The richest seam in the UK’s pension landscape traces the M62 corridor, a motorway that threads east to west across northern England beginning in Liverpool and taking in Manchester, Bradford and Leeds.

These cities are home to the biggest local authority pension schemes in England and custodians to a vast cluster of wealth.

“Merseyside, Tameside, West Yorkshire there is a huge amount of money in a very small space here,” enthuses Rodney Barton, director of the Bradford-based £9.9 billion ($15 billion) West Yorkshire Pension Fund which he joined four years ago from nearby schemes East Riding, and before that Merseyside.

Despite these funds proximity, each is guided by its own particular ethos. At West Yorkshire the mantra has been a bold equity strategy that it refused to pare back in the wake of the financial crisis. Now the fund is reaping the benefits of the equity lift off, returning 14 per cent in the year to March 2013.

About 67 per cent of West Yorkshire’s assets are portioned to equity in a portfolio split between the UK (36 per cent) the US and Europe (8 per cent each) Japan (4 per cent) and Asian and emerging markets (12 per cent) with the UK allocation invested only in companies with a global reach.

“We choose big companies that are not dependent on UK income,” says Barton. As the scheme taps global markets through UK equities, so it taps emerging markets – an allocation it plans to grow – through companies deriving their profits from growth in developing markets but listed elsewhere.

“We gain exposure to China through Hong Kong or Taiwan,” says Barton. “One of our primary concerns is corporate governance so we want exposure this way because we can be more certain of the accuracy of the annual report.”

Although the scheme will use unit trusts or exchange traded funds in smaller markets, the bulk of the equity portfolio is actively managed in-house.

“In markets of any size we own the stocks directly,” he says. Even the US allocation, where some pension funds have abandoned any attempt to outperform the market, is actively managed.

“Compared to other markets the US is more difficult,” he admits. “Recently we have come in below the index but not enough to worry us; long-term we are still ahead of the game.”

 

Equity downturn

Barton expects the equity boom to tail off, predicting total equity returns of 7 per cent over the long run.

“Years like this are nice but they won’t continue,” he says. But there is no plan to pare down the scheme’s equity allocation just yet.

An actuarial evaluation, out in nine months, will cast more light on the fund’s liability profile but until then, backed by rosy fundamentals, it is full steam ahead.

Of West Yorkshire’s 245,000 members, 91,000 still actively contribute to the fund and 81,000 have deferred benefits; the fact the scheme is 93 per cent funded, adds to the buoyant mood. It’s a small deficit that Barton attributes to a decision six years ago to ask members to contribute more.

“We were fairly aggressive in increasing our contribution rates back in 2007,” he says.

The scheme has also worked hard to cut costs, topping the list of the UK’s 89 local authority schemes in a recent report by the Local Government Pension Scheme.

“Our scheme costs each of our members just £28 ($43) a year; we have a very tight grip on out costs. One of the ways we do this is in-house management. It’s cheaper to do it yourself.”

 

Allocation changes

After an eight year hiatus during which the fund hasn’t allocated any fresh money to property, the scheme is now looking at boosting its 3 per cent allocation.

Assets here are currently portioned between the UK (two thirds) and Europe (one third). Similarly, West Yorkshire’s unquoted infrastructure allocation is minimal, perhaps 1 per cent, with most exposure channelled through the equity portfolio via investments in utilities like water companies, where it has “positions with big dividend payers.”

Unquoted PFI infrastructure funds sit in the 5 per cent private equity allocation.  “The original PFI contracts had a much higher risk and reward and they now provide long-term index-linked cash flow and are very attractive assets for pension funds.”

The scheme hasn’t joined the government’s Pension Infrastructure Platform partly because “it wasn’t approached in the first wave and discounted the idea” but also because of the stop-start nature of the PIP’s progress to date as it struggles to find a balance between the priorities of its founder members, and the government’s desire for infrastructure investment.

Elsewhere, a 6 per cent allocation to hedge funds stood West Yorkshire in good stead during the financial crisis. Since then the allocation has disappointed however, and been shaved to 3 per cent.

