The investment strategy of Pensionskassernes Administration (PKA), the administration company for eight occupational pension funds in Denmark, is based on three key principles, according to CIO Michael Nellemann Pedersen.

“The principles of our strategy are diversification and keeping a stable allocation between the main asset classes. We also rely on risk budgeting in order to make sure that we have the possibility to rebalance our asset allocation both in good and bad times,” he says.

PKA’s DKr120bn (€16bn) portfolio is invested in several asset classes, and its equity portfolio in different regions. At present, 44 per cent of the fund’s portfolio consists of bonds. Equities make up 33 per cent of the portfolio, property 15 per cent, liability hedging instruments 6 per cent and private equity 2 per cent. In 2006, PKA’s eight funds yielded an average return of 6.3 per cent. This was notably less than the 18.6 per cent of 2005. Both figures include liability hedging.

Last year, the best-yielding asset class was property, which pulled in an impressive 60.9 per cent. Private equity was next, yielding 27.1 per cent. Danish equities pulled in 22.6 per cent, and foreign equities an overall return of 9.8 per cent. Within the equities portfolio, emerging markets also posted a healthy return of 18 per cent. Bonds, on the other hand, yielded 1.3 per cent while liability hedging instruments lost 36.4 per cent.

According Mr Nellemann Pedersen, the results reflect the challenges of a general low yielding environment.

“On the one hand, increasing interest rates in 2006 helped us to maintain our ALM approach. But the overall low-yielding environment meant we had to work harder to maintain our liabilities and give our customers the pensions we promised them,” he says.

Mr Nellemann Pedersen points out that the demographics of PKA’s members also pose a challenge. “The industries we insure are relatively female-dominated, and therefore a large part of our clients are women. Changing patterns in demographics and longevity put extra pressure on us to arrange our portfolio in a way that yields the best possible returns.”

Changing exposures

In response to the low-yield environment, PKA made several adjustments to its asset allocation in 2006. Exposure to bonds was reduced from 47 per cent to 44 per cent. At the same time, exposure to liability hedging instruments fell from 11 per cent to 6 per cent. PKA also increased its property investments from 9 per cent to 15 per cent of all holdings.

“In 2007 we will continue diversifying our portfolio. We started investing in infrastructure approximately six months ago and will continue to place more funds in the asset class. So far we have made two commitments to infrastructure: one to a US-based energy fund and one to an EU-based energy fund. Our target is to allocate approximately 3-4 per cent of all assets to infrastructure over the coming two or three years,” Mr Nellemann Pedersen explains.

Although equities yielded good returns in 2006, PKA has no intention of expanding its exposure to the asset class in the near future. “We have a good exposure to equities at present, and we intend to maintain it at the current level for now. We are not planning to change our exposure to different geographical regions, such as domestic or emerging markets, either.”

At present the lion’s share (28.2 per cent) of PKA’s equity portfolio consists of Danish listed equities. The fund also has exposure (27.4 per cent) to US-based equities. UK equities form 7.2 per cent of the portfolio, other European equities 18 per cent, Japanese equities

5.2 per cent, Pacific equities 2.1 per cent and emerging market equities 6.2 per cent. The remaining 5.7 per cent of the equity portfolio is invested in unlisted shares. In 2006, domestic equities yielded the best returns of all geographical regions.

Mr Nellemann Pedersen points out that the fund is already overweight in domestic markets with a 28.2 per cent allocation to Denmark. “The debate on the pros and cons of domestic investments at times ignores the realities of Danish business life. Approximately 95 per cent of listed Danish companies are already active exporters or have extensive operations abroad. Therefore, making a sharp division between domestic and foreign equity investments is not reasonable or even possible,” he says.

This year, PKA is also planning to increase its exposure to private equity and property.

At the same time, it will reduce exposure to bonds by approximately 1-2 per cent. Today the fund’s fixed income holdings consist of Danish and euro-denominated bonds (78 per cent), index-linked bonds (12.2 per cent), high yield bonds (7 per cent) and emerging markets bonds (2.8 per cent).

Venturing into private equity

Claus Jørgensen, PKA’s head of equities, explains that the fund will increase its private equity investments from 2.5 to 5 per cent of all holdings over the next two years. “Most of our future investments in private equity will be made via foreign funds and fund of funds because already have notable investments in Danish private equity. The main purpose of our private equity expansion is to spread the risk,” he says.

“It takes time to see the results of private equity investments. Although the cost of investing in private equity is somewhat high, we can see that it has yielded very healthy returns. This positive contribution private equity has made to our returns gives us an appetite for more,” adds Mr Nellemann Pedersen.

The fund’s property holdings will also be expanded. At present, 80 per cent of PKA’s property portfolio consists of large domestic residential holdings. The remaining investments consist of commercial properties.

Some 5.7 per cent of PKA’s property holdings are outside Denmark. Since 2005 PKA has collaborated in indirect property investments with four other Danish pension funds (PenSam, Sampension, PFA and Finanssektorens Pensionskasse). Together the five funds form the so-called Danish Real Estate Club. Since 2005 the club members have shared knowledge of overseas property investments, and chosen several funds in which to invest. Cooperation helps the members to secure better investment terms and reduced costs, and enables them to exchange information on foreign real estate markets and taxation rules.

Mr Nellemann Pedersen adds: “We are observing the commodities markets and find the asset class an interesting means to diversify the portfolio. However, high oil prices have led us to wait and see how the market develops,” he says.

The selection process of managers is also something PKA is working on. The fund is considering launching a joint private equity and infrastructure manager selection project with other Danish pension funds.

“Choosing managers for private equity and infrastructure is a project that requires a lot of resources. Together with other Danish pension funds, we are planning to cut down on our costs, make the process more efficient and bring more quality to it by unifying our forces and cooperating in manager selection,” explains Mr Nellemann Pedersen.

PKA has outsourced investments in international equities, emerging markets debt and high yield bonds to 12 external managers. The outsourced assets make approximately one third of all PKA’s assets. The most recent manager addition was Intech, which PKA appointed to run its US large cap investments this year.

PKA uses consultants rarely and primarily for special projects. Last year, for example, it hired a consultant to evaluate the fees the fund pays to external managers. The research showed that PKA was paying fees that were consistent with or slightly below the market average. “Only in a few cases did we end up renegotiating the fees we pay,” confirms Mr Jørgensen.

PENSIONSKASSERNES ADMINISTRATION

Location: Hellerup, Denmark

Assets: DKr120bn (€16bn)

Members: 210,000

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