Nine out of the 10 largest pension funds of the Nordic region have all reported lower returns for 2006 than in 2005. On average total returns showed a decline of 5.4 per cent.

This decline was most noticeable in Denmark. At ATP, the €53.18bn Danish supplementary pension scheme, investments yielded a return of 7.8 per cent in 2006 compared with 20.7 per cent. At PFA Pension, the €28.6bn fund, returns declined from 14.3 per cent to 3.1 per cent. Likewise, the €32bn Danica Pension, Denmark’s largest pensions company, recorded significant declines. In 2005 its portfolio yielded 12.6 per cent and in 2006 just 2.9 per cent.

The two major Norwegian pension funds, Storebrand and Vital, however, did much better. At Storebrand Life, returns improved by 0.7 percentage points on 2005. The company’s €26.58bn portfolio yielded a total return of 8.3 per cent in 2006. Vital, the largest pension insurance company in Norway, pulled in 8.1 per cent last year and 8.3 per cent in 2005.

Jesper Kirstein, managing director at Kirstein Finance investment consultancy in Copenhagen, believes there are two main reasons for the slump in performance among Danish pension funds.

“The first reason is that bonds performed relatively poorly last year – a problem because Danish funds have always historically allocated large amounts to fixed income,” he says. “The second reason is that they use derivatives more than other Nordic funds to protect their liabilities. When interest rates fall, the return on derivatives triggers a deterioration of reserves, whereas an increase in interest rates generates losses on the assets.”

Equity-driven returns

In 2006 Kirstein Finance’s Nordic Investor Survey found that Danish funds allocate 62 per cent of their assets to fixed income and 29 per cent to equities on average. In Sweden, however, 59 per cent of all holdings are invested in equities and only 38 per cent are exposed to fixed income. Kirstein’s study also found that the proportion invested in alternative asset classes among Nordic funds is highest in Finland and Norway, 11 per cent on average in both countries. In Sweden only 3 per cent of assets are invested in alternatives.

Trond Grande, head of financial risk management at Storebrand Life, the €19.6bn fund, told nrpn that its 8.3 per cent return was largely equity-driven. “Both our domestic and foreign equities yielded higher than expected returns. Domestic equities pulled in 30 per cent and international equities 15 per cent. We also got very positive returns from our property holdings, 13 per cent.”

At present Storebrand Life’s portfolio consists of equities (28 per cent), bonds (44 per cent), property (13 per cent), money markets (8 per cent) and alternative investments (7 per cent). Mr Grande is also keen to underline that rising interest rates are not always a bad thing.

“We see rising interest rates as a two-fold issue,” he says. “When interest rates go up, bond returns go down. But on the other hand, the higher interest rates are the better value they offer. This is because in Storebrand’s defined benefit schemes we have embedded guarantees of 3.6 per cent on average. The higher the interest rates are, the more likely it is that we can deliver our return and offer better value for our members.”

The investments of the two largest Finnish funds, Varma (€26.9bn) and Ilmarinen (€23bn), yielded healthy returns in 2006. Varma turned in 9.4 per cent, a decline of 2.3 per cent on 2005. By the end of 2006 Varma’s investment portfolio consisted of equities (46.3 per cent), bonds (38.6 per cent), property (10.2 per cent), loans (3.5 per cent) and other money market vehicles (1.4 per cent). The fund also has a 12 per cent exposure to alternative asset classes, which is included in its equity portfolio.

Mikko Koivusalo, Varma’s director of investments, says its equity and in particular its alternative investments helped it achieve a healthy return regardless of the prevailing low yield environment. “We increased our exposure to alternative asset classes from 8 to 12 per cent of all holdings and this had a notable impact on returns,” he says. “Private equity yielded 25.4 per cent, unlisted equities 31.5 per cent and hedge funds 8 per cent. Also our equity portfolio yielded a very healthy 23.6 per cent. At present we have a 4 per cent exposure to private equity and an 8 per cent allocation to hedge funds. On a European scale this is relatively large.

“Bonds, however, were a cause of concern throughout the year, and yielded only 0.7 per cent. We reduced our exposure to the asset class from 47 to 38.6 per cent. However, because the existing solvency regulations require a relatively significant allocation to fixed income our exposure remains large.”

Reducing bond exposure

Ilmarinen CIO Jussi Laitinen points out that by cutting down more on bond holdings and replacing them with alternatives, his fund could have achieved healthier results in 2006.

“In all other aspects of investments, except fixed income, 2006 was an excellent year. We did reduce our exposure to bonds over the year from 49 to 45 per cent, but this was not enough to beat Varma,” Mr Laitinen told nrpn. In 2006 Ilmarinen’s portfolio yielded a return of 8.5 per cent.

Peter Carøe, interim chief investment officer at Denmark’s PFA, adds that rising interest rates played a key role in bringing down the returns of PFA.

“Because a large part of our portfolio is invested in bonds, the positive performance of property (42.6 per cent) and shares (17.3 per cent) was not enough to maintain our 2005 level of returns. The reason why we feel obliged to invest a large share of our portfolio in bonds is because of our liabilities, which are partly hedged in this way,” he says.

Sarah McPhee, CIO at Sweden’s €31.15bn AMF Pension, thinks that in 2007 rising interest rates will continue to be a challenge for pension funds in Europe and the Nordic region.

“We expect a positive growth in equities, but not as impressive as last year when our domestic equity investments yielded a very impressive 27.4 per cent,” she says. “On the other hand, we do not expect domestic bonds to improve their performance this year, if at all. The challenge posed by rising interest rates will continue to exist. However, we are very bullish about property, to which we allocated additional funds in last year. Today our exposure is approximately 7.5 per cent and we have very positive expectations for this part of our portfolio.”

Figure 1: Asset allocation of Nordic institutional investors (%)

Figure 2: 10 largest pension funds in the Nordic region by assets

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