“After 2007 I don’t think hedge funds saw the recovery coming. They got left behind and once you are left behind it is very difficult to catch up.”

In contrast, private equity has faired better. “Our experience with private equity has been pretty good; it’s delivered long-term 11-12 per cent returns. The bad periods have been a function of the equity market and an inability to sell anything, but pleasingly we had lots of realisations in 2011.” West Yorkshire’s most consistent private equity returns have come from small and medium-sized funds. All allocations to private equity, property and infrastructure are managed externally.

West Yorkshire has an 18 per cent allocation to bonds, a quarter of which is in corporate bonds and three quarters in government and index-linked bonds in the UK and overseas.

“We recently increased our corporate bond exposure because they have a shorter maturity and we have grown nervous around government bonds.” Most corporate bond exposure is in UK and US however. “We come across fewer opportunities at the right price to invest in European corporate bonds; companies there are much close to their banks,” he says.

Many institutional funds boast responsible investing credentials, but Switzerland’s Nest Sammelstiftung has taken the extra step of molding its investment strategy around a sustainable template.

The sustainable agenda is more than just a focus for Nest. It forms the very ethos of a fund that markets itself to potential members as “the ecological and ethical pension fund”.

Following a sustainable line to any level can be an exhaustive task, but Peter Signer, head of investments at Nest Sammelstiftung, admits that when investment strategy decisions run into debates in the sustainable sphere, an extra dimension of soul searching results.

For instance, should a sustainable investor adopt a hedge fund strategy?

Signer says that “there has been plenty of discussion as to whether we feel hedge funds are acceptable on sustainable grounds”.

It is not always a matter of simply accepting or rejecting an asset class though, and Nest’s pioneering approach has seen novel ideas being floated where the responsible investing and strategic asset interests meet.

Although it has not been able to realise it yet, Signer says there has been serious discussion of Nest Sammelstiftung launching a long-short strategy that would see it short sell the equities of companies it deems unsustainable.

If this strategy takes off it might be bad news for Swiss banking giants UBS and Credit Suisse.

The CHF 1.4 billion ($1.5 billion) Nest fund has blacklisted UBS “ever since we began our sustainable approach I think” says Signer – with perceived corporate governance shortcomings and the banking giant’s financing strategy coming under question.

While Credit Suisse “is close to rejoining our investment universe”, Nest Sammelstiftung’s ban on UBS remains on place.

Other banks are also on the blacklist with Nest tracking funding policies and in particular the financing of weaponry firms – an activity it feels violates its sustainable beliefs.

Signer makes it clear that these exclusions result from a careful sustainable policy rather than an anti-finance bias. After all, Nest invests close to CHF 5 million ($5.40 million) in London-based HSBC, while Russia’s Sberbank and China’s ICBC are both among its top-ten emerging market equity stakes.

Avoiding investing in ETFs is named by Signer as another consequence of Nest formulating its asset strategy under a sustainable gaze.

The fund shuns the index products just as it steers clear of all benchmarks – it would rather pick its own sector biases rather than have them carried into the strategy by the market.

In particular “we want to avoid investing in commodities as they are not at the top for us on sustainable reasons,” says Signer.

 

Ethical taste unsatisfied

Nest Sammelstiftung has taken its sustainable focus so far that its asset strategy is simply unable to keep pace in some regards.

Signer explains that its 25.7 per cent real estate holdings and 2.9 per cent private equity exposure would both be bigger positions if it was easier to invest towards its ideals in these asset classes.

The problem with real estate is that Nest is actively looking to invest in buildings with maximum energy efficiency – and there are apparently not enough ways to do that yet in its native Switzerland.

“There is not a big enough market for energy efficient buildings here so we have taken an indirect approach via funds” explains Signer. That has led it into a further stumbling block of accessing suitable funds, and ultimately “as not all real estate funds have green criteria we haven’t been able to fully implement our approach”, Signer reflects.

