KPA has its eye on the Swedish pensions investor in search of both a good return and a clear conscience. Fennell Betson reports

When you are in the middle of a revolution, the best ploy may be to lead one of your own - albeit a small one. The Swedish local government pension system is certainly living through revolutionary times. As Stefan Clevhammar, who runs the assets of KPA (Local Government Pensions), puts it: The pension scene has changed dramatically for local government."

As elsewhere in Sweden, the shift has been from defined benefit to defined contribution and to a larger element of funding, resulting in greater participation by individuals. In addition to the changes in the state system, the supplementary pension scheme for 1m local authority employees, designed to bring the 65% of final salary provided under state benefits up to 70%, is being radically overhauled.

"It is now more of a hybrid system for municipalities and county councils. The connection has been broken between the basic pension and the supplementary one," he explains. Depending on local agreements, the amount contributed to the supplementary pension is now between 3.4 and 4.5% of salary, of which at least 1.1% is under the control of the employee to invest. "The other 2.3 to 3.4% can be retained by the municipality within its budget, on a funded or unfunded basis, or indeed the whole amount can be passed to the individual employee to decide where it is invested." Where the contribution is retained by the employer, it is accrued to provide pay-related benefits. Where the employee has control, benefits are on a DC basis.

KPA sees itself as the natural provider of pensions to the local government sector and not without reason. Firstly, it is two-thirds owned by the 288 municipalities and a third by 23 county councils. KPA looks after the calculation and payment of the pay-as-you-go supplementary pension and is responsible for the disbursement to the sector's 300,000 pensioners of their state pension entitlement, involving in all the transfer of Skr34bn ($4.2bn) ann-ually.

But the in-creasing in-volvement of individual em-ployees in the in-vestment decision -making, where they will be free to choose from a range of fund managers and insurance products, poses a severe challenge to KPA. As an employer organisation, it is not known to the bulk of local government staff. "The 300,000 whoreceive their pensions from us might well know who KPA is," says Clevhammar.

Next year the problem becomes all the more acute when changes come into force within the national pension scheme. Like the rest of the Swedish workforce, local government employees will have another 2.5% of pay to allocate to investment managers of their choice. Clevhammar points out: "The potential market for this 'free' pension fund money ranges from 3.6% to 7% of pay depending on what the local employer decides to do." With a sector wages and salaries bill of Skr200bn annually, this market becomes "doubly interesting", as he puts it.

KPA will not be on its own. All major financial groups will be chasing this market too. It does have a head start, because if local authority employees do not make a choice of manager, KPA becomes the default election and will look after this allocation automatically.

Clevhammar adds: "Then the question facing us was how could we compete with the big names that dominated the mutual fund market. Our view was that we needed to provide a service that would be asked for by individuals."

So in 1997, KPA started on its revolution, by undertaking a detailed quantitative and qualitative study of the people in their sector. "The results found that this sector is made up of 80% women. Though they are generally low salaried, they differ in one major respect from the bulk of the population in that they are usually highly qualified and skilled with a good educational background, such as nurses and teachers, this means that they are idealistic and more highly motivated than other groups." The message that came through on the investment side was that they could be very interested in "someone who had an ethical outlook when investing their money, by which they meant having criteria about how the money was invested, including the environmental aspects".

KPA has adopted this message with zeal. The whole organisation has gone green, becoming the country's first financial group to be environmentally certified under ISO 14001. In line with the Agenda 21 ecological proposals, it is committed "to assuming a social and ethical responsibility for its business activities," according to the 1997 annual report.

Of the Skr7bn that KPA now manages, about Skr5bn is assets of the two insurance companies, and these portfolios will be run according to the ethical and environmental criteria. About Skr1bn is managed on a discretionary basis for third party clients and it is in discussion with these about running their funds on the new basis. Should they not want to change, they can continue as before.

Three mutual funds are being launched to provide ethical investment vehicles for individual investors, ready for the new choices in 1999. "We are solely dedicated to this approach now and it will be implemented in all the products we offer to the market."

Clevhammar is the first to acknowledge that this is no easy path. The new tack means screening companies from both ethical and environmental standpoints. "On the environmental side we have two main criteria - the exclusion of fossil fuel production for energy and uranium production and use. The other is positive, to see if we can measure if the companies we invest in show an improvement in their effect on the environment over time."

On the ethical side, KPA has developed criteria relating to weapons production, tobacco, alcohol and gambling - so far. "We are looking into human rights but have not found any criteria that completely suit our needs."

KPA uses three internal analysts. "Our first job, as it is for everyone else on this path, is looking for investible companies," says Clevhammar. The first step is to look at the fundamentals to see if these are companies that the portfolios would invest in anyway. Then the analysts use the criteria to screen out the companies on ethical and environmental grounds. An outside agency, the Stockholm-based Caring Company, is used to help here. "If there is any disagreement between our analysts and the agency, we have an ethical advisory board to provide independent counsel."

"Once we have our approved list of companies, we will actively select from this run our portfolio to maximise returns." In the case of Swedish companies, only about 25 of the 230 companies met the eligibility criteria. Currently, the top 100 European companies are being vetted.

"The difficulty is to put hard facts into a mould that is measurable for our purposes," he says. "You have to start with simple things like measuring a company's energy consumption, as there can be a link between this input and pollution." Another tricky problem is monitoring companies to ensure they stay within the criteria or that those now ineligible change and meet the conditions.

Clevhammar remarks even though there are invariably grey areas when going green, it is none-theless an all-or-nothing approach: "You can't be a little bit pregnant."

As to whether it will work or not, he is philosophical, both as a marketing exercise, where KPA is the first Swedish financial group to dedicate itself to pursuing such a course, and as an investment strategy.

Of the individual investor market, he says: "It is down to the assumption that people will act in accordance with their moral predilections - and we do not know this at this stage!" From the point of view of local authority investors, he points out that they are responsible for carrying out Agenda 21 commitments at the local level. "Questions could be raised as to how they invest their money."

Regarding the investment approach, he says: "We have studied what has been done in the UK and elsewhere. Nothing tells us that it cannot work, but at the same time, nothing tells that you will obtain worse performance by adopting this view."

Implementing the change has not been without its difficulties. "Since we are not that big, it has been easier to make the shift. It is an enormous challenge, but it is fantastic fun!""

Topics