, Smith joins the NAPF from his role as pensions director at Tesco since 2002. The retailer’s $11-billion defined benefit scheme has 300,000 members and is internally managed by Tesco Pension Investment, where strategy is headed up by Steven Daniels, the former chief investment officer at Liverpool Victoria, an insurance company. Smith has held a non-executive role at NAPF since 2007 and lobbied on behalf of the industry earlier this year when he represented the NAPF at a Parliamentary Treasury Select Committee. Together with other experts, he argued how quantitative easing has affected pension fund investments and liabilities.

In a wide-ranging speech, Smith also looked beyond the next two years, talking about the need for a vision for the next decade. He pointed out that an ageing population and the country’s future economic needs pose challenges that extend beyond pensions to questions that “we haven’t even started thinking about as a nation, never mind tackling”. He also asked how best to create more employment opportunities for older generations when youth unemployment is now running at 20 per cent.

Smith’s new tenure promises a fresh set of priorities or “step change” at the organisation, which he is determined to ensure continues to serve its members. “Having worked in retail for the last decade, I believe the customer is at the heart of everything we do,” he said referring to the gathered delegates as his customers. “For me, this will be no different at the NAPF.”

Sylvester Eijffinger, a Tilburg University professor and renowned international monetary policy expert said “financial repression is everywhere in the OECD” in a keynote address to the Fiduciary Investors Symposium in Amsterdam.

Eijffinger says “the globalisation of monetary policy makes it very hard for emerging economies to shield themselves from these influences”.

Eijffinger points to negative real interest rates in northern European states and elsewhere as a clear sign of a global era of financial repression. Eijffinger highlighted Japan’s expansionary ‘Abenomics’ monetary policy as being the “most extreme form of the phenomenon”, but mentioned the recent nomination of “dovish” Janet Yellen as the next head of the US Federal Reserve as another clear sign of the times.

Eijffinger reckons fiscal interest gained dominance over monetary policy in the midst of the financial crisis in 2008 to create financial repression via negative real rates. “It’s a wealth tax in a very opaque way, which is likely to continue for another five years if not 10 years,” he argues.

The professor identified clear motives for governments to continue a policy of financial repression. Firstly, he explains “it is very difficult to cut government expenditure – even in Germany, which is the most stability-oriented country you could imagine.” Populism is forcing governments into a corner when it comes to deficit cutting in many countries such as the Netherlands, he argues.

The possibility of governments reducing deficits via strong growth also appears slim in the years ahead, says Eijffinger, making inflating away deficits via downward pressure on interest rates an attractive option. “Negative real interest rates allow governments to deleverage at the expense of investors and private savers,” adds Eijffinger.

Independent spirit

Financial repression seriously irks Eijffinger, who states “I’m a believer in the independence of central banks, I am convinced it is the best thing for a country in terms of social welfare”. He is dismissive of continued claims to independence by the worlds’ central banks, saying “an independent central bank is one that can say no to politicians.” He reckons the US Federal Reserve’s official position of being “independent within government” is false.

Eijffinger sees a power grab by governments over monetary policy occurring in the aftermath of the financial crisis in 2008: “Politicians stepped in to save banks and they thought ‘Gosh, we really are important!’ The balance of power between politics, banking and central banks was completely reversed as 20 years of monetary dominance and fiscal accommodation was replaced by fiscal dominance and monetary accommodation.”

Eijffinger argues that a consequence in 2013 is that “politics is making a mess” of the economic upswing in the Netherlands, in words in defence of recently criticised remarks from the president of the Dutch central bank.

History of repression

Eijffinger’s prognosis of another five years of financial repression is based upon his detailed take on monetary policy history. “If you look at periods of financial repression, going back to even before the Second World War, you’ll see they last 15 years on average,” he says.

Eijffinger gleefully cites the lessons from history as he argues “people forget that financial repression is nothing new”. He outlines a 30-year period from the end of the Second World War, with interest rates “effectively zero” in the US from 1948 to 1952, “direct monetary financing” introduced in a 1952 accord and negative real interest rates seen during the stagflation of the 1970s.

Eijffinger says that the lessons learnt in the 1980s and 1990s of the virtues of central bank independence are now being forgotten.

Future

Eijffinger believes the tapering of quantitative easing is the US will now start in spring 2014 in the earliest but will be “very grave” for investors. Eijffinger recalled former Federal Reserve chairman William McChesney Martin’s well known maxim of taking the punch bowl out of the party to describe what federal banks should be doing. In reality, Eijffinger believes there is now a lag of 18 months to two years developing in monetary transmission.

Eijffinger urges investors “to think about what financial repression means for investment policy decisions on bonds and stocks”. Clearly it is something they could be thinking about for quite some time.