Finland has been feeling the impact of the global economic crisis, but unlike other countries it has strong diversification tactics
With equity markets across the globe plummeting, institutional investors have had little choice but to reduce their allocation to equities or sit cautiously on the sidelines while deciding when the best time to re-enter the market is. For Finnish pension companies, it has been a bit of both.
Like most pension systems around the world, the Finnish system has not been unscathed by the financial crisis. As a result, the major pension players in the European Union's eighth largest country have generally opted to reduce equity allocations in order to better handle the relentless market volatility.
Along with the other Nordic countries, the Finnish pension system is held as very forward thinking when it comes to investment. Investors in this part of the world are very up to date on diversification, actively exploring the likes of private equity, real estate, emerging market debt, high yield and hedge funds. Nordic companies, for example, were among the first to invest in the Baltic states, areas of Eastern Europe, Russia and in Asia.
With this in mind, how have Finnish investors been handling the market woes?
No place like home
HSBC Global Asset Management managing director Nordic region Sten Ankarcrona said a lot of the large Finnish pension funds had been able to get out of non-Finnish equities quite early because many have large stabilisation programmes.
"They have been strategically staying in Finnish equity," he said, "and then playing with large portions of cash and in the bond market buying individual papers."
Ankarcrona explained the bias among the larger Finnish funds towards domestic equities as a case of seeking security in what is familiar. "You can't get out of equities altogether so in the current environment one tends to crawl back into one's shell and stay with the products one knows well," he said. "I suspect there are certain pension funds holding equities that are non Finnish but I think they have pulled back quite dramatically and lowered their risk budget."
Indeed, risk has been a key driver in the Finnish pension fund system during the past few years. Until 2006, the solvency laws in Finland dictated the amount private pension schemes could invest in different asset classes was dependent on their solvency ratio. The higher the solvency of the fund, the more flexibility there was given to investing in high risk areas.
Traditionally, pension providers in the private sector could invest up to 25% in equity. Then in January 2007 a reform was established so that the share will be increased in steps of 2% across the ensuing five years. So, by 2012 the allocation could be up to 35%.
Additionally, last Autumn the Finnish government relaxed the solvency laws in the private sector in order to prevent pushing pension funds into quick, mass sales of stocks at low prices.
Finnish Centre for Pensions development manager Ismo Risku explained the situation: "Some companies were forced to sell their stocks and to some extent this was already a reality because the situation was not right. It was acute action but they had to anticipate that it could turn out to be worse."
This relaxing of solvency laws was implemented on a temporary basis until 2012 but many industry members feel something should be implemented long-term to make it possible for funds to take the appropriate amount of risk again. The minister for social affairs and health has put a working group in place to discuss the solvency framework and how to invest going forward but no developments have come to light thus far.
On the private sector side of the fence, the €29bn Varma Mutual Pension Insurance Company - the largest in Finland - recently issued its interim report for Q1 (Jan 1-March 31). The return on the equities portfolio was -2.1%, of which quoted equities made up -3.4% and unquoted equities 5.2%.
Varma chief investment officer Risto Murto admitted that market conditions were very volatile and in such circumstances the company was happy to have a positive return of 0.3% in Q1, which was the result of having a diversified portfolio.
"The portfolio behaved in a much more usual way than in previous quarters - it was more like getting back to a normal quarter for us," said Murto. "The diversification benefits were clear and the correlation between different asset classes was more like in normal years."
Elsewhere, the €24bn Ilmarinen Mutual Pension Insurance Company's equity portfolio accounted for about €7bn of its total investment assets at the end of 2008. Some 35.3% of this (€2.5bn) was in domestic equity investments.
Ilmarinen deputy chief executive Jaakko Tuomikoski said the company's allocation to equities had diminished but not by active measures. "The proportion of equities is around 20% but it used to be 30% or 35%. Most of our competitors have taken down equity risk almost totally," he said.
Tuomikoski was blunt when he said: "If we measure our solvency according to the present regulation we are not all that rich." But he added Ilmarinen remained optimistic and although its equity investment has dropped it still has one eye open all the time for positive developments.