In the private equity space, the Nest fund has switched from investing via fund-of-funds to look for sustainable private equity funds under a managed account.

Signer is pleased that Nest has been able to use its private equity exposure to spur the development of renewable energies. It is an industry that a sustainable fund can clearly reap benefits from throughout the long investment horizons of its members.

“There have been a few problems in the European renewable energy industry and while growth isn’t linear we think there is good long-term potential”, says a convinced Signer.

Exclusion by business activity plays a part in Nest’s sustainable approach, with nuclear and weapon firms lodged on its blacklist. The fund aims for dialogue with companies that are close to falling out of its universe or alternatively are in a position to join.

While converts to the sustainable investment movement are these days free to pick and choose from a number of sustainable consultants, Nest has forged its own way to assess the myriad of companies it could invest in.

The fund co-founded the Inrate sustainable investing rating agency in 1995, a dozen years after its own foundation. Signer says that using Inrate has allowed Nest to tap into worldwide networks and bring engagement to its international equity picks. He says that sustainable scrutiny has seen Nest focusing its investment universe on merely a third of companies in the MSCI World index – a strategy which he confesses makes stock picking a difficult task.

 

Hard realities

 

No matter how sustainable its investing approach is, Nest clearly operates in the same environment as the rest of the world’s pension funds. It has made a substantial change in strategy in the past couple of years due to a background of persistent low bond yields.

Its fixed income exposure has been reduced since the start of 2011 to March 2013 from 39 per cent to 29 per cent – a figure at the very bottom of its tactical allocation range. Over the same period, equities have leapt from under 23 per cent to over 30 per cent with Signer saying “we don’t have many alternatives to equities” to mitigate fears of rising interest rates.

Nest was able to safeguard against Euro crisis fears though by reducing its government debt exposure to cover only Switzerland, Germany, the Netherlands and the UK. A new position on insurance-linked strategies is set to enter the portfolio in the second half of the year as Nest seeks further diversification, Signer adds. Other alternative approaches, like the possible long-short strategy might follow in time.

 

Nest Sammelstiftung’s 2012 returns of 6.31 per cent look good but perhaps unspectacular. Has it found its mission to grow its assets compromised in any way by its strictly ethical approach?

“Sustainable investing doesn’t always help returns but in the long run it will”, says Signer. Looking across the Swiss pension landscape, “our returns are higher than average but with a greater standard deviation”, he argues. Just as importantly for the staff at Nest’s headquarters, the sustainable credentials are proving a real attraction to the small and medium enterprises Nest seeks to provide pension cover for.

Hermes Ownership Principles address a simple question: What should owners expect of listed companies and what should these companies expect from their owners?

The expectations set out in this document are derived from Hermes extensive experience as an active and engaged shareholder. This experience suggests that there are a number of reasons companies fail in their primary goal of delivering long-term value. Our experience suggests there are good central management disciplines which will greatly increase the likelihood of value delivery.

Usually when the $129-billion Ontario Teachers Pension Plan makes a strategic move, the rest of the investing community pays attention.

With a 15-per-cent allocation to emerging markets and a strategic plan to increase it to 20 per cent over the next couple of years, OTPP just opened an office in Hong Kong to take advantage of opportunities in Asia.

“Something like 80 per cent of the world trade in 2025 will be intra-Asia – we just have to be there,” chief executive of OTPP, Jim Leech, says.

The pension plan’s emphasis on emerging markets is indicative of a strategic philosophy being explored by many investors around the globe.

With rapid economic growth, shifting demographics, growing urbanisation and fiscal strength it is no wonder emerging markets have attracted investors’ attention.

In the Asian engine room

Australia’s largest pension fund, the $45-billion AustralianSuper, has nearly half of its international equities in emerging markets and is particularly keen on Asia, which makes up 50 per cent of its emerging markets exposure. It recently opened an office in Beijing and has a specific Asian advisory board.

AustralianSuper argues that investors must adapt their portfolios to Asia as it matures if they are to maintain and potentially grow their exposure to the future engine room of the world’s economy.

