A low interest rate environment and wide market fluctuations are currently the biggest nuisances to the pension industry. In the pursuit of good returns, many pension funds abandon regular stocks and bonds, and instead choose new – and riskier – paths to alternative investments.
However, there are several examples of things going wrong, such as the case with tire recycling company Genan, or the ongoing scandal surrounding lamp company Hesalight, in which several pension funds stand to lose hundreds of millions of Danish kroner.
Danish pension giant PFA, which is not among the Hesalight og Genan investors, also sees the appeal in alternative investment. But regarding the question of whether the pension fund wants to guarantee that its clients' savings do not disappear into investment blunders like Hesalight, the CFO's response is clear:
"I don't believe that we can guarantee that," says Anders Damgaard, responsible for finance, investment, and risk at PFA, in an interview with FWAM.
The future of the pension industry
FWAM recently met with Damgaard at business newspaper Børsen's annual pension conference, where pension industry top executives were invited to discuss the future of the industry and the challenges awaiting them all.
Alternative investment, which covers everything from infrastructure and property to green energy and direct commercial loans, is a rising trend among pension funds, to the great concern of the Danish Financial Supervisory Agency (FSA), which was also represented at the conference.
Deputy Director General at the Danish FSA, Jan Parner, opened the conference, but he was not greeted with a standing ovation.
"You can take or leave my arguments," said Parner, voicing his skepticism as to whether the companies' managements and boards of directors have the competences necessary to make alternative investments.
It is a topic that increasingly worries the Danish FSA, which for the past few years has criticized pension funds for their handling of alternative investments, which could ultimately harm the pension savers. It is an issue that Danish Minister for Industry, Business and Financial Affairs, Brian Mikkelsen, also has put on the agenda, and recently he made the first moves to increase the Danish FSA's supervision of the field with DKK 2 million (EUR 268,976) a year.
Closer to investments
According to Parner, pension funds should have more knowledge of their investments and work out more models to handle the more risky asset classes.
"It requires very specific competences to understand and handle all these different sectors, and the more you invest in them, the bigger your investment fund needs to be," Parner said.
"Alternatives are illiquid and are not traded on the regulated market, so there is no objective price. There's just a lot of assumptions about both price and returns, and they could turn out to be much too optimistic. My question for you is, are your investments as good as you claim they are?," Parner asked the assembly, which remained silent.
Shares the concern
At PFA, whose alternative investments constitute 14 percent of the total DKK 438 billion (EUR 58.9 billion) assets under management, Damgaard agrees with the Danish FSA.
He shares their concern for the pension industry, but explains that PFA has chosen a careful approach to alternatives.
"We have fewer alternative investments compared to other pension funds. We build them slowly and carefully, and only to the extent that we have sufficient competences and the internal set-up for it," he says. Damgaard has 20 employees exclusively handling the pension fund's alternative investments.
According to Damgaard, PFA follows a model where alternative investments are made with a partner that has specific knowledge of the individual sectors. A partner that ensures the competence level and tracks down good investments, but still takes on part of the risk while PFA monitors the companies.
"Unlisted assets require more responsibility than listed assets, and active ownership is expected. The new types of investments place heavier demands on our organization, and they are supposed to do so. In PFA, we are figuring out how to assess investments, both regarding their compatibility with our portfolio, and whether they give enough security," says Damgaard, adding that PFA's alternative investments are mainly properties.
Nobody is absolutely safe
Even though PFA believes that the homework is done, Damgaard acknowledges that the pension fund is not absolutely safe from bad investments.
"If you make a loan to a company, we know from banks that problems might arise. It's not necessarily because the pension fund made a mistake in the due diligence process, but for unknown reasons, a situation might just suddenly appear where the borrower can't pay interest and repayment," says Damgaard.
"But it stands to reason that companies or projects with obvious risks should be sorted out during the preliminary phases."
Despite the risk of pension funds encountering e.g. fraud in their investments, Parner from the Danish FSA believes that some disasters can be avoided if the pension funds are more thorough in their preparatory work.
"My impression is that some of the pension funds act a little too fast, and that their due diligence process is simply not thorough enough. Some companies are very confident in entering into investments that are actually very insecure," Parner said to the conference attendees.
According to Parner, banks have gained hard-earned experience in the field over many years, building competence and knowledge within alternative investments, which is something that pension funds have yet to achieve.
Stocks and bonds are not safer
Despite how investments in infrastructure, like trains, or green energy, such as windmills, may seem more insecure than listed stocks and obligations, Damgaard does not believe that they carry more risk than unlisted alternatives.
"It's not that black-and-white, because stocks and bonds carry different risks than alternatives. It's comparable to a house. You can either build a house from the ground or buy one ready-made. If you build it yourself, you have to go through every detail, which takes time, but gives insight that you don't get with a ready-made house," he says.
"Unlisted stocks are impossible to find ready-made. It grants you more liberty of action to build the legal structure and gain a deeper insight into the investment. Listed assets are standard structure with documentation and regulations, which can be an advantage, but you just don't get the same level of insight."
Alternatives are here to stay
Regarding the question of whether alternative investments will be given a lower priority in PFA's portfolio if interest rates increase again, Damgaard is certain:
"Once we have built competences in the field, alternative investments look promising from a long-term perspective. There is no doubt going to be attractive investments on the unlisted market, so we will pursue them as long as we can handle it," says Damgaard, not excluding any alternative asset classes from PFA's portfolio.
English Edit: Marie Honoré