Icelandic pension funds exhibit a certain satisfaction when reviewing their performance during last year and the first half of this. But that just reflects their Nordic reserve. Pension funds in most other countries that produced similar results would be forgiven for indulging in triumphalism.
“The average real return at end-2003 was 11.3% and the size of the pension funds arena grew by 18.2% on the year to E9.56bn,” notes Hrafn Magnússon, managing director the National Association of Pension Funds, Landssamtok lifeyrssjódur. “Total second pillar pension fund assets amounted to 102% of GDP.” Not bad for a country with a working population of 164,600.
Unlike elsewhere in Europe, pensions are not a politically destabilising issue despite a decision by the state to gradually withdraw from the arena and the imminent raising of minimum pensions contributions. “It’s pretty settled here, we think that we have a good pension system, one of the best in the world,” says Haukur Hafsteinsson, managing director the State Employees Pension Fund, Lifeyrissjódur Starfsmanna Risikins. “The pension fund system as a whole in Iceland is fully funded.”
Thorgeir Eyjólfsson, managing director of the Pension Fund of Commerce, Lifeyrissjódur Verzlunarmanna, Iceland’s second-largest fund, agrees. “An important reason why pensions are not a problem is that the social partners decided as early as 1970 that people should pay 10% of their salary into a pension fund and legislation in 1980 extended it to all wage earners.”
Earlier this year social partners agreed to raise contributions to 11% of gross salaries from the beginning of 2005 and to 12% at the beginning of 2007. The third pillar is funded up to 4% from the employees and 2% by the employers. “The government is happy to leave pensions to the social partners,” notes Magnússon. “The first pillar is means-tested and decreases every year as benefits from pension funds rise, allowing the state element to just about end within 20 years and the government limits itself to focusing on the State Social Security Institute which will take over the old state benefits.”
The results were largely due to the exceptional performance of Iceland’s equities market last year, with the ICEX 15 index rising 56.4% in 2003. The outturn favoured those that were weighted towards the domestic market. “At end-2003 equities accounted for 28% of pension funds’ portfolio, up from just 1% in 1990, and bonds account for about 72%, with most of this going to domestic bonds,” Magnússon says. “Foreign assets came in at 19.4% at the end of the year and have since risen to 21-22% of the total, mostly global equities, although the funds may also be investing in hedge funds and other such instruments.” Icelandic pension funds are forbidden to invest in property.
After such a bull run the industry is faced with the problem of how to maintain returns at a time when equities may have topped and a shift to a firming global interest rate cycle suggesting that sovereign debt will no longer produce such healthy returns.
“If we had thought like this at the end of last year we would have missed out on a run of 44% on the domestic equity market,” says Verzlunarmanna’s Eyjólfsson. Last year saw the best performance in the pension fund’s 48 years: “The nominal return was 15.2%, with a real return of 12.1%. At year-end domestic equities represented 13% of the portfolio, foreign equities 24%, mostly in global mandates, while 63% was in domestic bonds. Up to now we have not been looking at foreign bonds because the domestic bond market has been doing so well - until lately you could buy index-linked, government-backed domestic bonds, issued by the state housing agency, with a median lifetime of 10-12 years and with a real rate of return around 4.5%. Domestic bonds are still attractive but we are looking more closely at foreign bonds now because there is a 50% ceiling on the total that we can have in equities - both domestic and foreign - and we have recently exceeded 40%. We also have a small stake in foreign private equity but have only dipped our toes into alternatives.”
United Pension Fund, Sameinadi lífeyrissjódurinn, Iceland’s fifth-largest, had also pursued a strategy of investing in Icelandic rather than foreign bonds, notes portfolio manager and director of asset management Sigrídur Hrund Gudmundsdóttir. On the equity front “the fund has been emphasising global rather than the local market because of size and liquidity, and the ICEX index rise hurt the last year’s return,” she concedes. The nominal yield for the fund in 2003 was 10.1%, real 7.2%. “This year we have been adding Icelandic equities to our portfolio. The main strategy change this year has been to control currency risk, where large part of the foreign portfolio is now being hedged.”
But the calm surface of the Icelandic pensions industry is about to be disturbed by the merger of third and fourth largest funds, Framsyn lifeyrissjódur and the Seaman’s pension fund Sjomanna lifeyrissjódur. The negotiations began in April, after rules giving Sjomanna a special status to reflect the importance of the fishing and maritime sector to the Icelandic economy were changed two years ago. The fit with Framsyn is good; both have similar subscribers, Framsyn being the pension fund for blue-collar workers in the Reykjavik metropolitan area, and they are of similar size, Framsyn being a little over $1bn and Sjomanna a little under.
Framsyn managing director and CIO Bjarni Brynjólfsson says: “A merger would increase the services to the members of the enlarged fund and there is bargaining power in size reducing the fees when buying foreign securities.” Sjomanna managing director Arni Gudmundsson agrees: “We think that a bigger fund will deliver a better quality of asset management, and there would be more people paying into the fund.”
Framsyn’s real yield over the past financial year of 13.9%, 17% nominal, was the second-best since its foundation through the merger of six other funds. “And the first-half performance by the domestic equity market has been even better,” says Brynjólfsson. “Today we have some 62% in mainly domestic bonds and a roughly equal split of 18-19% in both domestic and foreign equities, with the remainder in alternatives. We are buying private equities and putting some money into alternatives, including hedge funds and private equity.”
Sjomanna produced a real return of 15.2%, 18% nominal, last year and the fund grew about 19.6%, says its portfolio manager and assistant director Tryggvi Tryggvason. “Our portfolio is mainly in Icelandic assets, but we have increased our foreign stock market exposure gradually over the last two years and it is now about 20-25%,” he says. “Our goal this year is to increase the fund ratio and to be fully funded next year. Currently it is -2.2%. Our long-term real return objective is 5-6% and with a real return for the last five years of around 5% we are in line with our target. The first half of this year showed a real return of 21.5% on an annual basis, 27.6% nominal and we are very pleased with the outturn.”