Nordic noir: Swedish state pension fund’s outlook is austere

Sweden’s AP1 aims to ditch illiquid assets and target realistic returns with equities

Clouds over Stockholm; the Swedish capital is home to AP1

The prospect for fixed income returns is grim. And in the current low-to-no-yield world, targeting returns in high single figures is simply not realistic. This is the pragmatic take of Mikael Angberg, chief investment officer at AP1 – Första AP-fonden – Sweden’s state pension fund.

“If the risk-free interest rate goes from 5% to zero, there’s no magic one can do,” says Angberg. “I feel sorry for some of the US pension funds that still have to generate 8–9% nominal returns. I think it’s not possible.”

While some US counterparts continue to chase these highs, AP1 has reduced its own return expectations to 3% for the coming 10 years – and accepted the fact that yields have collapsed.

Over the 40-year horizon, AP1’s return objective remains a modest 4%.

“As we move out [along] the risk curve, you get more compensation, albeit at a lower level than historically,” says Angberg.

AP1 is tasked with managing a Skr355 billion ($40 billion) slice of the Swedish state pension system’s funds.

To sniff out solid returns away from fixed income, the fund is seeking yield in “traditional assets where there’s still a term premium on the risk curve”.

But around a quarter of its balance sheet is still in illiquid real estate, infrastructure and private equity, says Angberg.

And this, he adds, is way too much.

“What this pandemic showed us was the damage that can be done by having so much of your balance sheet locked up in illiquid assets that aren’t necessarily repriced, [or marked to market] as other parts of the portfolio are.”

Angberg’s team was nonetheless able to carry out some timely damage limitation.

Mikael Angberg
Mikael Angberg

“We reacted very quickly when the pandemic accelerated,” says Angberg. “We managed to scale down the risk reasonably well [as it took hold],” he says.

The fund began de-risking in early March, but – when a turnaround was anticipated – became a buyer of risk on the way down.

“We decided to start buying back risk around 20% drawdown on the major equity indexes,” he says. “And since then we’ve built our risk positions into the recovery – so, today, we’re actually overweight risk.”

But managing the illiquid portion of the portfolio did cause some minor headaches, Angberg acknowledges.

While the fund didn’t quite end up in a liquidity squeeze, in the sense of lacking free cashflow to meet payment obligations, it nonetheless experienced a “liquidity situation”, whereby it couldn’t rebalance the portfolio in the way it wanted, says Angberg.

As an example, he says: “If 20% of your balance sheet isn’t affected by a repricing, but 50% of [it] is – through equity exposure – as that 50% shrinks to 30%, then obviously the proportion of unlisted or illiquid assets grows.”

“When I as an asset allocator want to buy back that liquid risk, I simply can’t, unless I use leverage,” he adds, citing the inability to sell illiquid assets to source cash.

Angberg is sceptical that there is even a premium associated with illiquid assets and is looking for yield elsewhere. Since the nadir of the Covid-19 crisis, AP1 has been allocating more to equities.

According to its interim report for the first six months of the year, AP1’s equity exposure went up to 42% from 36% in 2019. Fixed income exposure fell to 29%, while real estate, infrastructure and private equity funds accounted for 23% of the balance sheet – broadly unchanged from last year.

But, speaking to in October, Angberg says that since then the fund has decreased its fixed income exposure to 25% and increased its equity exposure to around 52%.

While the strategy didn’t “hit the trough perfectly”, Angberg is satisfied AP1 had a “clear game plan at what levels we would buy back risk”.

What this pandemic showed us was the damage that can be done by having so much of your balance sheet locked up in illiquid assets
Mikael Angberg

Some of the equity exposure was achieved through leverage.

“Obviously, there’s a liquidity risk associated with taking leveraged exposure in equities, but we’re much better equipped to look through that type of risk management than the risk of a liquidity event that might happen with private assets,” he says.

“Private asset liquidity events are often more legally complex, as they involve partly or fully owned companies. Liquidity risk in leveraged exposure is more about understanding and controlling effects of market volatility, margin calls, etc. We have a treasury desk who are experts in managing this type of risk.”

