Finnish firms keep it cool

Finland’s pension funds remain unfazed by recent market developments although some are reassessing their asset allocation, finds Reeta Paakkinen

Although the renewed crisis following the collapse of US investment bank Lehman Brothers and the takeover of US insurer AIG in mid-September triggered notable concerns and financial losses in global markets, solvency levels at Finland’s seven pensions insurance companies remained within required limits, the Finnish insurance supervisory authority (VVV) reported in late September.

The VVV, which examined the immediate impact of the Lehman Brothers and AIG developments, found that the exposure of local pension insurance companies to the two firms as minor, at €30m of a total asset volume of approximately €75bn. All Finnish pension institutions, including corporate pension funds, had a total asset volume of €119.3bn in the end of June 2008.

Matti Leppälä, director of international and legal affairs at the Finnish Pension Alliance (TELA), notes that the developments in the US did not cause major panic among Finnish investors. “Solvency levels are still clearly above minimum requirements,” he says. “Whereas in August operating capital exceeded solvency requirement by 1.9 times on average, it exceeds it on average by 1.5 times and in some pension foundations with particularly healthy asset bases by approximately 2.0.”

Timo Ritakallio, head of investments at Ilmarinen, Finland’s second-largest pension insurance company in terms of assets, says Ilmarinen’s investments in Lehman Brothers totalled around €10m. “This sum consists of only direct exposure as senior bonds,” he says. “However, as our portfolio is worth some €25.2bn, the loss did not have any major impact on our overall portfolio, it rather tested how our existing strategy works. Our solvency is still satisfactory.”

In June 2008, Ilmarinen’s portfolio consisted of 40% equities, 45% bonds, 10% real estate and 5% loans. Its equity portfolio includes a 3% allocation to hedge funds. Over the first half of the year Ilmarinen reduced its equities exposure to 40% from 47%, while increasing its bond holdings accordingly.

Timo Löyttyniemi, managing director of the €11.4bn State Pension Fund (VER), on the other hand, notes that the escalation of the global crisis is not having a notable effect on VER’s investment strategy for next year. “However, we do think that in the future it will be worth checking the strategic asset allocation more frequently, and react to changes more rapidly,” he says.

Although many funds are currently updating their strategic asset allocation and the escalation of the crisis is likely to weigh in their decisions, Ilmarinen at least still trusts the return potential of equities, Ritakallio says. “We believe equities will rise again, and will therefore maintain our status as an equities investor. We do not believe in any major slump. Equities will pick up sooner or later,” he adds.

Mika Pesonen, (pictured right) chief investment officer at €5.67bn mutual pension insurer Etera, agrees with Ritakallio about the future potential of equities. Etera had an approximately €1m exposure to Lehman Brothers, calculated on the basis of the company’s investment in US equity funds. “Drops in returns of around 10% are relatively upsetting,” Pesonen says. “But equities are still the asset class that yields best returns in the long term and is a transparent investment target. One should take as much risk as one can endure, has the ability to manage and interest to maintain. Bad times like this will always come and go.”

The slowdown in equity markets and the fall in equity prices may offer interesting opportunities to investors who still have sufficient funds to make new investments, Ritakallio notes. “In times like this when assets are being redistributed some equities have particularly good pricings,” he says. “If future returns are evaluated with a perspective of one to two years, for some investors this may actually be a good time to buy as there are so few other buyers around.”

Several funds mention private equity as the upcoming asset class where funds will be looking for compensating returns in the near future. “We are planning to increase our private equity portfolio from 2.3% to 3-4% of all investments in the coming four to five years,” says Ritakallio. “The asset class still offers good potential.”

“Private equity is a very interesting investment target at present,” agrees Pesonen. Etera has some 2% of its portfolio invested in private equity funds. “We have been steadily growing our private equity portfolio over the past two years, and are likely to continue doing so,” he says. “However, market turbulence affects prices. What we are looking for are targets that are actually priced according to today’s values - not last year’s.”

Ritakallio lists property as an attractive investment target for the future. Ilmarinen plans to increase its real estate exposure to 12% of all holdings from the current 9% over the next three years. “Two thirds of this will consist of domestic direct investments and the rest of property funds investing abroad as a diversification tool,” he says. “However, we are not going embark on this plan yet - we are waiting to see how property markets evolve and will make the first move when the time is right.”

Pesonen is more cautious. “Etera has already invested some 15% of its portfolio in property, which is a relatively high share,” he says. “We expect property markets to slow slightly - winter may be difficult for the market, so for now we are just observing how property investments perform.”

A reform of investment regulations in January 2007 allowed Finnish funds to take a more notable exposure to hedge funds, but since the recent events several funds have started reconsidering their take on the asset class.

Antti Koura, head of investments at €1.84bn Veritas Pension Insurance, says the fund had been planning to increase its allocation to hedge funds, but has decided to see how the situation evolves. “We have an allocation of about 1.5% to hedge funds, but will evaluate in the near future how to develop this as the escalation of the financial crisis has notably changed the operating environment of hedge funds,” he says.

“There is a general consideration under way in the market about what funds should do with their hedge fund holdings,” says Pesonen. “Returns have not been very satisfactory over the second half of the year and the lack of transparency worries many. We are also thinking how to approach this issue in the future.”

Löyttyniemi notes that alternatives come with added baggage these days. “Alternative investments are the most challenging asset class in terms of future return and risk at the moment because of the market turbulence,” he says. “However, bond investments are naturally safe. We are waiting for interest rates to go down when uncertainty in financial markets erodes and economic outlook weakens.”

Petri Tofferi, chief investment officer at €300m Sonera Pension fund agrees. “The recent turbulence has pulled down the value of our equity and corporate debt investments. But yields from government bonds remain healthy. For now we are not making any notable changes, but observing how events unfold.”

However, Pekka Korhonen, managing director of the €920m OP Bank Group Pension Foundation, feels that it is not yet possible to evaluate in detail what the developments of recent weeks mean. “Only when there is a clear picture of the events can we discuss possible changes to our asset allocation in more detail,” he says. “Our solvency level has gone down but it is still satisfactory. We may, therefore, have no need to make any radical changes. Furthermore, in the future it may well be that no asset class offers particularly impressive returns.”