Matti Leppälä, director of international and legal affairs at the Finnish Pension Alliance (Tela), believes the reform has already led to the expansion of equity portfolios and increased allocation outside the eurozone. “Last year’s figures show that there is increased interest in non-OECD regions and alternative asset classes. Local funds already started expanding their equity portfolios before the new regulations came into force,” he says.

According to Tela, Finnish pension institutions increased their overseas holdings from 70.8 to 81.1 per cent in 2006. Last year, Finnish pension funds had invested some 33.4 per cent of their assets in equities, in comparison with 29.9 per cent in 2005. Pension insurance companies increased their allocation to equities from 32.8 to 39.9 per cent over the same period.

Increasing popularity

Mr Leppälä points out that the new regulations motivated several Finnish funds to allocate to alternative asset classes. “Nowadays almost all pension investors in Finland have at least some exposure to hedge funds. Private equity is also increasing in popularity, but the industry is still considering how large a proportion of their assets should be invested,” he says.

Tela is observing the plan of the Dutch association of industry-wide pension funds (VB) to create a classification system for hedge funds to help local pension funds manage their alternative investments. “It will be very interesting to see how the Dutch system will look. In the future it be might be useful to consider establishing a similar system in Finland, as investing in hedge funds is clearly increasing,” Mr Leppälä says.

Hannu Hokka, managing director of the VR Pension Fund, the €1bn scheme for workers in the Finnish state railways, agrees that the reform has made alternative asset classes more popular. “Alternatives, particularly hedge funds, are the real winners of the reform. The enthusiasm to increase exposure to these is notable,” he says. In 2006, VR also increased its exposure to hedge funds from 3 to 8 per cent. “Recently we increased our strategic benchmark to private equity to 5 per cent. However, so far, we have invested only 1 per cent of this. In the future this part of our alternative investments will grow,” Mr Hokka says.

Mr Hokka adds that his fund will take advantage of the new freedoms by also increasing allocations outside the OECD region. The new regulations allow an exposure of 20 per cent to assets outside the eurozone. Before, the limit was 10 per cent for pension companies and zero for pension funds.

“We are interested in finding out more about emerging market debt, which the new regulations have us enabled to invest in. We are observing the debt markets and are considering if and how we should enter the field. One thing that makes us hesitate slightly is the risk level of emerging market debt investments, which local currency increases,” he explains.

Pekka Korhonen, managing director at the €890m OP Bank pension fund, notes that property funds are also gradually becoming a more popular diversifier. “We find foreign property funds an interesting investment vehicle. They have offered an efficient way to diversify and have also yielded very healthy returns.”

Keeping up with peers

In 2007, OP will observe how its peers in the Finnish pensions industry make use of the new regulations. “What is interesting about the new regulations is that, in a way, they pressure funds to have very similar portfolios. We are interested to see how our peers will maintain their equity portfolios in this new environment,” says Mr Korhonen.

Esko Haavisto, senior strategist at Nordea Investment Management, points out that the new regulations may pose a challenge for those pension institutions that have a smaller equity exposure than most Finnish funds. “The regulations stipulate that the return requirement of those funds, which have less exposure to equities, and consequently do not benefit from an equity market rally, will still be treated as if they would have been in the same position as other funds.”

According to Mr Haavisto, this may lead to the deterioration of the fund’s solvency position, which actually prevents it from increasing its equity exposure as it would also increase the investment risk. “As a result, the fund may find itself in a vicious circle: having a low exposure to equities and a lower long-term return expectation than its peers. Not ending up in this kind of situation will be crucial if a fund is to survive in the new regulatory environment,” he says.

RC

THE ROAD TO NEW ASSET CLASSES

• The new investment and solvency regulations for Finnish pension institutions came into force in January 2007. They were drafted by Kari Puro, the former CEO of Ilmarinen, and a group of industry specialists.
• The most important aspect of the reform is the increased ability of pension institutions to invest in equities.
• The new regulations also enable funds to invest more in alternative asset classes. Also the upper limit for investing in non-eurozone assets has been increased to 20 per cent.
• The reform also changed the way the risk of an investment portfolio is calculated. Before, risk was classified by its legal nature. This provided the incentive to invest in risky assets which legally qualified as bonds. Risk is now calculated via the financial risks involved.

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