February was marked by a series of difficult announcements from Nordic pension funds as the full force of the global financial meltdown became apparent. The Swedish AP funds, the Norwegian Government Pension Fund – Global and Finnish pension insurers were among those revealing double-digit falls in portfolio performance during 2008. Mid-way through February, AP1, one of Sweden’s national buffer funds, reported a total return of -21.9 per cent for last year, representing losses of SKr47.2bn (e4.33bn). Similarly, AP2 saw assets decline by -24.1 per cent, while AP3 lost SKr43.9bn on the back of returns of -19.8 per cent.

At Norges Bank Investment Management (NBIM), which manages the Norwegian global government fund, the story was equally grim with returns of -23.3 per cent, equivalent to losses of NKr633bn (e71.8bn). In Finland, the miserable pattern continued with Varma, the country’s largest private sector pension insurance company, posting returns on investment of -15.2 per cent for 2008.

The root cause for the disappointing performance in the Nordic region is common to every country that has seen billions wiped from their pension values: the wholesale erosion of the global stock markets on which many schemes remain heavily reliant.

Kerstin Hessius, chief executive at Swedish buffer fund AP3, says: “Our primary losses in 2008 were on equity portfolio investments and credit bonds. We underestimated the risk of a mass flight from equities and other securities. In retrospect, we should have reduced portfolio risk further in order to limit losses.”

AP1 also laid the blame for its dramatic losses at the door of global stock markets, noting: “Fixed income assets returned a healthy 8.3 per cent, [but] this was not sufficient to offset the negative return of -40.1 per cent on equity investments.”

However, the deterioration in pension funding was not solely attributable to falling equity markets; active management across all asset classes played a significant part in forcing down returns.

AP2 chief executive Eva Halvarsson described the fund’s active management result as “far from satisfactory”, adding: “The weak result may be attributed to a number of the fund’s equity mandates and some investment products that were poorly positioned in the extreme turbulence that affected the financial market in the autumn. As a result of the financial crisis, almost all active investment mandates underperformed simultaneously.”

Consequently, pension funds are starting to re-evaluate their active positions and are making changes to their investment strategies. While the obvious route may be a simple switch to passive management, thereby reducing management costs and lowering investment risk, Hans-Olov Bornemann, head of SEB Asset Management’s global quant team in Stockholm, says such a move has limitations.

“I understand that some schemes say they are going to go for the low-cost solutions, however, that is only a small part of the investment puzzle. The important thing is to make decisions about allocation; 90-95 per cent of the end result is dependent on your asset allocation decisions and only the remaining 5-10 per cent are dependent on your security selection decisions,” he says.

This view is reflected in changes to strategy at AP1, where managing director Johan Magnusson says the focus has switched from active management to a greater appreciation of strategic asset allocation.

He says: “The main focus of the fund will now be our strategic asset allocation. This does not mean that we will only rely on passive management of the capital when it comes to implementing our strategic views, but the share of active management will decrease over time and we will not disclose active return any more as our main focus from now on is on total return.”

Mr Magnusson adds that the scheme will be better placed to react to changes in market fortunes with greater flexibility in asset allocation.

“Dynamic asset allocation will give us more flexibility when it comes to mid-term allocation decisions,” he says.

Elsewhere across the region, changes to investment strategy have not meant a wholesale move out of active management. Indeed, many of the schemes are still ardent supporters of the active approach and will continue to include the style in their portfolios. However, the way in which active management is employed is set to change with increased emphasis on separating market returns (beta) from outperformance (alpha). Several years ago, pension funds in the region started to adopt this approach as part of efforts to improve flexibility and capitalise on opportunities thrown up by the market. The early adopters of the strategy claim it has served them well during the recent financial crisis and as such, schemes are looking at rolling alpha/beta separation out to further areas of their portfolios.

Richard Gröttheim, deputy CEO at AP7, which moved into alpha/beta separation three years ago, says: “Even under the extreme circumstances we experienced during 2008, we saw that separating alpha from beta worked better than the long-only active management. We will move from long-only into this pure alpha strategy for the whole portfolio.”

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