Keva, the €20bn Finnish Local Government Pension Fund, intends to increase its exposure to equities, alternative asset classes and property over the next three years. It will also introduce commodities and reduce its exposure to bond holdings.

“We have decided to change our strategy thoroughly in order to be able to reach our future investment targets,” says Ari Huotari, CIO of the fund. “Our most recent ALM study showed that in the coming 20 years our current strategy will not be able to bring about our annual real return of 4 per cent.”

In 2005, the fund’s investments yielded a return of 14.3 per cent, while its cumulative real return from 1988 to 2005 was 4.9 per cent. Keva is not covered by the Finnish investment regulations for pension funds because it is regarded as a public authority.

“One of the central decisions is that our equity exposure will be increased from 45 per cent to 50 per cent. It is very likely that the increase will take place on the emerging markets side,” says Mr Huotari.

Global equity increase

This year the fund has already made several new commitments to global equity funds. “We have allocated approximately €1.2bn in European, Japanese and North American equity products. We are also actively observing the development of the Asian markets. However, analysing funds thoroughly and reaching informed decisions on new mandates is challenging and always takes time,” says Mr Huotari.

In late 2005, Keva reduced its domestic equity exposure from 7 per cent to 2 per cent, sparking controversy among many Finns.

“We maintain a thoroughly diversified portfolio because diversification and managing risks are our primary concerns,” says Mr Huotari.

“We should also remember that we invest in Finland very actively through our property portfolio, 95 per cent of which is allocated domestically. We also invest in Finland through our private equity holdings,” says Mr Huotari.

Today Keva’s remaining equity portfolio consists of European (58 per cent), North American (18 per cent), and Asian (22 per cent) equities. In 2005, equities yielded a total return of 26.1 per cent. Approximately 50.3 per cent of the portfolio was outsourced.

Alternative investments

Keva also intends to double its strategic alternatives exposure from 4.5 per cent to 9 per cent within the coming three years. The fund allocates 3.4 per cent of its total portfolio to the asset class of which 2.6 per cent is in private equity and 0.8 per cent is in hedge funds.

“So far we have been careful with hedge fund investments because we are not sure if the markets are overheating due to continuously increasing allocations. Because of low bond yields, however, we have decided to increase our hedge fund exposure.

“In the future, our alternatives portfolio will be made up of 5 per cent private equity and 2 per cent hedge funds,” says Mr Huotari.

Keva prefers to invest in hedge funds through fund of funds. “Some may say that this is an expensive way to take exposure into the asset class. However, we have found that with our limited resources funds of funds are the best way to maintain a well-managed exposure to hedge funds,” adds Mr Huotari.

In 2005, Keva’s private equity investments yielded a return of 28.5 per cent and hedge funds 3.9 per cent. Returns from the total alternatives portfolio were 20.8 per cent.

Commodities

The fund is also introducing commodities as a new asset class in its investments. “We have been observing the development of commodity markets for a while. The asset class is very interesting and offers good opportunities for diversification.

“However, we are not sure how the market will be affected if several notable investors, like the €164.3bn California Public Employees’ Retirement System (Calpers), enter the market around the same time. One of our analysts is examining this. We also have not decided when to start investing in commodities because of the recent increase in prices.”

The new strategy includes the expansion of Keva’s property portfolio from the current 8.5 per cent to 9 per cent of all investments. In future, the fund will also increase its exposure to domestic and foreign property funds. In 2005, its property holdings yielded a return of 7.2 per cent.

There will also be major changes within Keva’s bond portfolio. “We intend to reduce our current bond exposure of 42 per cent to 32 per cent and increase risk-taking by increasing exposure to high yield bonds,” explains Mr Huotari. Last year bond holdings yielded a return of 4.1 per cent.

Because of the new strategy the fund is appointing two new members of staff. The first, an alternatives specialist, is expected to join the fund soon. “When we have completed the recruitment process of the first new team member, we will start looking for another industry specialist to join our operations later this year,” Mr Huotari concludes.

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