Sweden's AP3 Gains 10.8% in H1 2019

Michael Katz of Chief Investment Officer reports that Swedish pension fund AP3 recorded a net gain of 10.8% during the first half of 2019:

Swedish pension fund AP3 reported a 10.8% return after expenses for its investment portfolio during the first half of 2019, raising its total market value by SEK36.51 billion ($3.79 billion) to SEK374.1 billion as of June 30, up from SEK340.7 billion at the end of 2018, and from SEK353.1 billion at the same time last year.

All asset classes earned positive returns for the fund, with equity investments making the largest single positive contribution to the returns, while the fund’s real estate investments also performed well. The fund reported five- and 10-year annualized returns of 8.6% and 9.1%, respectively.

“Equity markets recovered swiftly from the sharp downturn in the last quarter of 2018,” AP3 Chief Executive Officer Kerstin Hessius said in a statement. “Financial market risk levels dropped after the US Federal Reserve began the year by signaling a restrictive approach to continued interest rate hikes and later guided the market to prepare for cuts during the year.”

Despite the robust returns for the first six months of 2019, the AP3 portfolio underperformed by 0.8 of a percentage point its long-term static portfolio (LSP), which serves as its benchmark and consists of liquid assets. However, the fund outperformed the LSP in the second half of 2018, and for the year ended June 30.

New investment rules for the AP funds came into effect at the beginning of the year that reduced the minimum for investments in fixed income instruments with a low credit risk from 30% of portfolio assets to 20%. The funds were also given increased scope to invest in unlisted assets. As a result of the changes, the AP3 board of directors adjusted the level of risk in the LSP by raising equity risk to 55% from 50%, and raising the weight in index-linked bonds and currency exposure.

Although this didn’t alter the portfolio’s asset allocation during the period, the fund said the strength of the equity market during the first six months and the higher equity weight in the LSP were the main reasons the AP3 portfolio underperformed the LSP.

“Large holdings of unlisted assets give the AP3 portfolio a higher level of diversification than the LSP,” said Hessius. “This means that the AP3 portfolio will lag the LSP when stock markets make rapid gains. Conversely, the AP3 portfolio will outperform the LSP when stock markets fall sharply.”

The asset allocation for the fund as of June 30 was 31% in foreign equities, 19% in real estate and infrastructure, 18% in foreign nominal fixed income, 12% in Swedish equities, 9% in Swedish nominal fixed income, 5% in index-linked bonds, 4% in unlisted Swedish and foreign equities, 1% in Swedish index-linked bonds, and 1% in other assets.

According to Pensions & Investments, as at the end of June, AP3's assets increased by 9.8% to 374 billion Swedish kronor ($40.2 billion) over the two first quarters of the year. Also, for the year ended June 30, assets increased 5.9%.

More importantly, the annualized net return for the five-year period ended June 30 was 8.6%; the 10-year annualized return was 9.1%.

I would definitely say Kerstin Hessius has done a great job at AP3 since being appointed CEO back in May 2004. She is part of a small club of women who are actually CEOs of pension funds (there aren't many) and this is something Sweden can be proud of in terms of gender diversity.

I've been covering international pensions lately as I want to broaden my coverage from just covering Canadian and US pensions.

Sweden is unique in that it is the only country which utilizes a structure of multiple pension reserve funds (AP1-4 and AP6). A full review of Sweden's national pension funds was done by the OECD in 2012 and is available here for those of you who want more details.

I also found this on AP6's website:

Part of the state pension system

The five AP funds (AP1-4 and AP6) are typically referred to as buffer capital and they account for approximately 10-15 percent of the pension system. Balance sheet ratios are updated each year, showing the relationship between the pensions system’s assets and liabilities. Since 2009, payments to current pensioners have been larger than the contributions paid in by employers and individuals who are self-employed. Funds are thus withdrawn each year from the AP1-4 funds to cover the payments to current pensioners. AP1-4 are equal in size. They also have the same investment rules, where investments are diversified over a wide range of asset categories. Each of these funds has both inflows and outflows to the pension system. AP6, however, is a closed fund, which means without any inflows or outflows of capital linked to the rest of the pension system.