Public sector pension funds, on the other hand, are not as tightly regulated on solvency which explains why the Finnish Local Government Pension Institution (KEVA) still has a strong allocation to equities.
Executive director Jarri Sokka explained: "We don't have the legal and regulatory requirements but we are still quite low compared to our own strategic benchmark." The institution's equity share has dropped to between 35%-40% when it used to be around 50%, illustrating the fact that not even the public sector has been safe from the crisis.
Sokka continued to say research is under way about how to change the allocation in the future. For public sector funds, risk is there for the taking but the board is still not convinced that now is the right time to dive headfirst back into the pre-financial crisis equity allocation.
"I'm not saying we should be increasing equities but the big question is what the right allocation from here is," said Sokka. "The Local Government can take the risk but at this point in time it is not very popular among the board members to have a high allocation to equities."
Hedge funds have been brought into question the world over because of their lack of transparency and this is no exception in Finland. To this end, many people have queried their suitability for private sector pension funds.
Barclays Global Investors head of Nordic Sales Rune Sanbeck said that a lot of hedge fund investments had been into fund of funds but now with hedge fund programmes being restructured fund of funds are being replaced with single strategies, and also smaller hedge funds are being replaced.
"There are three dimensions," said Sanbeck. "Return, liquidity and risk control. A lot of the smaller hedge fund players have not been able to control their risk so it [risk] has been increasing while the market was falling.
"If pension funds have wanted to get out of hedge funds they cannot because many hedge funds have been gating their investments. Liquidity has been really bad for some single strategies, especially for smaller hedge funds, so pension funds are now looking at this and asking which players deliver good returns but promise a good liquidity and are able to control risk."
As Sanbeck described, recently a lot of hedge funds have used gating measures so investors in hedge funds wanting to get out have not been able to get their money when they needed it leading to a lack of liquidity.
"You might have a case when the fund did okay on the return but the liquidity was gone and then the pension fund will say they don't want to experience that again. Now these small players who tend to have this gating will be filtered out and at tougher times pension funds will go for the bigger ones."
Ankarcrona said that opportunities currently exist in emerging markets - Asia, Latin America, India - and it is an area where HSBC Global Asset Management can certainly add value as a compliment to existing portfolios.
"If you look at it from a European perspective the emerging market space has not created the present crisis," said Ankarcrona. "It is a western phenomenon and although the emerging markets have been hit by it but there is still growth in India and China. India would probably grow by 6% compared with Europe where the GDP growth is not that large."
Additionally, Ankarcrona believed inflation-linked bonds are one asset class that could enter the spotlight in the near future.
"If you look at the amount of liquidity being pumped into the system I strongly feel that when all this money hits the consumer we are going to be faced with risk of inflation and inflation-linked bond products are probably a good space for clients to take a look at."
Looking ahead, Murto of Varma said: "I think we will be rebalancing our portfolio. We did have an extremely low equity exposure and in future we will move back to the more normal level but I am not going to speculate about when this will be."
At present, a large number of institutional investors must share Murto's thoughts. As the markets remain volatile and correlation between asset classes is high, it is anyone's guess when markets will be strong again. In the meantime, despite the overwhelming urge to tinker with asset allocations, it seems wise to play the cautious game, sit tight and wait for the right time to revert back to a full equity exposure.
One increasingly popular yet unique investment strategy in the Finnish pension system is for pension funds to make corporate loans to their pension associated companies - a move which has also led to lowering allocations to equities.
For example, if a company has made its plan together with, say, Varma or Ilmarinen then it has the possibility to also take a loan from them, so in this sense they basically operate as a bank.
Pensions insurance companies are doing a lot of these type of loans and by doing so they are taking a lot of credit exposure and therefore reducing their equity exposure.
An example of this in practice has been Ilmarinen who had seen this strategy evolve more throughout 2008, as Ilmarinen deputy chief executive Jaakko Tuomikoski said.
"The employers who have taken insurance with us can borrow back part of the premium and those have grown rapidly in 2008," he said. "They used to be something like 5% of the portfolio but now it is up to 13%."
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