A Danish pension fund is growing more savvy about its exposure to alpha, while Sweden's AP may raise fund limits to alternative investment. George Mitton reports.
When Danish pension fund ATP announced last year it would close its internal hedge fund unit, ATP Alpha, with the loss of nearly half the unit’s 35 employees, it seemed to spell bad news for alternative investment firms.
It was not that ATP Alpha performed badly. Since 2006 it had returned a total profit of €200 million. Rather, it was that the unit was expensive, and ATP believed it could achieve the same results, at lower costs, by managing the money as part of its main portfolio.
For alternative managers, the closure was a potentially worrying precedent. What if other pension funds, which had money in external hedge funds, insourced their alternative investment budgets to their main portfolios?
In at least one respect, alternative managers were right to be worried. ATP has become sceptical about what alpha really is.
“When we did our initial alpha-beta separation in 2005, the way we looked at the world was that some 50% of our return comes from market risk and the rest comes from what is usually called alpha,” says Anders Svennesen, co-chief investment officer at ATP. “As time has passed, our understanding developed.”
Svennesen now believes alpha makes up a much smaller proportion of his fund’s total return. Much of what ATP used to think of as alpha, it has renamed “systematic risk”. The difference is that while alpha is idiosyncratic and unpredictable, systematic risk can be quantified. “You can more or less write it down as a formula,” he says.
Svennesen and his colleagues found that much of ATP Alpha’s returns were because of systematic risk, not alpha. Moreover, these were the same kinds of systematic risks the main ATP portfolio invested in, and more cheaply because of economies of scale.
It made sense to close the unit, transferring any successful strategies to the main portfolio where they could be scaled up.
Will other pension funds in the Nordic region follow ATP’s example? Perhaps. However, alternative asset managers need not give up hope yet. A rising demand for alternatives could come from at least one other source: Sweden’s AP funds.
The increase could happen if politicians raise a cap that limits the amount the state pension funds can invest in alternatives. The limit was criticised in a report commissioned by Peter Normans, minister for financial markets, which says the 5% cap gives the funds “limited ability to invest in unlisted assets which potentially could diversify portfolio properties and increase risk-adjusted returns.
“Removing the quantitative guidelines will give the management of the buffer capital the flexibility to better utilise its comparative advantages of being a long-term pension reserve fund,” adds the report, which was based on a review chaired by Mats Langensjö.
Politicians in Sweden are discussing whether to adopt the proposals of the report. Sven Lidén, chief executive at Adveq, a private equity fund of funds, says he believes the alternative investment limit will be raised, though he concedes that “what I don’t know is if it will take two months or two years”.
Demand for private equity investment could come from other places, too, says Lidén. He has noted a trend for pension fund investors to separate their portfolio into risk baskets. Managing a portfolio this way can lead to an increase in unlisted equity exposure, or private equity, because of the higher return expectations, he claims.
“All these developments help us gain market share for private equity,” he says. “It makes the cake bigger.”
It is prudent not to expect a sudden decision on reform of the AP funds, though. Politicians have to decide what to do about another proposal in the report, which is to merge some of the five AP “buffer” funds.
The funds most likely to be merged are AP funds 1-4, which broadly do the same thing. AP6 is somewhat different as it is a private equity and venture capital fund. There is no AP5 fund.
The Swedish government has said it might merge some of the buffer funds, but would keep three at a minimum.
“Merging the AP funds is sensitive in Sweden,” says Jonas Eriksson, communications officer at Skagen Funds.
Eriksson says a full merger would be reminiscent of a Social Democrat-led scheme in the early 1980s to establish “wage-earner funds”, which would take a percentage of companies’ profits and workers’ wages and buy shares in listed companies, gradually taking them over. Many regard the scheme as a failed socialist experiment.
“I don’t see who would force [a full merger],” he says. “Not the Conservatives and Liberals in power. But I don’t see the Social Democrats doing it either. They would stir up a conversation they lost 20 years ago.”
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