Specialized in unlisted assets

Unlike the other AP funds, AP6 is entirely focused on investing in unlisted assets, which is different from investing in listed companies that are traded on the stock market. For those, you can literally buy and sell shares with the click of a button, via your bank, stock broker or online. The corresponding process for unlisted companies takes much longer and it requires a great deal of skill and experience. The investor role in unlisted companies requires a long time horizon, a shared understanding among owners and access to capital for making necessary investments to develop the company.

AP6 invests directly and indirectly in unlisted companies

AP6 invests in unlisted companies in two ways. Direct Investments are made by purchasing shares in an unlisted company. Indirect investments are made by investing in a fund, and then having the fund invest in unlisted companies. In the first example, AP6 obtains direct ownership in the company. In the second, it obtains indirect ownership.

Network and expertise help lower the costs

Investments in unlisted companies are time-consuming and they require special expertise in the various forms of transactions that are involved. AP6 has been involved in making unlisted investments for more than 20 years. During this time, the organization has built up an extensive network along with vast expertise and experience. This has enabled AP6 to participate in many types of investments, including co-investments and secondary transactions. Co-investments are an attractive way of investing because the costs are lower compared to indirect investments. Because of that, it lowers the average management costs for investing activities.

Closed fund

AP6 is a closed fund, which means without any inflows or outflows of capital linked to the rest of the pension system. At its inception in 1996, AP6 received SEK 10.4 billion. AP6 covers its own costs and the earnings from investments are reinvested on a continuous basis. At year-end 2018, the original capital had grown to SEK 34.7 billion.

Responsible Investments

Sustainability is an integral part of investing activities and value creation. Sustainability is always part of the supporting documentation presented to the Investment Committee and Board of Directors prior to decision-making. AP6 puts requirements on both governing documents and processes. The tools and methods for direct investments and fund investments differ, but for the entire portfolio the same focus is applied, with requirements on continual development and improvement. AP6 has established long-term goals for sustainability efforts for both direct investments and fund investments. Each year a climate analysis is carried out on the holdings in the portfolio.

This provides excellent background for this comment.

Now, AP3 put out a press release going over its strong result for the first half of 2019:

The first six months of the year brought solid growth in the AP3 portfolio as equity markets recovered swiftly from the sharp downturn in the last quarter of 2018. AP3 recorded a net result of SEK 36,511 million for the six months ended 30 June. The total return was 10.8% after expenses.

AP3 CEO Kerstin Hessius commented: “Equity markets made the largest single positive contribution – 10.8% – to overall return and the Fund’s real estate investments also performed strongly.”

AP3 has adopted new ambitious sustainability targets for the period 2019-2025. The Fund engages widely with stakeholders via the AP funds’ Council on Ethics. During the period, this work focused especially on collaborative investor efforts to improve safety at tailings dams and on social media responsibility.

During the spring, AP3 partnered with AP1 and AP4 to found Polhem Infra, an investment firm that will focus on unlisted sustainability-focused Swedish infrastructure companies. This will bring long-term benefits both for the pension system and the wider community.

Highlights 1 January – 30 June 2019 – Results and payments

• AP3 recorded a net result of SEK 36,511 million (11,165) for the first six months of 2019.
• The total return was 10.8% (3.3) before expenses and 10.8% (3.3) after expenses. The Equities and Inflation risk categories made the largest contributions to this performance.
• The annualised asset management cost ratio was 0.10% (0.09), of which operating expenses totalled 0.06% (0.06).
• Fund capital rose to SEK 374,138 million (340,668 at 31 Dec 2018), an increase of SEK 33,470 million.
• SEK 3,040 million (3,320) was paid from fund capital to the Swedish Pensions Agency in the first half of 2019 to cover the difference between paid-in pension contributions and outgoing pensions and to meet pension system costs.
• AP3 has generated an annual average return of 8.6% over the last five years and 9.1% over the last 10 years.
• Return underperformed the LSP benchmark portfolio by 0.8 percentage points during the period.