Similarly, the equities allocation of the $39-billion Finnish fund, Ilmarinen, is on an upward trend towards emerging markets, currently at 18 per cent of equities. The fund has investment people on the ground in Shanghai and is exploring whether to send a representative to South America as it intensifies its emerging markets focus.

Overweight emerging markets

From an asset allocation stance, a view on emerging markets is one of the more strategic decisions being made by investors. In fact managing director and head of investment strategy and risk at Neuberger Berman, Alan Dorsey, believes the allocation to emerging markets is the most significant contemporary asset allocation decision an investor can make.

“The biggest strategic asset allocation decision in my lifetime will be to overweight emerging markets,” he says.

The $22-billion New Zealand Super Fund is exploring just that, and is about a month away from finalising an investigation into whether to overweight to emerging markets.

It currently has a benchmark weighting consistent with the MSCI ACWI Investable Market Index, and head of asset allocation at NZ Super Fund, David Iverson, says the fund is looking at the growth and risk profile of emerging market equities and bonds when making decisions on overweighting.

He says the investigation is slightly different to that usually taken by funds in deciding whether to overweight, as it starts with the market view.

“The strategic asset allocation to emerging markets is a combination of market views and our view,” he says. “Most funds treat emerging markets equities and bonds separately, and then have a view inside that whether it is attractive. We start with what the market’s assessment is, which is the market-cap weighting that is already captured. Then we make a view on the market’s view and whether we have a separate view to that.”

In this way, NZ Super Fund is separating the fundamental valuations of the market, whether it has confidence in those valuations, and then assessing a manager’s ability to add value.

Strengthening position

Emerging markets has moved from an opportunistic to a strategic viewpoint in the eyes of investors, according to Rob Drijkoningen, co-head of emerging market debt at Neuberger Berman, and one of the driving factors of that move has been the importance of emerging markets from an economic point of view.

The European Central Bank reports that the emerging economies’ share in global output has increased from less than 20 per cent in the early 1990s to more than 30 per cent now.

The equation is tilted even more in favour of emerging markets if purchasing power parity, which takes account of cost of living differences, is used. According to the International Monetary Fund’s World Economic Outlook, the share of emerging market economies in world gross domestic product will surpass 50 per cent this year on this basis.

Of course, the relative attractiveness of emerging markets is strengthened by problems in the developed world, and emerging markets tend to be in better fiscal shape now than developed markets, including a pretty good GDP-growth dynamic.

Domestic stability

Conrad Saldanha, managing director and portfolio manager of the global equity team at Neuberger Berman, says emerging markets have lower debt-to-GDP numbers than developed markets, in fact there is a 50-basis-point differential.

“The shoe is on the other foot now,” he says. “There is a fiscal deficit and lower economic growth in developed markets.”

There has also been a fundamental shift in that domestic investors within emerging market countries are investing in their own markets.

“Hesitation by investors into emerging markets has come from a few angles. The market generally has been more short term and even institutional money has been fickle,” Saldanha says. “But now it is more stable because of the domestic investors.”

Saldanha says it pays to focus on the emerging markets that have been more consistent in their valuation premiums and volatility. That tends to be the countries that have a strong domestic institutional pension-investor base such as Chile, Mexico and Malaysia (as a result the manager is underweight Korea and Taiwan).

“Domestic investors buying in their own market is a big distinction for us,” he says.

Indexes and outperformance

One of the alluring aspects of the emerging market investment proposition has been its outperformance.

Over the 10 years to April 30, 2013 the MSCI ACWI IMI has returned 9.78 per cent. The emerging markets component, as measured by the MSCI Emerging Markets IMI, has returned 16.68 per cent in that time, while the MSCI World IMI has returned 9.37 per cent.

The $65-billion Washington State Investment Board uses the MSCI ACWI Investable Market Index, rebalancing to that index in 2007, which executive director Theresa Whitmarsh says gave the fund a “healthy dose” of emerging markets.

