No one who works at New Zealand Super has a business card that has an asset class attached to it. This simple representation speaks volumes to the investment approach taken by the fund.

One could work for the strategy team or the investment analysis team, but the investment structure by which NZ Super invests, such as equities, is seen as a legal structure, an access point, not a predetermined allocation, desire or need. So having staff organised according to those lines makes little sense.

“Everyone is working on or for the same fund. It is very hard to implement and you have to be very disciplined,” chief executive of the NZ$24 billion ($19 billion)NZ Super, Adrian Orr, explains.

“It has changed how we recruit, and the culture, everyone has to understand what each other does as much as the whole part and what they do as individuals. You have to be very open-minded and encouraging to understand where everyone’s coming from.”

The reference portfolio and reality

In a similar way to how the Canadian Pension Plan Investment Board approaches investments, NZ Super has a reference portfolio, which is the low-cost growth-oriented portfolio that could achieve the fund’s objectives.

“The reference fund is deliberately chosen as passive, the listed cheapest access point to the risk we want to achieve our goals. It’s not a strategic asset allocation in that sense. The actual portfolio can be and is very different to that – but at our own peril,” Orr says. “We are judged on the total return and value add.”

In this context active investment is viewed as anywhere the asset allocation differs from the reference portfolio, for example, even adding private equity to strategic asset allocation is an active decision.

It also provides a clear benchmark to assess the value added as an active manager, something NZ Super does through dynamic asset allocation, investment strategies (such as timber, private equity and infrastructure) and treasury management (such as foreign exchange and liquidity management).

The asset allocation of the reference portfolio is really simple: 70 per cent in global equities; 20 per cent fixed interest; 5 per cent global listed property; and 5 per cent New Zealand equities.

In reality the portfolio looks quite different to that and at the end of January 2013 it had 61 per cent in global equities, 9 per cent in fixed income, 8 per cent in infrastructure, 6 per cent in timber, 6 per cent in property, 5 per cent in New Zealand equities, 2 per cent in other private markets, 2 per cent in private equity and 1 per cent in rural farmland.

The access point, or asset structure, is the last thing to be considered.

Orr says there are three lenses to look through the portfolio: asset class, risk factors such as market, credit, liquidity, duration, price/asset, and an economic lens such as exposure to growth or inflation. NZ Super continuously cross-checks all of these, taking the attention off the asset class lens, which Orr says is useful but is just the legal form within which those investments are bundled.

Playing to advantage

NZ Super doesn’t change the strategic asset allocation every couple of years, because it doesn’t have one.

“How we choose to actively invest through dynamic asset allocation or active strategies is done through a stable consistent framework: we look at what are our advantages and play to them,” he says. “We primarily invest in price/valuation gaps where we are confident that gap truly exists. We are more contrarian in our investing than trend or momentum driven. We were long equities in March 2009 when the natural position was the foetal position.”

In recent years there has been quite a lot of active risk in the dynamic asset allocation.

The fund strategically tilts underweight or overweight across major asset classes, equities, fixed income, property, credit and has been heavily tilted towards growth since March 2009. It has been long equities and short fixed income plus increasingly long the US dollar, where it has been tradition to be 100-per-cent hedged to the New Zealand dollar.

“This was done on the best estimates of valuation gaps,” he says.

Rankings, relationships and risk management

The process is in constant evolution. The fund recently introduced a new ranking system so that every investment opportunity can now be ranked on consistent financial attractiveness and confidence factors. This has resulted in the fund managing more internally, a reorganisation of the investment teams and an impact on costs – which, net of performance-fees expenses, remain flat at 0.45 per cent of funds under management – and it has changed the dynamic of its external relationships to include more flexibility.

About 45 per cent of the fund’s exposures are through derivatives, and the treasury, asset tilting, investment analysis and asset allocation are all done in house. It has also recently established a New Zealand active-listed-equities desk, and the internal team also conducts external manager-search activities.

The $22-billion fund has about 30 external mandates, which include private equity and multi-strategy hedge funds.