Summary of AP3’s interim results at 30 June 2019

Unfortunately, AP3's Interim Report is only available in Swedish here.

Still, I found a few things interesting in this press release. Yes, AP3's return underperformed the LSP benchmark portfolio by 0.8 percentage points in the first half of the year but as explained above, new investment rules for the AP funds came into effect at the beginning of the year that reduced the minimum for investments in fixed income instruments with a low credit risk from 30% of portfolio assets to 20%.

The funds were also given increased scope to invest in unlisted assets. As a result of the changes, the AP3 board of directors adjusted the level of risk in the LSP by raising equity risk to 55% from 50%, and raising the weight in index-linked bonds and currency exposure.

Hessius is spot on: “Large holdings of unlisted assets give the AP3 portfolio a higher level of diversification than the LSP. This means that the AP3 portfolio will lag the LSP when stock markets make rapid gains. Conversely, the AP3 portfolio will outperform the LSP when stock markets fall sharply.”

Interestingly, compared to Canada's large pensions plans, AP3 is very under-invested in private equity (only 4% compared to an average 12% weighting at Canada's large pensions), but it does have 19% in real estate and infrastructure (regulations limit its holdings in unlisted equities).

Private equity is one of the best-performing asset classes in large pensions over the long run so it's surprising to see AP3 and other Swedish pension funds don't have more of their assets there but as stated above, that is the sole responsibility of AP6.

I did find this passage in AP3's press release very interesting:

During the spring, AP3 partnered with AP1 and AP4 to found Polhem Infra, an investment firm that will focus on unlisted sustainability-focused Swedish infrastructure companies. This will bring long-term benefits both for the pension system and the wider community.

AP4 put out a press release on Polhem Infra when it was formed this spring:

AP1, AP3 and AP4 have formed Polhem Infra to lay the best possible foundation for making long-term investments in infrastructure, professionally and cost-effectively, to meet society’s long-term needs for investment. The focus is on cooperation and sustainability.

Infrastructure is defined by Polhem Infra as businesses that manage or provide social services and assets such as renewable power production, energy storage, energy distribution and digital infrastructure. Polhem Infra’s goal is to be a stable, responsible, long-term owner.

Polhem Infra will focus on large investments in the private and public sectors. Investments will primarily be made alongside other long-term industrial or financial partners.

Polhem Infra is backed by public Swedish pension capital through AP1, AP3 and AP4. The role of the funds in the pension system is to generate good returns at a well-balanced risk, in order to bolster the pension system for current and future pensioners. Polhem Infra complies with AP Funds legislation as regards to investments rules.

The funds have long experience of investing in and building profitable unlisted companies, Vasakronan, Hemsö, Ellevio, Rikshem, CityHold and Willhem being examples. Infrastructure complements the investment categories of equities, bonds and traditional real estate through long-term, stable, inflation-linked cash flows.

Johan Magnusson, CEO of AP1, Kerstin Hessius, CEO of AP3 and Niklas Ekvall, CEO of AP4, have jointly issued the following statement:

“Sweden has a great need of both public and private investment in infrastructure. Parts of the existing infrastructure will require major investment to meet society’s demands for quality and sustainability. With long-term ownership and a focused sustainability process, Polhem Infra has the capacity to be an attractive, priority player and business partner, which in the long term will benefit both the pension system and society in general.”

It's worth noting AP1’s board of directors just dismissed its CEO, Johan Magnusson, for allegedly violating “internal regulations on the holding and trading of financial instruments”: 

“Johan Magnusson has successfully developed AP1 during his time as CEO, and we on the board are grateful for his efforts,” Urban Hansson Brusewitz, chairman of the board, said in a statement. “Since it has now emerged that Mr. Magnusson has broken our internal regulations, he unfortunately no longer has the board’s confidence.” 

This has nothing to do with Kerstin Hessius and AP3 and good on AP1's board for applying their rules to everyone so vigorously, including the CEO of the organization (especially the CEO!).

