Currently, the world is in constant flux, and never has this felt more true than during the period following the global financial crisis. Negative interest rates, Quantitative Easing, Brexit and Trump's election win were all events which provoked shock and surprise.
In these times of constant shift, asset managers are expected to be more adaptable, sharp and far-reaching than ever before – a reality which also rings true at PFA Asset Management.
Everyone in the investment industry is on the hunt for reasonable returns, and the asset manager for one of Denmark's largest commercial pension providers is no exception.
"We are basically positive on the stock markets. We do not believe that you can achieve large returns in bonds, but nor do we believe that you will lose a lot of money on it over the next two years. However, there could be a lot of unforeseen events, which could send us in the wrong direction. We could enter recession, or we could hit unforeseen explosive growth," says Anders Damgaard, Chairman at PFA Asset Management and group CFO at PFA.
"We invest in our basis positions based on our main scenario, which is moderate growth. However, we will have to be able to manage all three scenarios in a sensible way," he continues.
In the long term, PFA projects 10–20 years of moderate growth. Not necessarily consistently, and perhaps not in the way seen in classic business cyles. However, productivity gains and savings is, according to PFA, not likely to lead to historic growth levels.
"We believe that we are looking at average global growth rates of 2.5–3 percent over the next twenty years," is Damgaard's forecast.
PFA has about 570 billion danish kroner under management. According to Damgaard, PFA's ownership structure gives PFA AM a clear advantage in comparison to many other asset managers.
Amongst other things, the annual dividend is set at just 50,000 danish kroner annually according to the company's bylaws.
However, PFA has the same challenges as other asset managers in finding investments with attractive returns. This holds especially true as interest rates hover near the bottom of a downward curve.
The 'buffer effect' is out of order
"Since the 1980's, bond returns have simply grown, grown, and grown because of the structural decline in interest rates. Now we are in a situation where the bond yields are not continuing to rise, because the interest rates cannot come any further down," says PFA's Damgaard.
"There are two things, which are important to bear in mind: Returns will be low. We can count on bond coupons. However, the capital gains will not be there – but rather capital losses if the interest rates rise. Secondly, what I like to call the 'buffer effect' is about to reach a minimum. For many years it has been the case that when a crisis hits and shares therefore dive, the central banks lowered interest rates. So bond prices increased. So when you lose on the shares, you win on the bonds. This is the buffer effect. It is probably still there, but because the rates can't go much further down, it is significantly reduced," says Damgaard.
PFA projects that the current European interest rate level is not at an economic equilibrium. The interest rate level is thus hugely affected both by ECB's bond acquisition program and the central bank's credit facilities. The US yield curve is according to PFA closer to a long-term equilibrium, as are emerging markets.
What does that mean for PFA AM and investment decisions?
"As far as we are concerned, it's not that complicated. We will only say, that when the yield curve is as it is, we must put more in the US and less in Europe. This naturally brings dollar risk with it, but we can hedge against that. It does, of course, cost something, but still, some return remains," says Damgaard.
Former strategies to rise on the combination of shares and bonds and drive towards an end result simply no longer work. Nor for the long term investors, says Damgaard.
"The trend we have known, is over. Nor do we know whether we are witnessing a new tren,d or whether we are moving along in a zig-zag pattern," says Damgaard.
"The value of having a dynamic mindset is much much higher today, when there's no clear trend. Previously, you could make an investment, sit back and receive a return. If you traded in and out along the way, this had some significance but was not notable. Going forward, being able to trade in and out, when the market changes, will have much more importance."
Focus on alternative investments
PFA has partly looked towards the US, but other markets are also interesting for the asset manager. Notably, PFA has allocated both money and ressources towards alternative investments.
In order to minimize the costs of this more expensive alternative, an increasing number of alternative investments will be managed internally in-house, rather than outsourcing the business to more expensive external managers.
"We have looked at what it costs to make alternative investments in-house instead of externally, and the bottom line is that we could do it approximately five times cheaper than external managers can," explains Damgaard.
