A professional, focused continuously developing organisation based on team orientation, openness and enjoyment is how the management at the E14.4bn AP3 buffer fund describes itself. At the beginning of this year, legislation came into effect in Sweden that radically changed the mandate of the AP funds by relaxing the investment restrictions and allowing them to increase their exposure to both foreign assets and equities. As the figures below suggest, the fund has developed and changed its investment approach this year.
The first half of the year was dominated by the transition of the initial portfolio, made up predominantly of Swedish government bonds, to the strategic benchmark determined by the recent ALM study. And it is this ALM study that was behind AP3’s decision to put forward an application for the IPE awards. According to the fund, the study required some novel thinking in terms of modelling and analysis due to the complex and unusual liability side of AP3 as a public buffer fund. Instead of analysing the liability side in terms of cash flow, the study included detailed modelling of the dynamics of a buffer fund and the model considered stochastic asset prices as well as liabilities.
One of the most critical projects last year was setting up the philosophy and mechanism by which the fund executed its investment. AP3 admits to taking a highly analytical approach at almost every step and risk budgeting features large in the process. But before this comes the decision-making process, something in itself that is highly regimented and operates within strict guidelines.
Responsibility for individual investment decisions is decentralised to a number of well-defined decision points and those managers in charge of a specific decision point are given the final say. In taking this approach, AP3 believes it differs from other investment managers who tend to centralise responsibility for investment decisions in the likes of an investment committee. According to the annual report, this structure eases the evaluation of the overall operation and makes it possible to measure exactly how much each decision point has contributed to performance.
Another attribute that the fund highlights is its flexible approach towards risk budgeting, an activity that is the core of the fund’s investment approach and essential in determining whether the fund manages a specific asset class internally or externally. The fund says that the two questions it asks are, first, where it can generate active return by taking active risk and, secondly, who is best suited to running the various mandates.
Under the new legislation, AP3 is obliged to make over at least 10% of the capital to external managers. In preparation for the new mandate, the fund found it possible to recruit qualified internal expertise to manage Swedish and European equities as well as fixed income and foreign exchange. For non-European equities, it felt the recruitment base in Sweden was too narrow and therefore decided to use external managers to run the non-European equities.
That said, at the end of last year it decided to allocate some of the European equities to external managers, thereby allowing flexible reallocations between regions, in line with the TAA strategy. The fund has been appointing external managers for some of the European mandates this year.
In terms of internal management, there are two of the so-called decision points: the allocation between sectors and the selection of equities within each sector. One strategist is responsible for the sector allocation while seven sector managers pick the individual equities. The approach of the equity team is quantitative and model-oriented and numerous valuation methods are used. Equities and sectors are ranked according to how the valuation deviates from the long-term norm for individual equities and sectors.
The purpose of this is to see which equities are under or over valued, relatively speaking. AP3 believes that the danger of a valuation-oriented investment style is buying too early and selling to early. To avoid this, it employs timing tools with companies and sectors being ranked on the basis of price momentum and revision trends for market earnings forecasts.
On the fixed income side, the investment process takes the same approach with clearly defined decision points. For the best part of the year the team was involved in transforming the original portfolio to the new strategic benchmark. In the mean time though, the fund is introducing three new decision points – the allocation between sovereign and other bonds; the maturity choice in sovereign yield curves, foreign and domestic; and the allocation between different rating categories and sectors.
The team also oversees the fund’s foreign exchange exposure. Initially this was largely administrative ie currency exchange and ensuring the total exposure remains consistent with the ALM strategy. AP3’s aim is that foreign exchange will become an asset class of its own with active positions being taken.
The past 18 months have been particularly busy for AP3 but it can, and does, say with some justification: “we have established a clear structure of decisions, accountability, monitoring and risk control throughout the investment process”.

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