Lastly, it's worth noting AP3 appointed Pablo Bernengo as its new permanent chief investment officer, overseeing its SEK341bn (€31.7bn) portfolio back in May. He replaced the acting CIO Kerim Kaskal, who had been in the position since the death of AP3’s previous investment chief Mårten Lindeborg in August last year.

Bernengo joined the fund from his position as chief executive of Swedish asset manager Öhman Fonder, where he has worked since 2011. He has previously worked in the asset management sector for companies including Norway’s largest financial services group DNB (previously DnB NOR), Swedish pension provider Skandia, and Carlson Investment Management. His previous roles have included chief executive, CIO and portfolio manager.

I've never met or spoken with Pablo Bernengo or Kerstin Hessius but they both have great credentials and are leading an organization which is properly managing AP3's assets at a very low cost basis.

Below, an older clip (2014) explaining the Swedish pension system and responsible investing.It's worth listening to all his remarks. I also embedded a clip featuring a presentation by Kerstin Hessius but don't ask me to translate.

Update: Michael Katz of Chief Investment Officer reports that Sweden's AP2 gained 10.7% in the first half of the year:

Swedish pension fund AP2’s investment portfolio returned 10.7% after costs during the first half of 2019, raising the fund’s total asset value to SEK367.4 billion ($37.7 billion).

Although the strong performance easily surpassed the fund’s long-term assumed rate of return of 4.5% a year, it was 0.4% below that of its benchmark index, excluding alternative investments and costs.

“The beginning of 2019 saw a strong recovery in the world markets after the major downturn at the end of 2018, however, this was followed by growing concern that global real economic growth may lose momentum,”AP2 CEO Eva Halvarsson said in statement.

“This concern was amplified by uncertainties regarding Brexit and, in May and June, the escalating trade conflict between USA and China,” she added. “This political uncertainty seems to have played a part in a declining investment climate the world over.”

The fund’s average annual real return rate over the past 10 years has been 8.1%, according to the H1 report.

The total return of the fund’s Swedish and foreign equity portfolios for the half-year was 19.8% and 21.5% respectively. Emerging-market equities increased in value by 13.9%, while Swedish fixed-income securities returned 1.1%. Emerging-market bonds , foreign credits, green bonds, and foreign government bonds returned 13.6%, 13.5%, 10.5%, and 9.9%, respectively.

Meanwhile, the fund’s alternative investments, which are made up of Chinese domestic market equities, non-listed real estate, private equity funds, alternative risk premiums, and alternative credits, returned 7.7%.

In the first half of the year the fund adjusted its listed portfolio to increase its holdings of real estate and private equity funds while reducing its allocation to Swedish and foreign equities, and Swedish bonds. It also increased its capital allocated to emerging-market bonds issued in US dollars. The fund’s board also decided that the fund will no longer invest in tobacco companies, or companies that are involved in the maintenance and modernization of nuclear weapons systems.

AP2 also completed a reorganization in the spring and the fund’s sustainability analysts are now part of the asset management’s strategy, as it looked to integrate sustainability issues into the fund’s management. During the first half of the year it voted at 74 general meetings for Swedish listed companies, and at 742 foreign general meetings, the plan said.

The asset allocation of the portfolio as of the end of June was 28.4% in alternative investments, 20.4% in developed markets equities, 10.5% in fixed-income, foreign credits; 10.4% in emerging markets equities; 9.1% in Swedish equities; 8.7% in 7.5% in fixed-income, emerging markets; 4.0% in fixed-income, foreign government bonds; and 1% in fixed-income, global green bonds.

You can read AP2's press release here as well as read the Half Year Report here. Obviously, there are similarities with AP3 but they are not exactly the same as AP2 allocates more to alternative investments.

Below, I embedded a clip where Climate Action caught up with Eva Halvarsson, CEO at AP2, during the Sustainable Investment Forum Europe 2019. Organised in partnership with UNEP Finance Initiative, the Forum was held on 12 March 2019 at Le Pavillon Dauphine in Paris.