“We are pushing very hard on external relationships,” he says. “We are narrowing those down, we have to understand the opportunity set they’re looking at. We don’t believe in skill alone but have to understand the opportunity set and then decide whether to manage that inhouse or externally.”

The internal team has grown from 17 to 90 in six years, decreasing the fund’s cost base and increasing the range of internal activities. But Orr says it doesn’t have aspirations around the team size.

“We do want to look at the scalebale bits and how to make the ships go faster,” he says.

Next for the fund is an increased focus on risk management and the development and integration of investment themes, which it has identified as emerging markets, resource sustainability and evolving demand patterns.

One of the first actions is to look at how responsible investment can be embedded within investments rather than being learned outside the investment decision-making process.

“We want to look at ESG up front as part of the investment decisions and the expected return in terms of sustainablility.”

NZ Super has exceeded both its predetermined measures of performance since inception, outperforming the New Zealand treasury bill by 3.28 per cent and the reference portfolio by 0.74 per cent.

They may be on opposite sides of the Earth, but Chile in Latin America and Central Asia’s sparsely populated Mongolia share more than a few similarities. Both boast some of the biggest copper deposits in the world and now Mongolia has turned to Chile for advice on how best to steward income from its forecast bounty that stretches out beneath the Gobi desert. It is sourcing help from one of the architect’s of Chile’s rocketing $22.9-billion sovereign fund. Eric Parrado, former international financial coordinator at Chile’s ministry of finance and now advising other emerging economies on the steps to managing resource wealth, has become synonymous with Chile’s global reputation on wealth fund expertise. “At the beginning in Chile nobody thought there was any point in saving money because we were an emerging market economy. Chile needed to spend money, so why save it?” says Parrado, just back from the Mongolian capital Ulan Bator. “But by saving in the good times, we were able to spend in the crisis and now all our critics applaud us.”

A guide for novice sovereign savers

His advice to Mongolia starts with tight fiscal management. Mongolia passed a new fiscal stability law in 2011, the foundation, says Parrado, on which any successful sovereign wealth fund must stand and the key to establishing discipline in commodity-driven economies prone to boom and bust. In a next step, Mongolia is drawing up a bill to create a framework for several sovereign funds, which will likely take on similar lines to Chile’s Pension Reserve Fund, established in 2006, and the Economic and Social Stabilisation Fund (ESSF), set up in 2007. The concept behind any stabilisation, or rainy-day fund, is to keep investment strategy liquid and conservative so financial help is close to hand in times of economic crisis. A pension reserve fund would cover future state pension liabilities and Mongolia is also considering a future generations fund, through which returns, but not capital, could be used to invest domestically. “Mongolia has only just begun discussions and there is no money to invest as yet, but it is likely assets will be split between these types of funds,” he says.

In his guide for novice sovereign savers, Parrado counsels that assets be allocated to safe and liquid allocations overseas to avoid Dutch disease, so-called after The Netherlands economy slumped following discoveries of natural gas in the North Sea in the 1960s. Investment strategy for countries without any experience of “formal strategies” should mirror the same asset allocation as their central banks use to manage international reserves. “This is what we did in Chile,” he says. It meant that in the embryonic years of Chile’s sovereign fund, assets were split between a 70-per-cent allocation to US, European and Japanese sovereign debt and a 30-per-cent allocation to money market instruments. “It was plain vanilla but it was very good,” says Parrado. “Between 2007 and 2010 Chile had some of the best returns in the sovereign wealth fund world because we chose safe assets.” He doesn’t advise rejigging allocations in the early stages of a fund’s life, drawing on the experiences of seasoned sovereign saver Norway during the financial crisis as an example of the merits of leaving investment strategy well alone. “Take the case of Norway,” he says, referring to Norway’s $650-billion Government Pension Fund Global. “In 2008 they decided to boost their equity allocation to 60 per cent. Equities were falling yet they had to buy more equities to reach the 60-per-cent mark. They lost $100 billion in 2008. It was really crazy and there is no way Chile could have done this.”