That index captures large, mid and small-cap representation across 24 developed and 21 emerging markets. It claims to cover 99 per cent of the global equity investment opportunity set.

While WSIB was quite early to emerging markets, because of the shift to the global index Whitmarsh says it would like the option to overweight but has been prevented by the difficulty finding managers to allocate to. With six emerging markets managers, WSIB is looking to propose to the board the prospect of passive emerging markets exposures because of this perceived barrier.

People on the ground

“We are not necessarily overweight but we would like the option,” she says. “There are problems in overweighting, including finding enough good external managers that are open.”

In selecting managers, WSIB has a preference for staff from those countries.

“We look for managers with homegrown talent and connections,” she says.

“One of the risks of emerging markets is that macroeconomics can look good, but the political risks are real. It is hard to assess that from the outside, it is so critical to have on-the-ground partners.”

Phil Edwards, principal at Mercer in London, says the broad range of risks in emerging markets, in particular the political risks, means the selection of managers needs to encompass those considerations.

“With regard to manager selection, we use similar rating criteria as for other markets, such as the manager’s ability to generate good ideas, put the portfolio together and implement it. But because of the political risks, we also look at managers that have access to senior politicians and figures in various economies, and reflect that in their portfolios,” he says.

“Emerging markets is quite heterogeneous and includes a broad mix of different economies, so we look for managers who have understanding and expertise of different regions and understand the differences between countries.”

While there is a continuing trend for investors to look at the emerging market weightings, the majority remain underweight emerging markets asset classes relative to developed markets, partly due to a bias towards historical perceptions of safety.

This is the first of a three-part series on emerging markets. The next two stories will explore the opportunity sets in emerging market debt and emerging market equities respectively.

Peter Wallach, head of the United Kingdom’s Merseyside Pension Fund isn’t overly worried about the recent fall in equities.

“Markets are being driven by liquidity from central banks; this is more about central banks just needing to reassure investors,” he says.

“It is bonds, to our mind, that are over-valued in the medium to long term.”

There is another reason why Wallach, speaking from the local authority fund’s Liverpool headquarters on the banks of the Mersey, can afford to play down recent jitters in global equities. Despite the £5.75 billion open, defined-benefit local authority scheme still being very much in growth mode, a strategy to iron out volatility has afforded Merseyside an extra cushion from market bouts like today’s.

The fund has a 55 per cent equity allocation; a 10 per cent real estate allocation invested in the UK and international and specialist property funds; 14 per cent in alternatives; and 1 per cent in cash. The balance is in fixed income, namely government and corporate bonds. It’s an asset mix shaped by a gradual paring down of the fund’s equity exposure and boosting of its alternatives in a strategy designed to end the volatility attached to the large equity portfolios typical of many local authority schemes where the average equity allocation is 63 per cent.

Alternative view

In 2007 Merseyside’s only alternative allocations were to private equity and hedge funds. Now its alternative holdings encompass private equity (4 per cent) hedge funds (5 per cent) infrastructure (2 per cent) and an opportunities fund (3 per cent). A seven-strong team manages the entire alternative portfolio in. In contrast the full bond and the majority of the equity mandates are run externally.

“Excluding private equity our alternatives are less correlated; there was also a feeling that bonds wouldn’t give us the returns we needed and that core infrastructure was more likely to,” says Wallach, who ran portfolios for high-net-worth individuals (HNWIs) as a private sector wealth manager before joining Merseyside.

“I suppose you could say I’ve bought a more commercial outlook.”

Within the alternatives allocation, private equity is doing best. In a strategy honed over the past 20 years, Merseyside uses advisors but identifies, implements and monitors all private equity plays in-house, holding a diverse portfolio split by geography, vintage and fund type, although Wallach notes the geographical diversity is increasingly less significant as funds become more global.

“Apart from small European or US buy-out funds, a geographical weighting is hard now because large buy-out funds aren’t limited by geography,” he says.

The shift away from regional plays hasn’t impacted returns, averaging 14 per cent a year for the last two decades.

“We are very pleased with private equity,” he says.

