You know those people who think the next generation is smarter than the previous one? Well, I’m sure they are right.’
Marten Lindeborg, CIO of the €33 billion Swedish pension fund AP3, has confidence in the bright young things who are about to begin their careers. However, he’s less sanguine on the prospect of the global economy that awaits them.
Secular stagnation, weak demographics and zero interest rate policies have put investors and savers in a corner. ‘Consultancy giant McKinsey has predicted lacklustre global growth for the next 50 years. I believe the system is fraught with structural problems that will reinforce inequality,’ he tells Modern Investor.
One of the main culprits of this situation, Lindeborg argues, is central banks. ‘The zero interest rate environment is creating instability. How can we value stocks? And can we get out of this situation?
‘Higher rates in future will significantly dampen an already fragile economy. At the same time, companies are not using QE money to invest, but rather to buy back their own shares.’
To deal with this situation pension funds need to equip themselves with new tools and ideas, Lindeborg says.
Lindeborg’s AP3 fund is one of Sweden’s AP public pension funds, which are responsible for managing the surpluses and deficits arising between paid-in contributions and pension disbursement. In common with all large pension investors, the global financial meltdown in 2008 caused a major shake-up at the scheme.
‘All AP funds went down 20% in 2008. Since 2012, we have established a benchmark and have beaten it by 13.3% after costs. We’re happy that the overall strategy has done well, but we also have to be modest with regards to what the future will look like.’
Though he believes global economic prospects are far from rosy, talented people and contrarian ideas could hold the key to thriving in this complex environment. ‘I am the coach of a youth soccer team, and I want them to play like Barcelona. Teamwork and ambition are very important in life as well as at work.’
Originally from South Korea, Lindeborg landed in Sweden when he was five years old in the town of Sundsvall. After working for Skandia Asset Management and DnB NOR Asset Management, he joined AP3 in 2009, at the height of the crisis.
‘It was a mess. The Swedish economy was down, pensions had been cut and headlines about pension funds’ strategies were very negative. There was a lot of work to do.’
AP funds was launched in 2001 with a government mandate to invest in equities. However, at that time valuations, especially in the tech sector, were very high. ‘We had to rethink the whole investment process, and by 2010 we had implemented a new dynamic asset allocation process, which was much simpler than the previous one. We also received a broader mandate from the board in terms of investment decisions.’
Lindeborg’s quiet revolution started by looking at the overall portfolio from a risk perspective. He gradually reduced the equity risk in it and started allocating more to alternative strategies. The CIO moved away from traditional beta and started investing in two new areas: hedge funds as well as what he defines as ‘alternatives’, which consists of real estate, infrastructure, insurance-linked securities and timber assets.
‘We have 7.4% of the portfolio in absolute return strategies and we are not planning to increase it at the moment. We use internal hedge funds, external products and so-called risk premia strategies. We know how the latter work, while the same cannot be always said about hedge funds.’
His decision not to allocate more to hedge funds reflects the lacklustre performance of the asset class. ‘Hedge funds have struggled for the past couple of years. They should provide diversification and, in theory, additional returns. But this has not happened recently.’
AP3 has focused on real estate both in Sweden and abroad over the past couple of years. The scheme invests in the asset class mainly through stakes in property holding companies such as Swedish business Vasakrona, in which it is the biggest shareholder along with other AP funds.
‘We like "boring" and safe infrastructure projects such as schools and hospitals. We expect a 7-9% annual return from these kinds of investments.’
At the end of 2015, the pension scheme entered into a joint venture with listed property company Balder to invest in Swedish rental housing.
‘Sweden has one of the highest rate of refugees coming from Syria [last year, 35,000 unaccompanied children claimed asylum in Sweden], as well a very high rate of immigration. Therefore we think the residential sector will grow significantly in the country.’
AP3 is also invested in the second-biggest timberland owner in the country, and has a 5% stake in timber company Bergvik Skog, as well as having allocated capital to some Australian and Latin American timber funds.
Elsewhere, the fund accesses infrastructure through a 20% stake in Swedish firm Ellevio, which owns part of the Swedish national grid, while also using listed and unlisted infrastructure funds.
‘There are not so many infrastructure projects that are suitable and brought forward for long-term institutional investors as some of them are too small,’ Lindeborg says.
TRADITION VS. INNOVATION
In both the traditional fixed income and equity portions of the portfolio, Lindeborg has implemented changes to modernise AP3’s investment strategy. He believes institutional investors should be more specific about where to invest in equities, which as an asset class now represents 44% of the whole allocation.
‘We have decided to focus more on quality stocks and small caps in Sweden, Europe and the US,’ he says.
While in Sweden the scheme mainly invests directly in equities, in the US and Europe it has awarded a passive mandates to BlackRock based on an AP3’s active allocation decision to go into small caps. BlackRock also runs some mandates on the behalf of the Swedish institution in Japanese and Asia Pacific equities.
Lindeborg says small caps have historically offered a risk premium of approximately 3%, more than is generally provided by large cap exposure. ‘We want to harvest the small cap risk premium, but selection is key in this sector. Also, the area is quite illiquid and highly exposed to the general business cycle.’
Fixed income investments account for 38% of the fund’s portfolio, which is exposed to sovereign bonds in Australia, Sweden, the US and the UK.
Lindeborg also pays a lot of attention to green bonds, an asset class it’s been active in since 2007.
‘We want to help establish this market. They are very simple investments with returns as high as a regular bond. The only difficult bit is to identify which bonds are really green, and which are not.’
Green bonds are set to become a mainstay of AP3 in future. At the end of 2015, the fund announced it will triple its green bond holdings by the end of 2018, with exposure rising from €486 million to €1.6 billion in the next two years.
As part of a strategy designed to hit new sustainability targets, the scheme also announced it will halve the carbon footprint of its listed equities and credits compared with 2014, as well as doubling its strategic sustainability investments, such as water treatment, from €1.09 billion to €2.1 billion by the end of 2018.
Finally, the fund said it will ensure that Vasakronan, Scandinavia’s largest real estate company, in which AP3 owns a 25% equity stake, will continue to lead the way in sustainability in Sweden’s real estate sector.
All these new targets came after AP3 signed the Paris Pledge for Action on 24 November, adding its weight to the agreement signed at the COP21 climate change conference, in which 195 countries agreed to adopt specific targets to tackle global warming.
‘Sustainability is a matter of risk assessment and puts a lot of responsibility on an organisation such as ours. The priorities we have set are based on our analysis of what creates long-term value.
‘For us, this is about high standards of corporate stewardship and social responsibility and good environmental practices.
‘The introduction of these changes will affect the entire portfolio. As investors we are doing our bit, but ultimately it is up to the companies to ensure their operating activities are sustainable.’