Benchmarks rather than indices

Only after what he calls “an essential learning process” did Chile begin to think about diversifying to other asset classes to manage risk. Assets were split to encompass equities and corporate bonds in passive, global strategies. “An active strategy isn’t worth it because it’s too difficult to gain against the market. There shouldn’t be any cherry picking, but following benchmarks rather than investing in indices.” Since Chile’s central bank had no specific experience of managing these riskier allocations, it used external managers for its equity and corporate bond portfolio. “One hundred and 10 external managers were invited to the ministry of finance,” he recalls. “Because it was 2008 and the middle of the crisis, we postponed allocation until 2012, awarding the biggest to Blackrock, Bank of New York Mellon, and Rogge. We have benchmarks and tracking errors for each one in passive strategies.”

Parrado acknowledges that saving is a hard sell in developing countries in need of investment in infrastructure, schools and health, but warns that Mongolia, one of the poorest countries in Asia, should only draw on sovereign reserves if they are channelled through the budget. It’s a strategy Norway leads on, with the government spending just 4 per cent of its sovereign fund’s annual return. It rules out strategic investment such as equity stakes in local companies, something Singapore’s sovereign fund GIC favours, but it ensures against downside risk. “Investing in local companies could work, but in my view, emerging market economies should only use the fund as a financing mechanism and shouldn’t invest directly in this way. It would involve careful allocation of money and an awareness of what type of investment was actually needed to ensure there weren’t white elephants everywhere.”

Risk rather than return

Nor does he suggest new funds target returns. Instead they should focus on risk, a strategy he believes is key to “preserving capital and legitimising the savings process” in poor countries. “All funds should begin from the point of expected risks rather than expected returns.” His advice to Mongolia is also to avoid some sectors of the economy to reduce risk further. In Chile managers are asked to not invest in Chilean copper companies because the risk correlation is too high in terms of economic activity.

In an era when sovereign wealth funds have become “flavour of the month”, Parrado doesn’t recommend any flamboyant asset diversification or that countries fashion strategic funds targeting local development. He espouses rigorous institutions and frameworks and cautions strategies in a model that now speaks for itself. “Of course there are different strategies and it is entirely dependent on what a government wants to do,” he says. “But from Chile’s experience in starting a fund from scratch in an economy that is close to other emerging market economies, this is the strategy we recommend.”

Conexus Financial, the financial services media and events company and publisher of top1000funds.com, has formed a partnership with the New York-based World Pension Forum (WPF) to create a major international conference business catering to the world’s largest institutional investors.

Conexus will apply its events management expertise and experience to enhance existing WPF events – three offshore and one domestic event for US-based institutional investors.

It will also create an online community to facilitate ongoing communication and engagement for conference audiences.

The World Pension Forum, founded 20 years ago by Philip Schaefer, boasts a strong track record of attracting chief investment officers, board chairs, trustees, fund chief executives and senior investment decision makers to its events. Schaefer will remain as president of the expanded business.

In a statement, Conexus co-founder and chief executive Colin Tate said that both he and Schaefer believe that “challenging long-term institutional investors to think differently and encouraging them to engage globally has the power to make a difference in the world”.

He said that WPF events “help investors connect the dots between their fiduciary responsibility, member returns and risk management for the ultimate betterment of retirees. It will also provide a platform to work with policy makers on addressing the world’s urgent fiscal, environmental and social issues”.

WPF’s scholar-in-residence Stephen Kotkin, professor at the Woodrow Wilson School for Public and International Affairs at Princeton University, will continue to be responsible for programming and managing all speakers and content at WPF events.

A statement from Conexus and WPF sets out further details of the partnership.

The Australian fund, HESTA Superannuation stands out among its peer of industry funds for a few reasons, not the least of which is its predominantly female (80 per cent) member base, but it’s also one that has seen notable growth in the past 20 years.

From a fiduciary perspective, the fund has gone from less than $1 billion funds under management in 1994 to more than $20 billion. That was the year its current chair of three years, Angela Emslie, was elected to the board, though the fund itself was established in 1987.