Currently, PFA Asset Management has approximately 15 billion danish kroner in alternatives. Over 50 percent of the money are outsourced to private equity funds and other fund managers, but it has also been done internally in-house, as has been seen with FIH, Dong Energy, and Danish Ship Finance.
"If we can deliver an in-house return, that is just as good as receiving it from external sources, and we can do it five times cheaper than externally, there's a spread, you can deliever as return to customers," says Damgaard.
Anders Damgaard acknowledges, however, that it is not an entirely cost-free investment method. Due diligence and comprehensive reviews of all data within a transaction must be carried out before investing, costing both time and experts.
"It IS a much more expensive way to invest. There is no doubt about it. This is really difficult. You have to employ someone who has the capabilities for it, so you can't be stingy when hunting for external partners – accountants, lawyers, consultants, who have the knowledge about this kind of thing," says Damgaard, shifting a little in his seat.
Is a Solar Panel Farm risky business?
Meanwhile, Damgaard will not concede that alternative investments automatically are riskier than ordinarily listed companies.
"You cannot ultimately say that it is riskier. It depends on what kind of alternative investments there are," says Damgaard, adding:
"A solar panel farm is not particularly risky. The largest risk is the energy price and the electricity price. On the other hand, not everyone can invest in solar panel farms. So as major players we have a competitive advantage, in that we can set aside a huge amount, and we have critical mass to have in-house expertise."
But there is no market price on alternative investments. How do you know that you are paying the right price?
"With listed companies, you can naturally better document that others are willing to give the same price, but that does not necessarily mean it is the right price. When we go out and buy a company such as Danish Ship Finance, then we gain access to the data, to the credit books and we can carry out a completely different kind of due diligence than we could on a listed company," explains Damgaard.
He does not believe that the entire OW Bunker scandal would have happened, had there been a private deal rather than a public listing.
"It would likely never have happened, because a comprehensive due diligence would have been performed and the price that was given would never have been offered. Likely, the parties would also have had a far better understanding of their credit and risk management, which went completely wrong and ultimately overturned the company," is Damgaard's take.
There is more liquidity within alternative investments and it costs something to get rid of the alternative investments again. Therefore, there can also be a risk premium tied to certain company acquisitions. But despite the additional disadvantages of alternative investments, Damgaard believes that it can nevertheless still pay off.
"We are constantly comparing with what we can go out and get from the market – the easy way. Which is not so easy any more. That is why we are forced into this," he points out.
Meanwhile, alternative investments in PFA's caliber have the advantage that the everyman cannot just buy Danish Ship Finance or Refshaløen in Copenhagen.
First of all, you must be approved by the Financial Supervisory Authority (FSA) and not everyone can be. And in addition, not everyone can simply toss DKK 2 billion on the table. Therefore, the competition is perhaps less hard, and we can get things for a more reasonable price," he explains to FWAM.
Therefore, PFA AM also relies on the strategy to demand exclusivity early in the process, so they do not exit the bidding rounds and thus waste their expensive due diligence money on a price which ends up for too high.
Only five percent of the alternative investments evaluated at PFA Asset Management end up transpiring.
The team which will work with alternative investments currently consists of seven employees who have spent most of the past year locking the right governance structures, credit policies, and report policies into place and to acquaint the board with what the department actually will do.
"We have not really begun yet. Although we took investments for approximately DKK 6 billion last year, we would like to be able to turn it up to three times as much. Perhaps not in 2017, where it may only come to DKK 10 billion," says Damgaard, outlining the future for the alternative investments team:
"But we cannot make a firm goal that we will push out DKK 10 billion in 2017, because nobody knows whether there are good deals to the tune of DKK 10 billion in 2017. It would be madness to have such an objective," says Damgaard, concluding
"But when the good deals show up, our intention is to have so much in-house expertise that we can deal with it in an effective and relatively cheap manner."