The infrastructure allocation is similarly global. The core allocation is in private finance initiative (PFI) funds, some backed over ten years ago, but the scheme also invests in Asia Pacific infrastructure funds that are higher risk or “development-type” funds; and in renewable energy infrastructure designed to benefit from European subsidies to the sector.

Although Wallach hasn’t ruled out investing in the government’s Pension Infrastructure Platform (PIP), Merseyside isn’t a founder investor because of the start-up nature of the fund.

“In principle the PIP makes a lot of sense and we will continue to evaluate it as it comes on stream but we wanted to get money to work more quickly and the PIP is still in its genesis,” Wallach says.

A long look at hedge funds

It is hedge funds that have been the trickiest alternative. Although the allocation has modestly outperformed HRRX hedge fund indices, lacklustre returns and a changed market prompted the scheme to take a “long look” at its hedge fund allocations six months ago, testing their case for remaining in the portfolio.

“Absolute returns in the hedge fund allocation have only been satisfactory and not as high as we would have liked over the past five years,” Wallach says.

He who attributes part of the problem to the strong equity market.

“Hedge funds need more differentiation at the stock level and dispersion of returns has been low for a long time,” he says.

“However I do think the market is starting to move back in favour of equity long short and arbitrage funds as dispersion increases.”

In another strategy to reduce volatility, Merseyside has invested in smart beta. About five years ago, around the same time it pushed its allocation to alternatives, the fund allocated 3 per cent of its equity portfolio to an actively managed European minimum variance portfolio with Swiss asset manager Unigestion.

“We think there is a lot to be said for smart beta,” enthuses Wallach.

“The idea that the greater risk leads to the greater return has been challenged by the persistent outperformance of low volatility stocks.”

Since inception, returns have been 81.1 per cent, beating the benchmark, and with a volatility of 16 per cent against the benchmark’s 21.5 per cent. Given the European benchmark has risen 66.6 per cent over the equivalent period, Wallach is quick to credit what he calls an element of luck in the timing of the investment – but he says it’s a strategy that is likely to grow at the fund nonetheless.

“It’s not a silver bullet; we’d always hold it alongside other equity strategies,” he says.

Within that broader equity allocation, all US mandates are passive.

“The US is the most efficient market; it’s very difficult to outperform here,” Wallach says.

The UK is a mixture of active and passive while Japan and emerging market equity allocations are wholly active. Merseyside also allocates its equity portfolio regionally, rather than globally in a targeted approach because “the world is an enormous benchmark”.

Tapping into growth

It is a strategy also designed to tap growth in fast-growing mid-cap stocks. Although global managers get to invest in the best companies in the world, this way Merseyside can invest in companies further down the market capitalization scale, Wallach explains.

“By default we end up looking at a larger number of stocks,” he says.

Although Wallach notes Merseyside’s gradual shift in maturity it has not had an impact on investment strategy yet.

“We have matured much more quickly in the last six years but it is not a significant worry,” he says.

“We are putting things in place to manage our maturity.”

Early signs include a shift from cash positive to cash negative in terms of payments, although Wallach says the fund has a buffer in substantial investment income. The scheme is looking at ways to hedge its liabilities more effectively but will only put such strategies in place when it’s “appropriate.” It already offers a few of its employers tailored liability matching strategies.

“There is a lot more scaremongering about the effects of maturity than is warranted,” he says.

One of the UK’s largest local authority schemes, and the first amongst its peers to adopt innovative strategies, when the time comes Merseyside is sure to lead here too.

 

A solvency ratio of 157 per cent is a clear mark of success for a pension fund at a time when so many are battling deficits. Remarkably, Sweden’s SEK90-billion ($14 billion) KPA Pension has gained this funding cushion without fully embracing the range of new asset classes or strategies often touted as the solution to funds’ problems.

KPA’s asset mix has a distinctly traditional look – 95 per cent is in bonds and equities – but much of its success can be attributed to picking the right extra investment devices at the right time.