From a governance standpoint, diversity has also been a marker of significant change. An independent chair among 13 trustees, Emslie says she was but one of two women out of 14 directors at the time she joined. The number of women now stands at seven, out of a total of 13 board members, including six employer and six union representatives.

 

Board diversity

To some degree, HESTA’s primary female demographic has been an influence on its board composition, Emslie says. “It’s really been a long-term process of engagement with our nominating bodies and sending the signal that board diversity is important. It has taken us many years of work.”

It’s no small feat given that, as Emslie points out, there are funds with a huge lack of gender balance: some have only one female on the board, while others are completely absent of any female representation.

“I think those organisations do need to focus [on this], particularly where they represent industries with a high proportion of women,” she says.

“I think that’s definitely something that needs to be worked on, and I think it can be done. You just have to look at the work that John Brumby’s done at MTAA and the work that HESTA’s done.”

Emslie is quick to emphasise, however, that the fund is committed to diversity across numerous elements – and always has been – namely in skill sets, interests and geographic representation Australia-wide.

“We’ve done a lot of restructuring of the board over the years to make sure that we have a good balance of the different industries we represent and the different unions,” Emslie says.
“I don’t know of any fund that’s done as much work in terms of restructuring its nominating bodies and its board as HESTA has.”

 

In an increasingly regulated environment, Emslie acknowledges a new age of enlightenment among funds when it comes to duty, but says there is still some way to go with boards making change for their members.

“People recognise the importance of transparency and demonstrating that we are good fiduciaries. I don’t think necessarily there’s a lot of evidence about boards changing their structure to represent the interests of their members and employers.”

 

On governance

In late February, HESTA was granted its MySuper licence, the product for which will be the current default for the fund, HESTA Core Pool. Emslie says the fund already had a lot of the requirements in place, which didn’t leave much extra work to do this year. She points to the contribution of one of the board’s two sub-committees, namely the governance and remuneration committee, regarding its Stronger Super readiness. The other sub-committee is focused on audit and risk.

“Those committees do a lot of the detailed work on those issues,” says Emslie, acknowledging in particular the work of the governance and remuneration committee around training policies, expectations of directors and recruitment and nomination processes.

A couple years ago, the board undertook a review of its investment governance and where it was headed. Asset allocation emerged as an area requiring greater consideration. The board dispensed with an investment committee because it found that it had the potential to disenfranchise the half of the directors not involved.

“We found that we had one group of people that was very involved and in the know, and the other group that wasn’t necessarily but still had questions that they wanted to ask, and often a lot of work could get doubled up again at the board,” Emslie explains.
The directors decided the fund’s investment is a core business of the board, and they try to keep discussion at the strategic level, focusing on strategy portfolio design and performance, and delegating implementation and operations to management. “And that’s been a process over time to get the balance of what that is right,” notes Emslie.

“The board really focuses on strategy and portfolio design and delegates the implementation of that strategy and the operational side. By implementation, I mean actually selecting fund managers and working with fund managers. We do very little of that these days.”

The board will see a manager at the end of the selection process to make the final decision, but Emslie says there’s no so-called “beauty parade” or line-up of managers. “That’s done by our investment and governance units and our asset consultant,” she says. “[They] do all of that selection process and bring the final manager to be selected to the board for a final decision, with all the rationale behind that.”

 

Advisory think tank

In place of the investment sub-committee and on the back of the review, HESTA set up an investment advisory panel, which includes three board members and two external participants with appropriate investment expertise. HESTA’s asset consulting and internal investment teams are also involved.

“That’s really like a think tank or thought-leadership group to really just kick around new ideas and test out our asset allocation and our thinking,” says Emslie, adding that she’s pretty pleased with the results so far. “It’s not a decision-making body in any way, shape or form, but it does feed into the asset allocation discussion, dynamic asset allocation and also strategy, sector review areas.”

On its investment approach, Emslie says the fund isn’t different to many others, with quite a large allocation to unlisted assets and infrastructure, as well as “quite a bit in opportunistic debt”.

