After several years where governance capacity was consumed by interest rate derivatives, Danish pension funds are starting to look once again at more exotic alternatives.

Aside from giants like ATP, Danish funds have typically had modest exposure to the alternative asset classes, preferring to invest in vanilla equity and bond portfolios, even if, with defined contribution plans dominant, funds have felt free to experiment with the riskier, higher-yielding end of the long-only spectrum.

But this is starting to change, according to Søren Andersen, a consultant at Invensure, the Danish investment and pensions consultancy.

He says: “Pension funds in this country have spent the last five years using interest rate derivatives to hedge liability guarantees. Denmark was the first country to do this, though the Netherlands are now starting to do the same thing. This has taken up a lot of internal resources within pension funds, trying to structure and understand these products.”

Playing catch up with alternatives

In his view, this has meant Denmark’s funds have been “a bit slow” in comparison with countries like the UK in their courtship of more up-to-the-minute asset classes. “The process has been on hold for a while as funds have investigated interest rate derivatives, but this is starting to change now.”

Even as funds acquire a new appetite to explore the frontiers of investment strategy, however, they are likely to be wary of the hedge fund exposure that is making such headway in other markets. “I am not sure you will see hedge funds coming in to play soon,” he says. “That has to do with different things – a lack of resources to investigate hedge funds, and also the fact that a lot of chief investment officers and investment professionals here have a very technical mathematical background and don’t really believe in hedge funds.” However, he thinks 130/30 funds may yet command attention. “We don’t really consider them hedge funds,” he says.

A report released earlier in the summer by the investment consultancy Kirstein Finans points in the same direction. The company’s most recent quarterly survey found that pension funds in the country were planning to cut their traditionally high levels of bond exposure in favour of a more diversified approach. Niels Erik Petersen, chief investment officer for the architects’ pension fund and the agronomists’ and veterinarians’ pension funds said at the time: “We are looking at whether we can get higher and/or more stable returns from other asset classes instead of bonds.” Despite Mr Andersen’s scepticism, however, he still held out the possibility of exploring hedge fund exposure. Kirstein’s report also found four fifths of pension funds looking seriously at ramping up their infrastructure exposure.

Mr Andersen prefers to add a nuance to this move away from bonds, however. Certainly, dropping bonds in a low interest-rate environment hardly needs a lot of explaining. At the same time, however, he thinks that regulation until recently created a systemic fixed-income bias. He says: “The reason we’ve had so much fixed-income exposure, mainly via Danish mortgage bonds and Danish sovereigns, is that we’ve had these high interest-rate guarantees. We haven’t really had that much capital strength to invest in equity.” Many schemes are still bound by guarantees made years or even decades before. Newer schemes, however, have much lower guarantees.

Move towards defined contribution

This explains the strong desire on the part of legacy defined benefit funds – long closed to new entrants – to encourage their members to accept a defined contribution pension. Mr Andersen explains: “If you look at older company funds, you are seeing the majority are trying to persuade their members to move from high guarantees to low guarantees. If you are successful in doing this, then you can have much higher equity exposure.”

Two asset classes with a long history in Danish institutional investment continue to make waves, this time as holdings become more internationally diversified. Private equity has a long history in Denmark, even though holdings have been scarce in recent years. Now, however, it is making a comeback through internationally diversified holdings. Mr Andersen says: “Private equity is a very natural class in Denmark. For 30 years we had a lot of directly owned domestic private equity, though most of the corporate funds got rid of it years back. Now, they’re trying to do it again with more international diversification.”

PBU, the early childhood teachers’ pension fund, is looking in this direction with its chief investment officer Morten Schou promising a more systematic look at the asset class in the near future.

Real estate, also a well established asset class in Denmark, is undergoing the same international diversification process. “We are seeing a very clear trend towards international real estate via funds,” Mr Andersen says.

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