The DKr65bn (e8.6bn) Danish PenSam is in the midst of a radical overhaul of its operational structure in an attempt to boost returns. The plan has already seen PenSam’s investment department restructured and its assets reclassified into equities, fixed income and alternatives.

Increased investment in riskier alternatives like forestry, mezzanine debt and potentially, hedge funds will stimulate returns; while the development of in-house skills to identify risk will also be a focus.

Last year, PenSam, which manages three occupational pension schemes for Danish municipalities and regions, posted returns of -9.3 per cent. Performance over the first half of 2009 has improved somewhat, with pre-tax returns of -2.4 per cent. Even so, the half-year report concluded that results were “unsatisfactory in relation to the development of financial markets and the fund’s risk profile”.

Chief investment officer Benny Buchardt Andersen admits that last year’s results were “not funny”. “The good thing is that we had a relatively low allocation to credit last year, but increased our exposure this year,” he says. “Our investment strategy for the coming year will be quite aggressive.”

PenSam expects that improved performance will be greatly aided by continued implementation of its ambitious four-part investment strategy, currently into its second phase.

The process began before the start of the global recession, but questions have arisen as to the wisdom of making such a radical structural change in the midst of the world’s most severe financial crisis since the 1930s. Nonetheless, Mr Buchardt Andersen argues that making such a change, at this time, is imperative for PenSam for a number of reasons.

At the top of his list is that the current financial crisis is creating numerous opportunities for a canny investor. Putting a team in place to exploit the emerging opportunities provided by low asset prices and a swing in securities values, will pay dividends in years to come.

He says: “I think that the coming years will provide good opportunities for investors with a long-term horizon to capture the illiquidity and risk premium stemming from the financial crisis.”

However, in the current financial climate, there is still a lot of systemic risk and the first green shoots of recovery might end up being a mirage. To mitigate, the second major overhaul that PenSam is undertaking is a review of its risk management practices.

To understand the new global risk environment, Mr Buchardt Andersen is beefing up PenSam’s risk management practice to include 14 professionals.

The new team will carve up the various areas of risk that PenSam’s investment portfolio may face. As well as the traditional risk management disciplines, which all investment managers have, PenSam is creating a team to deal with possible litigation and a quantitative analysis team that will continually monitor portfolio, investment and corporate risk. All of these departments will report to the CIO.

In the original review of PenSam’s organisational structure, which began two years ago, it was decided that a number of competencies should be brought in-house and not outsourced. The key competency that should be wholly managed by PenSam, says Mr Buchardt Andersen, was the function of legal due diligence.

He believes that the current mandate given to investment managers encourages conflicts of interest. As investment managers make portfolio investment decisions, undertake the quantitative research and are involved in manager selection, there is too much responsibility concentrated in one set of hands. He thinks that investment managers should concentrate just on investment and that the functions of due diligence, portfolio construction and manager selection should be managed by the pension fund itself.

“The legal aspect is as important as portfolio management and it gives us a clarity our peers lack. Madoff showed that it is vital to have complete control of where our money ends up,” he says.

The review will also address the risk management strategy of the pension fund, with the ultimate aim of creating an efficient, optimised portfolio. Crucial to this is the discipline of portfolio diversification. The objective of modern portfolio theory is to select a collection of investment assets that will have a collectively lower risk than any one single asset. The key to this is diversification and creating a blend of asset classes that will change in value in opposite ways, when the economic cycle changes.

To ensure that PenSam’s portfolio is optimized to provide positive returns in any economic climate, Mr Buchardt Andersen has removed the mandate for portfolio construction and analysis from external sources. By developing an in-house team he will insure, through the implementation of qualitative and quantitative filters, that PenSam’s portfolio is constructed in the most efficiently diversified manner, will meet its long-term investment objectives, lock in any capital appreciation and minimise investment risk.

As a by-product of this process, it is hoped that PenSam will be able to identify the sources of alpha that its managers are creating and hedge against negative beta. Mr Buchardt Andersen calls it a “true alpha-beta setup”.

The first results of the new regime are starting to be noticed this year, but the real proof of the pudding will come in 2010. Already, PenSam has shifted its investment focus: “Instead of investing in equities, we invested in credit and significantly raised our high-yield bond and structural credit exposure,” Mr Buchardt Andersen says. This portfolio diversification has already shown positive investment returns and reduced the risk profile of the fund.

Another initiative that Mr Buchardt Andersen is thinking of introducing is benchmarking. However, there has been vigorous debate within PenSam and the wider investment community of the validity and usefulness of benchmarking. “Setting up benchmarks is a big decision,” he said, “because benchmarks replicate the broader market, even though the broader market isn’t necessarily efficient.”

As the fund is increasing its exposure to alternative asset classes and alternatives, by their nature are notoriously difficult to benchmark, Mr Buchardt Andersen is unsure of how he would create a benchmark for his entire investment portfolio. But if he finds a solution he can then try to optimise the portfolio using a mix of traditional and alternative asset classes.

“We need to look into all the asset classes and find an efficient way to access the market in benchmark terms. If we do that research, then we can also find the optimum way to monitor passive investments and achieve the best returns.”