All of its investment management is done externally, but Emslie hints at other changes in relation to time savings. “We’re more to looking at how we can, particularly with some of our unlisted investments, move away from fund-to-fund products because they’re expensive, and ways in which we can save money there by having our team involved internally in a different way.

“That’s not necessarily direct investing, that’s just doing some of the things that perhaps fund-to-fund managers might have done and it’s also about possibly co-investing. That’s about efficiency, I think.”

 

Cost efficiency and survival of the biggest

Meanwhile, Emslie says HESTA has a very strong focus on driving down fees. It developed “quite a sophisticated model” called MER for alpha, which assesses each of the fund’s investment managers against their fees and what they deliver.

“In some cases, we have terminated managers because we don’t feel that the fees that we’re paying them justify the return that we would get from them,” says Emslie.

“It’s quite a complicated model developed by our investments and governance unit, but obviously it was approved by the board, and it’s something that we refer to whenever managers are selected, and also we look at it for asset classes as well. How much does it cost to be in this asset class, how much return are we going to get?”

Elsewhere, Emslie flags other challenges, in particular the “competitive marketplace”, and how the differences between funds are narrowing out, mainly for the smaller funds.

“[It’s] going to be challenging, because they’ll need more resources to manage the compliance issues,” she says. “It’s really just the next step up in sophistication, and some smaller organisations perhaps haven’t gotten to that level of capacity internally yet.”

 

In the city of Hillerød outside Copenhagen in Denmark, a small group of Danes want to teach the United Kingdom’s pensions industry a thing or two. Where UK trustees tend to see fund choice as a blessing, Denmark’s DKK579-billion ($101.6-billion) public pension plan ATP has always viewed picking and choosing between different managers as more of a curse. It has applied the ethos to its UK subsidiary, defined-contribution workplace pension-scheme provider, NOW: Pensions, which sells itself to UK companies looking to automatically enrol staff on the strength of one single investment strategy. Having set up a year ago, it’s still early days but NOW: Pensions Investments A/S chief investment officer, Mads Gosvig, is convinced he’s on the right track.

“Many schemes in the UK have been set up for people with higher incomes used to taking investment decisions, but you don’t want the same tool for everyone,” he says from Denmark where the NOW investment team sits alongside ATP’s. “With auto-enrolment, more people will be taking out pensions and our research shows it’s best to keep the number of decisions small because pensions are a specialist area.” NOW won’t ever pool assets with ATP but the two funds already share ideas and processes and, as NOW’s assets accumulate, the funds will implement the same strategies and buy into the same third party investment vehicles.

What’s NOW?

NOW offers members access to three funds catering first to a savings phase via a Diversified Growth Fund. A decade before retirement, members’ assets pass into a Retirement Protection Fund, in which returns from the growth phase are safeguarded through long-term gilt allocations and interest rate swaps in a hedged portfolio. Finally, assets pass to the Cash Protection Fund. The Growth Fund, split 60/40 between equities and bonds, targets a return of 3 per cent above cash, a target Gosvig believes is easily achievable given trial results from a $15.3-billion synthetic portfolio have returned 10 per cent. NOW only began accruing assets midway through 2012; Gosvig won’t be drawn on current assets under management just yet.

Like ATP, the Growth Fund is built around risk allocations rather than conventional asset allocations. It’s an approach that better manages risk since most asset classes have “an inherent exposure to equity risk,” explains Gosvig. The fund favours five classes comprising interest rate risk, credit risk, equity risk and inflation risk with allocations to government bonds, high yield bonds mostly in emerging markets, global listed equities, commodities and inflation-linked bonds. It’s a strategy eschewing any exposure to illiquid assets and although this could change, Gosvig isn’t convinced returns from the likes of private equity, infrastructure or property are worth the risk for NOW just yet. Liquidity, he says, is not only key to his scheme’s success, giving it an edge over other UK providers like NEST which don’t allow members to transfer assets in or out, but is also crucial in encouraging people to keep saving under auto-enrolment. “The average person in the UK changes jobs twelve times in their working life. You need liquid assets so they can take their pension with them.”

