nrpn: Unlike many other institutional investors, Länsförsäkringar escaped last year without losing more than a fraction of the assets. What did you do differently to other funds?

It was the use of financial hedging strategies that paid off. We used interest rate swaptions and put options to protect our investments. After Lehman, we decided to reduce our equities from 40 per cent to 10 per cent of assets. We had put options for our equity portfolio, which allowed us to sell our equities for around 85 per cent of the initial value when we entered the put option. Our swaptions increased around 60 times in value because of the decreased long-term interest rates. However, the main features that differentiates us from others are our focus on asset allocation and on keeping track of risks.

nrpn: Is it not costly to use financial strategies like put options and interest rate swaps?

We’ve had this protection since the burst of the IT-bubble in 2003, but it only paid off last year. We are using it to match our liabilities. It costs about 0.5 per cent a year, but if we wouldn’t have had this protection last year then our liabilities would have gone up and our assets dropped. Instead, because of interest rate swaps and put options, we returned -0.6 per cent in 2008.

nrpn: Surprisingly, the returns for the first months of 2009 were down compared to last year’s returns. Why was that?

The drawback with our strategy is that it’s rather difficult to describe why we had such good returns last year, at least compared with other pension funds. And often, we will have lower returns in a bear market rally or turnaround year like 2009.

Our returns for the first three months, which was -1.7 per cent, were expected. That was largely due to the increase in interest rates that made our swaptions suffer. Another contributing factor was that the value of our private equity holdings was written down at the beginning of the year. The return is now better and the probability to meet our target is very high.

nrpn: Are you confident that you will be able to make a comeback during the remaining months of the year?

I’m pretty optimistic. We’ve repositioned our portfolio to Swedish and foreign credits and have written down our private equity as much as is needed. In risk-adjusted terms, we see much more value in credits compared to equities. But we also have a smaller equity exposure via derivatives. Over the past five years, we’ve had returns of 7 per cent on average. This year, the returns will probably be lower, but in this very uncertain world, we prefer stable but lower returns. In the long run, still believe that we will have average returns of around 7 per cent.

nrpn: What have your main priorities been since taking over as finance director three years ago?

I made some pretty significant changes as soon as I took over the job. The main change had to do with our external management. We used to have all assets invested by ABN Amro, but the first thing I did was terminate that agreement. I don’t think it’s good to use one manager for all assets – it’s impossible for someone to be the best at everything. The active equity management had not worked, so we decided to go for indexed mandates in efficient markets, such as the US, Europe and Sweden, and only use active management in Asia and emerging markets.

nrpn: Are you not a believer in active management?

Most proponents of active management seem to be the active managers themselves, which I guess is understandable. But to be honest, I don’t think active management works in the long run and there’s too much that goes into fees. For example, a survey of American asset managers by Lipper showed that only 10 per cent of active managers were able to beat the benchmark and that 90 per cent of managers underperformed over a 20-year period.

nrpn: Then perhaps you should try to find that top 10 per cent?

Possibly, but the same study also showed that it is rarely the same managers that keep on overperforming. I guess it depends on what you believe you should focus your resources on. I’d say it’s better to focus the resources on the asset allocation, rather than on finding good active managers. In our case, the indexed funds have been able to pull in better returns than most active funds for a fraction of the costs.

nrpn: Do you believe that things like the active/passive debate sometime overshadow the importance of the asset allocation?

Historically, that has definitely been the case. About 90 per cent of the resources have been put into securities selection and beating the index, and 10 per cent on the asset allocation. Instead, you should do the opposite since 90 per cent of the result can be attributed to the asset allocation. We are putting at least 70 per cent of our resources into the asset allocation and would never have had such a good result last year if we hadn’t focused on having the right exposure and keeping track of the risks. However, the tide is starting to turn and many are beginning to concentrate their resources on the asset allocation, different protective strategies and duration matching. For example, it looks like AP1 is moving in this direction.

nrpn: There were extremely large differences between your 2007 and 2008 portfolios. Why did you make such radical changes to your asset allocation?

We don’t have any strategic or tactical allocation, just asset allocation. We made the changes because the risk levels in the markets changed so dramatically. If we would have kept the portfolio we had in June 2007 with 50 per cent equities, 40 per cent bonds and 10 per cent property, the risk as standard deviation would have increased from 10 per cent to 30 per cent in 2008. In other words, our risk level would have been three times higher when the world was going through a crisis. That would have been the result if we would have kept the asset allocation and I don’t think that makes sense. Instead, we opted for an asset allocation of 75 per cent bonds, 15 per cent equities and 10 per cent property.

nrpn: Is it not unusual for a pension fund to make such dramatic changes?

We are trying to work a bit like a macro hedge fund, for example, by focusing on constant risk instead of a constant asset allocation. During the crisis, this has proven to be hugely successful. Lately, a large number of volatility target funds have been launched. Theoretically, that has been considered a success for 10 years, but hardly anyone has done it. Instead, they have stuck with the old way of thinking.

nrpn: Why do you think that has been the case?

My impression is that there are very few in my position that actually read a lot of books and research literature and not many of them are aware of the latest research. Other things are more important to them. It’s therefore probably harder for them to take things like this on board. It’s difficult to invent the wheel by yourself, but you can get quite far by reading what the academics have concluded. I have many designated people around me who are looking into how to manage the assets efficiently and we also regularly get together to discuss interesting articles and research.

nrpn: Länsförsäkringar recently beguninvesting in hedge funds again, after shunning the asset class a few years ago. What caused this turnaround?

We’ve been sceptical about the return prospects and the high fees, but we saw an opportunity to take advantage of the arbitrage in the market. We’ve invested in the Nektar Special Opportunities fund, which we believe will pull in good returns and it also has low management fees.

We haven’t ruled out making further hedge fund investments if the right opportunity comes up, but we no longer have a target allocation. We’re an opportunistic investor in the asset class and don’t just stick to a long-term strategy.

nrpn: Have you considered adding any other alternative asset classes?

About 10 per cent of our equities are allocated to private equity, but we are also in the process of building up infrastructure and forestry portfolios. We have made some commitments to infrastructure funds, but most capital is yet to be drawn. We also have some limited exposure to forestry through investments in Bergvik Skog, but we have been looking to add some forestry funds.

Previously, we looked into Brazilian forestry, but that work was disrupted last year when so many other things came up. I’m expecting that we will get back to that soon. But the crisis has to some extent redrawn the map, and there are currently so many other interesting things to invest in, above all credit.

CV

GUSTAV KARNER

2006-present Chief financial offier and head of asset management, Länsförsäkringar;

2002-2006 Head of asset allocation, Länsförsäkringar Asset Management;

2001-2002 Quantitative strategist, Länsförsäkringar Asset Management;

1998-2001 Head of risk management, Alecta Investment Management;

1996-1998 Quantitative analyst, Handelsbanken Markets;

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