Pen-Sam manages the pension contributions of a quarter of a million public employees working mainly in the public sector in Denmark and is a leading player within the country’s labour market pension system.
It began in 1966 as the result of collective agreements between the Danish Trade Union of Public Employees (FOA) and public sector employers. Initially Pen-Sam comprised four separate defined contribution (DC) pension schemes for assistant nurses, hospital porters, public transport employees and county road inspectors.
However, in 1990 it was decided that the DC schemes lacked flexibility, and a life insurance company, Pen-Sam Life, was created to do the job instead. Members were transferred to one of the new pension schemes within Pen-Sam Life and no further contributions were paid after 1990 into the original DC schemes.
Today Pen-Sam’s DKK 47bn (e6.3bn) of assets are split between the four phasing out DC schemes and the single growing life insurance scheme. Naturally, their investment objectives are very different.
“The strategies for the old pension funds and for the life insurance company are not the same,” says Claus Asger Olsen, the chief investment officer of Pen-Sam. “The main difference is that there is no investment freedom in the old DC pension funds.”
Yet the assets of the old DC schemes are simpler to manage, since the liabilities are more predictable, he says. “Since we don’t have any new money or any new customers we know pretty much how much money we’re going to pay and at which date. So it’s quite simple to calculate the cash flow.”
Another advantage is that the life insurance company does not have to produce a minimum guaranteed return. “The old DC funds have a minimum guarantee of 4.25%, while the life insurance company’s guarantee has come down progressively over the years from 3% to 0% today. So in the recent bear market we were very lucky because the minimum guarantee in the life insurance company was lower. For the management of Pen-Sam Life’s assets, the priority has been to ensure that liabilities that are sensitive to interest rate movements are adequately matched,” says Olsen.
“We have tried to measure the interest rate sensitivity on our liabilities, and then tried to allocate the adequate amount of money to our interest-rate bearing investments to make sure that we have enough interest rate sensitivity of our assets. And when we have done that we have invested what was left into equities.”
Pen-Sam is using derivatives to provide Pen-Sam Life with the interest rate protection that it needs. “We have acquired a number of forward starting cancellable swaps with a cap, and are using them as our interest rate protection.” The advantage of this sort of arrangement, he says, is that it does not require any cash.
The investment team first used interest rate swaps in the management of the four DC pension funds, where they provided a ‘trial run’ for further use in Pen-Sam Life. “The interest rate sensitivities in the old DC plans are much greater, of course, because of the guaranteed rate of 4.25%. So we started out doing these sorts of transactions with the DC pension funds.
“After that we calculated also how things were in the life insurance company and found that the construction we have used in the DC pension funds, with, of course, some alterations, could be used also in the life insurance company.
On the equities side, Pen-Sam Life has reduced its allocation to equities from 40% to between 20% and 22%. “We, as well as many others, lost a lot of money on equities in 2000 and 2001, so we had to scale down our equities exposure,” says Olsen.
The allocation to equities may not return to its previous level, even if equity markets fully recover: “I do not think we will return to the former level in the near future because what the last bear market told us clearly was that we had quite a substantial amount of risk by having an equity portfolio of 40%,” he says.
Instead, Pen-Sam has sought to add value to its portfolio by diversification. “Two years ago we started the hunt for alpha-generating investments. We have been looking at emerging market debt, we have tried to develop our own process for investing into private equity and we’re going to put more into credit derivatives.”
It has also tried to squeeze more value out of its equities exposure. Last year Pen-Sam restructured some of its DKK 8bn equities portfolio by moving DKK 4.5bn from global passive mandates into regional active mandates. The bulk of this transfer was into international equities.
The restructured portfolio includes a global enhanced indexed mandate, managed by State Street, and active regional mandates. The active regional mandates comprise two European equities mandates, managed by AXA Rosenberg and Capital International; Asia-Pacific including Japan mandates managed by JP Morgan Fleming and State Street; a US equities index mandate run by Nordea Investment Management, a US all-cap equity mandate managed by T. Rowe Price, and a global emerging mandate run by Batterymarch.
Pen-Sam also manages DKK2bn in Danish equities in-house, although it has been progressively reducing its exposure to domestic equities, and focusing on smaller companies. However, Danish equities have performed particularly well in the past two years and Pen-Sam has been in no hurry to dispose of them.
Olsen says that Pen-Sam intends to take a core-satellite approach to investment, in which the satellites will give Pen-Sam the freedom to move in and out of areas of investment as the opportunity arises.
The move from passive to active management was prompted by a need to use equity assets more efficiently, says Olsen. Passive management was appropriate in a bear market. Something more was needed when the markets partially
recovered.
“We had been in a situation where we had to cut down risk, and we reduced our equities exposure, shortened the sails, and concentrated on keeping the money with the passive mandates. To some extent we could say that we were able to monitor the risk, namely the beta, during the tough years.
“We did not really want to expand our equity proportion again, but we thought it was time now to set out our equities investment in a way that was more efficient.”
In particular, Pen-Sam was looking for active equity managers who combined growth and value styles, he says. “We have been searching for managers with a mixed growth and value strategy.” However, these strategies must be managed in two discrete processes, he adds. “This means that we don’t have any growth analysts trying to take care of value companies.”
Pen-Sam has used IPE Quest to find the money managers it needs. “We haven’t been using consultants. We have found it to be important that the search and selection of external managers has to be our process. Indeed, if we couldn’t solve that task at least there would be very little need for an investment department in Pen-Sam.
“We think that in many ways we are obliged to our customers to devote our greatest efforts to finding managers who will help us to invest their money the best way.”
The results so far have been encouraging.
Performance has been impressive. The DC pension funds have returned 13% this year, and the life insurance company have returned around 11%. This has been particularly welcome, says Olsen, since a market revaluation of liabilities has compelled Pen-Sam to increase its liabilities
substantially.
“Cutting right down to the basics the only relevant overall benchmark for the investment department of Pen-Sam must be what is happening to the liabilities. My benchmark must always be that my assets will always perform as least as well as my liabilities. “
Pen-Sam has stood up well to the stress testing of the so called ‘traffic light’ stress testing of the Finanstilsynet, the Danish financial supervisory authority, and remained in the green-zone throughout the bear market years, unlike many of its peers.
Olsen says the traffic light system has been useful in alerting companies to the issue of risk. Pen-Sam is now designing a stress-testing tool of its own. “Deciding your overall investments strategy only on the green light testing is a rather static view. We are preparing a more dynamic analysis with an asset liability model that will predict our assets and liabilities going forward. Maybe when we have had that ALM implemented it may show us that we have been too careful.”

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