As the green shoots of economic recovery gradually turn into saplings, the horror stories of the past few years are gradually losing their edge and recoveries on the equity markets have helped to repair some of the damage done to pension portfolios during the financial crisis.

Across the Nordic region, pension funds are reporting healthier returns and an altogether happier picture of funding ratios is starting to emerge. Even in Iceland, one of the most beleaguered countries in Europe, there is a return to fortune supported by figures from the central bank, which revealed net pensions assets had rocketed by IKr44bn to reach IKr1.846trn (e11.6bn) in the year to March 2010.

Yet, in spite of this reversal of fortune, pension funds must remain cognisant of the reasons why they found themselves so vulnerable to market downturns; now is the time to examine risk management processes and systems, and learn from past mistakes.

Risk management now takes centre stage for pension funds not just in the Nordic region, but across the globe. Those responsible for providing retirement benefits to millions of savers need to ensure they not only understand the potential risks and threats to their portfolios, but have a robust, flexible and dynamic process in place to mitigate them.

Helen Kobæk, chief executive at Danish pensions company Pensam, says: “Why should we manage our risks? It keeps us one step ahead and ensures that we are able to react efficiently if a situation arises. In this respect, companies in the financial sector were not quite on their toes in the run-up to and during the financial crisis.

“Probably only a few companies had considered what initiatives were necessary if a crisis arose. It is always difficult to make the necessary decisions when a crisis comes crashing down around you, so being one step ahead is vital.”

Danish ATP was one of the few schemes that had some systematic risk management processes in place, which served the fund well during the darkest economic times. The fund has enjoyed a particularly rewarding start to 2010, reporting first quarter returns of DKr10.5bn (e1.4bn). Yet even during 2008 when the fund made losses of DKr17.38bn, it still increased pensions by 2 per cent, due to a risk management policy that protected the scheme’s reserves and allowed the fund to adjust and adapt to market conditions.

Bjarne Graven Larsen, ATP chief investment officer, says: “I guess that we were lucky in that we had discussed very much in advance of the financial crisis how we could protect against extreme situations. So during the crisis we tested our risk management set up and more or less found that it worked as we had hoped.”

Mr Graven Larsen says that there are three risk management processes that helped ATP weather the financial storm and that would work equally well at other pension schemes.

The first is to recognise the importance of liquidity. ATP benefitted from having a highly liquid portfolio, which meant it was able to purchase assets that were mispriced as a result of the financial crisis and use those to boost returns.

“You have to have a high degree of liquidity in your portfolio, which you can achieve in different ways. It does not necessarily have to be from cash; for example, if you hold bonds you need to make sure that you can use them as collateral in derivative structures,” Mr Graven Larsen says.

Ultimately, this means funds need to look beyond the long-term mantra that dominates received thinking on pension fund management, and accept that short-term strategies are just as important. “You need to look at both long and short; if you don’t survive in the short term then you won’t survive in the long term,” Mr Graven Larsen says.

Second, Mr Graven Larsen stresses the importance of diversification. During the course of 2008, ATP’s strategy of diversifying the portfolio helped shield ATP’s investments; three out of five asset classes returned a profit, with yields on government and mortgage bonds, in particular, bolstering returns.

“A portfolio should be diversified more significantly than most people think. A lot of pension funds had listed equities, private equity, real estate and hedge funds, but they turned out to be badly hit during the crisis because they probably didn’t diversify the underlying risk factors,” he says.

Mr Graven Larsen adds that ATP benefitted heavily from hedging strategies that took care of the exposure on the liabilities and also produced returns of DKr93.5bn.

Similarly, Steen Jørgensen, director at Finanssektorens Pensionskasse (FSP), says his scheme also used a liability-driven investment strategy to separate assets from liabilities and implement hedging strategies, an approach that limited some of the negative impact.

Next »

1  | 2  | 3