How NOW manages

In the same way other multi-asset funds rebalance a portfolio between asset classes as they see fit and aren’t locked into static allocations, the Growth Fund’s balanced allocation will make managing volatility easier. “Any losses in equities will be cancelled out by gains in bonds,” he says. NOW will actively manage volatility in “risk-on” and “risk-off” strategies. In what Gosvig calls a first line of defence, NOW will first alert trustees of the need to reduce allocations to riskier assets in the fund. A second “risk-on” tool kicks in automatically if the value of the fund falls 25 per cent over a twelve months period. “In this scenario risk is automatically taken off the portfolio with all risk classes reduced by 10 per cent,” he says, using a driving metaphor to illustrate his point. “From time to time we will need to take speed out of the portfolio and this way we can.”

Equity exposure will come via investing in indices. Gosvig believes this is the best way to buy into equity risk, but it’s a strategy that has still presented challenges since many indices include exposures NOW would rather not hold. Emerging markets equity indices, often characterised by clusters of big companies, bring a concentration of risk. How to buy into European equities without exposure to banking stocks is another challenge. “We’ve discussed creating own indices with ATP, but you need somebody to trade the index with and there’s a cost to that,” he says. Rather than buy bond indices, NOW will buy bond futures, primarily in the UK, US and Germany, but will access commodities via commodity future indices.

NOW’s UK subsidiary has no external managers, bar a handful of allocations to exchange traded funds, and its own investment team comprises just three people. Of course NOW isn’t the only fund built around a simple investment strategy; variations of the no-frills approach are apparent in a raft of much bigger and proven schemes. But it’s a low-cost model that APT could take beyond the UK to nations such as India, which is currently opening its pension sector to foreign investment. The concept that choice isn’t necessarily a good thing could be about to take off.

Innovation is associated more with bold new businesses than gently declining ones, but Denmark’s Lønmodtagernes Dyrtidsfond (LD) is embracing change as it enters its final years. The pension fund’s inevitable disappearance has nothing to do with any lack of competitiveness or poor investment returns – the 9.9-per-cent net return it generated in 2012 is testament to that. Instead it simply finds itself in the autumn of its investing cycle. Entrusted with investing assets promised to more or less the entire Danish workforce in the late 1970s, LD’s contributions dried up over 30 years ago and its members will all reach the age at which they are able to withdraw their savings in just over a decade from now. Investments are expected to dwindle to half the current 52 billion Danish Krone ($9 billion) by 2020. Except they aren’t dwindling at all – last year they climbed by $170 million, despite three times that amount being withdrawn.

Lars Wallberg, LD’s chief financial officer, explains how investment success has come as a consequence of a focus on intelligent outsourcing ensuring strategic flexibility and a focus on remaining competitive in both investment returns and costs. Curiously, the fund’s philosophy on outsourcing and controlling costs would not be at all out of place among the cost-sensitive lean start-up movement. Low investment costs are a “very important strategic point” says Wallberg, who is aware that they are a particular point of scrutiny for members of defined contribution schemes like LD. Lars Wallberg

Wallberg, pictured right, enthuses about how costs remain below 0.40 per cent. “When we did a tender for our investment managers in 2010, we deliberately designed our mandates to be relatively large and ensure there was truly global competition in what was one of the most extensive search and selection processes undertaken in Europe,” he explains. “That enabled us to get some very competitive offers.” Wallberg also says that LD keeps the competition going by closely analysing external managers’ performance to their benchmarks. It found in 2012 that the managers – who invest actively – added an extra 0.3 per cent of overperformance to the return figures (net of costs) with an additional 0.2 per cent coming from LDs own asset allocation choices and risk management.

Responsibility and risk

A top-down approach to outsourcing is cited as a priority in LD’s annual report, and there is a clear sense of responsibility for the 15 staff at the fund’s Copenhagen office. It is difficult to judge their efficiency from the outside, but certain feats point to it being a highly organised and engaged fund. Lønmodtagernes Dyrtidsfond was able to publish last year’s investment returns as early as January 2 and takes part in a Myanmar engagement forum as part of its many sustainable investing activities. As far as the investment strategy is concerned, an intense focus on asset allocation and risk management is the chief inhouse job. That itself had been outsourced to a fiduciary management subsidiary in 2005, only to be brought back in house five years later.