Based on the latest available results, AP1’s new strategy is yet to pay off. In the six months to June 30, the return on equities was -5.9%, whereas fixed income yielded 4.6%. Overall, the fund lost 1.8% after expenses over the period.

Ethics, but not at any price

AP1’s investments are governed by the rules of the AP Funds Act in Sweden, which means abiding by the environmental, social and corporate governance (ESG) considerations in its investment guidelines.  

But applying an ESG screen is not done at the expense of returns, Angberg emphasises. “We see ESG, as [we see] any risk factor, as something that we try and evaluate,” he says.

In the green bond sector, for example, AP1 perceives investors are paying a premium for upholding ESG principles and is wary of participation in that market.

In September, for example, the German government raised €6.5 billion ($7.5 billion) from its first green bond – issued at a slightly lower yield than conventional counterparts and investors will face a lower level of liquidity.

“There are occasions when there is a premium to pay for ESG-related investments,” Angberg says. “We’re not really willing to give away return for the sake of ESG.”

AP1 is also concerned that sourcing reliable and cost-effective data to judge companies on ESG factors is still a hindrance to ethical investing.

“It’s been difficult to assess the reliability of data sources,” says Angberg. “We’ve utilised many data sources to cross-reference and get a multi-dimensional perspective on ESG risk – because we don’t feel like we can rely on any one data set or data provider. The practical problem is if you decide to have every data source under the sun, you’re going pay a lot of money.”

MSCI is the fund’s main provider of index data and some ESG data. It also uses Sustainalytics and Arabesque S-Ray for ESG data. This piecemeal approach presents its own challenges, says Angberg.

There are occasions when there is a premium to pay for ESG-related investments. We’re not really willing to give away return for the sake of ESG
Mikael Angberg

“Some [data sources] are focused on a specific area of ESG, which is obviously an enormously broad area. So we’ve used different data providers for different things, but we would like very much to consolidate,” he says. “Having specialised data provided for every single area of ESG becomes difficult to manage and terribly expensive.”

Angberg also recognises that reliable data is crucial to AP1’s application of ESG principles across both its fundamental and quantitative investment strategies.

“We want to do it right,” he says. “We don’t want to do any sort of greenwashing or crowd-pleasing activities. We want proper decision-making capabilities when it comes to ESG questions.”

Career lens

Angberg’s career trajectory started as a physics engineer at Cern, the European Organisation for Nuclear Research, where he moved into software engineering before alighting in quantitative analysis for its pension fund. This led to other roles in investment management – at Axa Investment Managers, BNP Paribas, Goldman Sachs and Pimco, where he worked across areas such as liability-driven investing, equity derivatives and quantitative investment.

While at Pimco, he spearheaded the bond manager’s first foray into ESG, authoring its ESG policy statements, and by 2013 had accumulated a skill set that qualified him well for the role of CIO at AP1.

Seven years later, the pandemic has put these skills under the microscope along with the need to rebalance AP1’s portfolio.

Under Angberg, the fund is also increasingly focused on reducing its cost base. About a fifth of its balance sheet is managed externally, the rest in-house.

“Our ambition is to manage as much as we can ourselves, for cost reasons, in order to have better control of execution and better control of risks,” he says, but adds that if the fund cannot demonstrate sufficient expertise in areas such as emerging market equities, high yield and small caps, then outsourcing will still be justified.

When it comes to monitoring the costs of external managers, part of AP1’s qualitative due diligence evaluates the extent to which they trade and execute efficiently, says Angberg, but more could be done to drill down into whether managers are providing value.

The fund has a best execution policy, but it might also consider more explicitly setting targets and budgets for trading and execution, he says.

“What gets measured gets managed,” he adds. “And I think we have more work to do in that space, especially as we move more assets [under in-house management].”

“We have quite a lot of negotiation power with external managers. That said, I don’t think we necessarily always have the knowledge and the skill to unpick exactly what we’re paying,” he concludes.

“That’s probably an area where our due diligence process needs to be a little bit sharper. We probably aren’t asking tough enough questions, to be honest.”


Editing by Louise Marshall

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