Chief investment officer of KPA Michael Kjeller explains that gaining “very strong” interest rate protection via swaps in the build up to the financial crisis allowed the fund to thrive in 2008 and 2009 when others had their fingers burnt – the fund returned 6.3 per cent in 2008 and 11.9 per cent in 2009. A decade ago KPA could only count on a slight surplus so Kjeller is in no doubt of the “tremendous change” that this policy helped deliver.

A cautious approach after taking out the interest rate protection in 2005 helped KPA as it held the swaps through a couple of years of suffering. “You never know when the fire will start so we wanted to keep our insurance with interest rate swaps,” says Kjeller. When the flames of the financial crisis were subsequently lit, KPA then found its protection was in huge demand – it was therefore able to sell the interest rate swaps to others at much higher prices.

“Whether through luck or skill we did the right thing when there was most turbulence, and were then able to build on that position,” Kjeller says. With its solvency boosted, KPA started to delve into equity markets in March 2009. “From what we know today,” Kjeller chuckles, “early 2009 was a good starting point in investing in equities.” Stockholm’s OMX 30 index has doubled since then.

 Overlaying a solid foundation?

The current focal point for KPA is its use of overlays. Indeed, it is the main job at its central Stockholm headquarters as equities and fixed income assets are all managed externally. “We try to tailor the risk profile in equities, fixed income and foreign currency with futures and options,” Kjeller explains. Constructing overlays is not the easiest investment job, but KPA can count on plenty of experience in running the strategies and Kjeller is delighted with the results. “Overlays have helped us handle both positive and negative tail events rather efficiently,” he says.

The fund’s current asset mix sees fixed income take a 60-per-cent share, equities 35 per cent and the remaining 5 per cent is invested in a real estate-dominant alternative segment. Kjeller baulks at suggestions that this is a conservative approach, with the risk premium from equities having carried performance in the recent past. As stock indices have climbed, Kjeller says KPA is now more neutral on the asset class though. Approximately half of its equities are Swedish, with a “small chunk” of emerging market exposure in the international equity portfolio. As it focuses its internal efforts on overlay activities, Kjeller tries to “keep things simple” by gaining purely large-cap exposure in domestic equities.

Fixed income has played its part in KPA’s current health, with its relatively long-duration investments helping the fund to a decent 5.6-per-cent return in 2011. It is proving a little problematic these days: “Like any other pension fund the low yield on high-quality bonds is an issue for us,” Kjeller admits.

KPA invests predominantly in Swedish government bonds and covered bonds – 10-year Swedish government bonds have yields below the 2-per-cent mark. The fund has been unable to do much about the situation, Kjeller confesses. “We don’t want to take on new risk that we don’t fully understand.” This conservative view has led KPA to steer clear of high yield or senior debt investments as possible solutions.

Not so alternative

Conservatism, the desire for simplicity and the presence of the overlay strategy have all kept KPA away from embracing alternatives. “Overlays allow us to benefit from the market conditions in which alternative investments thrive, so our demand for them has decreased,” Kjeller explains.

The age of the fund has also played a part in the fund’s slow adoption of alternatives, says Kjeller. He says real estate was too much of a risk for the younger, smaller KPA – the fund was less than 5 per cent of its current size at the time it became the default fund for Swedish local authority workers in 2001. “In a mature pension fund, we feel real estate should account for between 5 to 10 per cent of assets”, says Kjeller, thereby indicating that its real estate holdings should grow further. KPA mainly invests directly in real estate, as it prefers the risk-return profile of that approach, he adds. A 1-per-cent exposure to private equity and renewable energy in its small existing alternative portfolio is “doing fine”, Kjeller states.

Having followed a sustainable policy since 1998, KPA has a strong record in sustainable investing. It blacklists alcohol companies in addition to arms, tobacco and gambling firms. Its activities in the sustainable space have incorporated Sweden’s tradition in gender equality, with KPA campaigning in support of a United Nations project that supports young women and opposes child marriage. Added to its strong solvency and investment record, it is clearly setting an ideal for other funds to emulate in many ways.