Lønmodtagernes Dyrtidsfond has commissioned Morningstar to monitor the risk of its fund, and it continues to place the default fund that covers over 90 per cent of its assets in the lower end of the medium risk category (LD also offers members a range of separate funds covering equities and fixed income, which are used by members wanting to invest individually). The medium risk appetite could explain why as much as one-third of the fund was held in equities at the end of 2012, in line with LD’s own benchmark weighting. This approach seems possibly at odds with that of nascent defined contribution funds in the United States and United Kingdom that generally propose ‘lifestyling’ away from equities in the years directly preceding retirement.

While LD is currently carrying out an asset-liability management study – including an analysis of its members’ perceived risk appetite – that will determine its approach for the years to come, Wallberg says this will probably not be a case of simply reducing risk. “The easiest thing to do would be to put the money we expect to be withdrawn in the near future in the bank and most of the rest in bonds”, he says.

Instead LD wants, in Wallberg’s words, to “honour the expectations of the members. We have to ask how much risk and illiquidity we can assume while still being able to disburse funds at any time. As long as we structure the portfolio to ensure the cash flow can service withdrawals, our analysis shows we can accept more risk than you might expect.”

Wallberg speaks about deploying a “multi-dimensional risk metric” at LD, rather than one driven by a traditional risk-return relationship. Illiquidity risk is a vital consideration for a fund that has to prepare for unexpected withdrawals (members can withdraw from age 60, but many wait beyond then). The pattern LD has seen of members preferring to withdraw after disappointing investment results further complicates that illiquidity risk.

Credit where it’s due

A bold move already undertaken by LD was to increase its corporate bond holdings in 2012 as it plans a 20-per-cent weighting to credit, double that of the past. Credit investments “proved very lucrative in 2012, no doubt about it,” says Wallberg: an enhanced $1-billion allocation to non-investment grade corporate and emerging market bonds returned 14.3 per cent. “We expect credit to offer a reasonable risk-return ratio and a good solid cash flow,” he says. “That’s the best of both worlds for us.” Lønmodtagernes Dyrtidsfond’s unique challenge is that 40 per cent of its assets belong to members over 60 years old and therefore must be convertible to benefits at short notice should the need arise.

Among the riskier asset options, LD plans to continue its significant position on Danish equities – currently around 10 per cent of the overall portfolio and “overweight to most if not all Danish pension funds” says Wallberg. This position delivered a huge return of 24.5 per cent in 2012. An increasing proportion of emerging market equities is one of the tools LD uses to diversify the risk of concentrating on the limited Danish equity market.

Wallberg expects equity holdings to gradually decline as LD nears its end. Private equity is an asset class that is losing favour slightly more rapidly as the illiquid assets pose problems in the case of sudden withdrawals and the ultimate winding up of the fund. Wallberg emphasises that LD is “still active” in private equity, mostly via funds, having begun from a large base. That should perhaps be no surprise after a glimpse at 15.8-per-cent annual returns for 2012 on its Danish non-listed equity and 13.3 per cent on its smaller overseas unlisted-equity holdings.

Lønmodtagernes Dyrtidsfond’s members have no doubt welcomed the strong returns of 2012, but how can the fund limit its classic volatility risk in an investing environment with few safe options? A sudden rise of interest rates could seemingly have a dangerous impact on LD’s 65 per cent allocation to fixed income. Wallberg says this threat has been discussed intensively with futures and other derivatives an option on the table to try to mitigate it, in combination with possible changes to its bonds managers’ risk profile.

Wallberg is confident that LD’s asset strategy can allow its remaining members to withdraw their savings “when the time is right for them”. It must be working as over 250,000 people who could have already withdrawn their money are keeping it in. If LD’s strategy needs further innovating in its final years to keep the members so satisfied with the results, then LD stands fully prepared to do that.