Peter Lindegaard, head of investments at Danica Pension, says fund selection is taking an ever more prominent role within his strategy as Denmark’s future pensioners increasingly turn to more flexible retirement solutions.
Copenhagen-based Lindegaard runs over €40 billion and says people’s changing attitudes towards their pension plans is slowly bringing about a more active form of institutional investment.
The largest of Denmark’s private pension companies, Danica Pension manages the retirement schemes of leading corporations such as shipping giant Maersk and pharmaceuticals group Novo Nordisk. It also runs the pension scheme of probably one of the best known beer companies in the world – Carlsberg.
Lindegaard has led the firm’s investment team for the past two years and has witnessed clients’ growing demand for pension plans with increased risk flexibility.
Into the looking glass
In order to understand this change we need to take a closer look at Danica’s pension structure. Clients can choose from three different pension plans. The first is a traditional offering, shown below, which provides set return guarantees – this is the firm’s largest product at around €25 billion.
The two remaining plans, life-cycle and unit-linked, offer a more flexible approach which allows contributors to tailor their pension plans to their needs as they grow older. It is within these two plans that Lindegaard’s fund selection plays the biggest role.
The main differences between the three options are their exposure to bonds and their use of fund selection. The traditional plan needs a higher exposure to fixed income in order to match its liabilities. It is managed almost entirely via mandates, which have been handed to Danske Capital and BlackRock.
The two other plans have a lot more exposure to equities and to riskier assets. The life-cycle option is split about 50-50 between relatively risky assets and bonds.
‘Although the traditional plan is a lot bigger than the others, inflows are larger in the life-cycle plan so we are focusing on this one,’ says Lindegaard. ‘We believe it is a better option than the old system and we are trying to make a cleverer product.
‘In a way it’s a move away from this idea that you can guarantee people anything and get a meaningful result. We don’t believe in this as we think you deliver an inferior result if you have guarantees.’
The clients determine how much risk they want to take depending on how long they have until their retirement and investing in funds gives Lindegaard the flexibility he needs to manage these assets.
In the life-cycle plan, for example, this means they can have a much higher exposure to riskier assets, as much as 50%. This can be gradually reduced in favour of bonds as the client approaches retirement and requires more secure returns.
For this flexible approach, Lindegaard uses funds from well-known investment houses. For equities he is currently using Fidelity’s Global Opportunities fund, managed by Sudipto Banerji, and the Fidelity Latin America fund, run by Citywire A-rated Alex Duffy and Angel Ortiz.
He is also invested in other emerging market funds, such as Skagen Kon-Tiki, managed by veteran Swedish investor and Euro Stars AAA-rated manager Kristoffer Stensrud, and the Aberdeen Emerging Markets fund run by Euro Stars AA-rated manager Devan Kaloo.
New pension style
The advantages of the flexible investment approach greatly outweigh those of the traditional plans you find in many pension funds, says Lindegaard, as the ultimate decision of how much risk to take rests with the client.
He believes pension funds’ traditional investment structure is becoming obsolete as enduring volatility means these funds can no longer guarantee clients a fixed and consistent return.
‘What this means, in the scenario where you have an interest rate guarantee, is you have to buy bonds when interest rates fall to cover those guarantees and you have to sell equities when they fall because you can’t handle the risk.
‘So what you end up doing in that kind of environment is buying bonds when prices are high and interest rates are low and selling equities when they are low. You end up being pro-cyclical in the way that you invest,‘ says Lindegaard.
And with the huge swings in global markets and the low interest rates we have seen over the last 10 years, this provides a very challenging environment for long-term investors to offer clients steady returns and ensure capital preservation, he says.
‘You buy high and sell low in equities. It is a stupid way of investing and all you end up doing is depleting your buffers. It is a very frustrating endeavour.
‘But if you have the life cycle plan, you start out with a high allocation and gradually you are scaling down equities over time.’
The philosophy behind this plan is simply to buy equities when they are low and sell when they are high. Everyone is a winner, according to Lindegaard, as this approach offers the client better returns and also benefits his group as they shift the risk decisions from themselves to their clients.
Lindegaard, who has run both bond and equity funds, likes to know exactly what he’s choosing and if a manager is unable to explain his strategy in a matter of minutes then he is cast aside.
‘What alarms me when I meet a manager is if his strategy is too "black boxish". If it is something that I don’t understand within two minutes then I have issues.
‘It’s important to understand what they are doing. What are their strategies and how do they see the world? It would also worry me if they use too much leverage to obtain their returns,’ he says.
Consistency is also key for Lindegaard and a manager who delivers alpha on a regular basis would be on his short list – as long his performance is not just a fluke.
‘Sometimes you see a manager that is doing really well but it turns out it was just because there were two or three years where the investment trend was going in one direction and everyone was running with that.’
He also avoids managers who present higher than acceptable market correlation. It is a risk he is not willing to take as he prefers active managers who are not at the whim of market fluctuations. But, he admits, this rule requires him to make sacrifices.
‘The time where you expect 25% return from your manager is over. It is difficult to get that kind of leverage and you don’t necessarily want that level anyway.
‘So somebody who can give you a high single-digit return with a very low volatility on an unlevered basis would really catch my eye.’
Fees are my red flag
Risk control has always been an important factor for Lindegaard when selecting a manager but since the crisis his clients have also pushed fund manager fees towards the top of the agenda.
‘Fees in general are a huge issue for our clients. When the markets go up 10% to 15% every year people don’t really care if they pay 1.5-2% fees. But if the expected return is very low that becomes very important and that is where we are now.’
This new client focus means he now avoids managers who demand high and unwarranted fees.
‘I would rather have something where I see some risk control and there is an alignment in interest on the fee side. I don’t mind paying performance fees over a reasonable hurdle rate but I don’t want to pay 2 and 20. I think those days are over.
‘Now there is this adjustment downwards in society so I think fees should also follow this trend downwards. There is evidence of a little bit of deflationary trend in that space.
‘The very popular managers that have big inflows are much more difficult to talk to. But in general, even among the better managers there is some understanding of the situation we are in,’ says Lindegaard.
Lindegaard’s investment strategy is now moving towards alternative assets. The benefits, he says, is that they can often provide a higher risk-adjusted return than many other types of assets. Almost all of his alternatives exposure comes via funds, such as ING’s High Yield fund, while offerings such as Goldman Sachs’s Infrastructure Partners are used to tap specific markets.
‘From our side there is a general shift towards alternatives. We try to limit the volatility in the portfolio and see if we can get the risk premiums without as much volatility as we’ve had historically.’
Other individual funds Lindegaard uses include boutique offerings such as the Skagen Global fund. He is also invested in the Carnegie Worldwide fund but uses products from other large investment groups such as JP Morgan, T Rowe Price and PIMCO as well.
‘We are also slowly moving towards a more global portfolio and that was one of the reasons we took on BlackRock to extend our global reach. We want to be more equally weighted between Europe, US and emerging markets but we are still behind when it comes to the emerging markets. The bulk of our investments are still in the developed markets.’
Aside from finding managers with acceptable fees, Lindegaard says one of his biggest challenges is how to make decent returns in an environment of low interest rates and high volatility. But he remains an optimist.
‘Cash is now king and pension funds at least do have inflows and do have money. A couple of years ago when people could borrow to buy into anything it was very difficult to get hold of the very good investments.
‘So if we do our jobs right we can find interesting investments with high expected returns. That is still possible. As long as you are not forced to buy 10-year government bonds at 2% then it looks OK.’
This article originally appeared in the November 2011 edition of Citywire Global.