Headstrong: The Danes' Investment Dominance

From aiCIO Europe's April issue: How Danish investors are making alternatives commonplace. Charlie Thomas reports.

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Denmark is on fire—in a good way. European television audiences are addicted to dramas Borgen, The Killing, and The Bridge, and readers continue to devour Stieg Larsson’s Millennium Trilogy. Last autumn, Denmark was even declared the happiest country on earth by the UN’s Happiness Survey—despite having one of the highest taxation levels.

Its pension funds are on fire, too. Before the financial crisis, many pension aficionados would have named the Netherlands the most innovative and pioneering of nations. Not anymore: Today, that mantle has passed rather decidedly to the Danes.

One of the starkest examples of innovation and pioneering spirit has been in alternative investments. Struggling, as many Europeans have, with a low-rate environment leading to poorly performing fixed income instruments, the Danes have demonstrated a sizeable shift—€152 billion as of February, according to the regulator—into real estate, private equity, hedge funds, and infrastructure.

While other nations have been moving that way too, Danish investors have increasingly been using the direct route, particularly in the energy and real estate sector. Data from consultants Kirstein estimates the average pension fund now has 7% to 8% of its asset allocation in alternatives, rising to 14% for some of the larger investors.

Some pension funds are even going beyond the traditional alternatives and investigating newer options, such as agriculture. In January, PensionDanmark, PKA, and PBU pension funds committed to the Danish Climate Investment Fund, established by the Danish Investment Fund for Developing Countries.

Thus, two obvious questions arise: Why, and how, are the Danes so far ahead of their European peers?


The “why” is an easy query to answer: Terrible yields from fixed income forced the Danish hand. Take PensionDanmark, a 20 billion lifecycle-style defined contribution (DC) fund that entered its first infrastructure deal back in 2009.

CIO Claus Stampe tells aiCIO that DONG Energy, one of the largest domestic energy suppliers, approached PensionDanmark and other pension funds to buy 50% of its offshore wind farm in the Danish North Sea.

The other pension funds walked away from the deal, but PensionDanmark stayed at the table, resulting in a 94 million investment in Nysted Wind Farm in 2010, and a500 million investment in the Anholt wind farm in 2011, its biggest investment in any asset to date.

“Our fixed income units were falling significantly,” Stampe says. “We used to have 70% in Danish fixed income, but it became obvious to us that with interest rates at 2%, if you’re a 65-year-old with 20 years remaining of his lifetime, it doesn’t make sense to have such a large proportion in fixed income. We had to do something, and the answer wasn’t just moving more money into equities.”

Today, real estate and infrastructure make up around 20% of the fund during the growth years, with lower allocations applying after members turn 65. PensionDanmark is targeting even more infrastructure exposure, with a 10% (or 2.6 billion) allocation target to direct infrastructure planned for 2017.

Almost all of these projects are in Danish infrastructure, made possible by PensionDanmark building a specialist team of seven working for the fund. It has another 15 working on the Copenhagen Infrastructure Partners, a platform set up by PensionDanmark in 2012.

Rival corporate pension provider Danica is also looking to expand its alternatives portfolio. Currently, Danica has 24 billion in a guaranteed defined benefit (DB) fund, 6.7 billion in a lifecycle DC, and another 4 billion in a unit linked product.

In the DB fund, alternatives make up 7% of the allocation; the DC fund has a 5% allocation. Both should increase their exposure over the next year, according to CIO Peter Lindegaard.

“Both of them should have a bigger allocation, but it depends on the opportunities,” he says. “Our strategy with alternatives is to look for the opportunities on an individual basis, investments where we understand the risks and there are good justifications for taking them… Even a 20% allocation to alternatives could make sense, if the right opportunities are there.”

Real estate is popular with even the most conservative of Danish funds. ATP’s CIO Henrik Gade Jepsen says that while his attitude towards many alternatives remains cool, the fund is far more active in real estate than it used to be.

“We’ve invested in very high quality real estate assets, mainly domestic ones,” he says. “But you have to be extremely selective. Easy monetary policy affects all assets, alternatives included. For example, we’ve looked at certain infrastructure investments where pricing was certainly not immune to the easy money markets.”

The 85 billion guaranteed pension plan has not shied away from private equity. “But we don’t assume that private equity gives you a lot of diversification from listed equities,” says Jepsen.

“Many investors see private equity as a totally different asset class, but we think it is driven by the same underlying risk factors as listed equity. We therefore see it as part of our overall equity exposure, so we can’t invest in private equity and say ‘it’s diversifying our equity risk’.”

Other pension funds do have a passion for private equity. Nordea Life and Pension, which runs 22 billion for corporate DB and DC pensions in Denmark, started building its private equity portfolio 10 years ago.

For the DC plans, private equity makes up around 6% of the portfolio, taking into account the slight differences in profiles depending on the members’ age and risk tolerance. That’s on top of 69% of its portfolio being in listed equities.

“We’ve actually increased the equity portfolio recently,” says CIO Anders Schelde. “We used to have a tilt towards minimum variance, but we’ve been reducing that over the years and building up a portfolio of small-cap equities.” Schelde is even considering emerging market equities again, though he hasn’t moved any assets just yet.

Danica’s Lindegaard was similarly positive on equities, and spoke passionately about his belief in active management.

“There’s an unholy trinity of the brokers, the press, and mad professors who say that everything’s a random walk down Wall Street and that it doesn’t pay to do anything actively. We don’t subscribe to that,” he says.

“We can add value, especially when you’re talking about alternative investments—we’re talking about making investments that make sense, rather than trying to beat a benchmark. It’s about absolute return.”

He’s also one of many Danish investors to move into structured products within his fixed income allocation. Bank loans are “interesting”, but it is collateralised loan obligations (CLOs) to which he’s devoted a lot of his allocation.

“I was at a conference in the UK last year when I said we were entering into the CLO market quite heavily, and you could hear this big intake of breath across the whole crowd,” he says. “But when you compare AAA-rated risk in CLOs with AAA-rated gilts or mortgages, you can pick up another 150 basis points.”


It’s not just their asset allocation that sets the Danes apart. Their risk management practices, it turns out, are winning them favour as well.

As one of the first nations to move to a mark-to-market model in 2001 (driven by a very forward-thinking regulator, Finanstilsynet, known as the FSA), the Danes were able to weather the financial crisis well, compared with their European peers.

The Danish financial services industry is also extremely advanced—even a simple product such as a mortgage has derivatives in it, meaning that from a young age financial graduates are comfortable with complex transactions.

Danish pension funds are also happy to use derivatives to hedge their portfolios, but many are now starting to sell some of them off, led by one of the biggest players in the market—ATP.

In the last quarter of 2013, ATP quietly and slowly placed 600 trades in two months, selling off 25% of its interest rate hedges.

Jepsen explains the decision was made when ATP decided it needed a new discount curve.

“Previously, we had a discount curve which extended indefinitely at the current 30-year yields. It was flat after 30 years, but would move up and down with market yields and 30-year bonds,” he says.

“There’s not really a market beyond 40 years, so beyond that point the yield curve is an abstraction. Then we asked: ‘Is it really in ATP’s interest to have this?’”

The problem was ATP’s huge amount of interest rate risk on its pension liabilities, which forced it to hold a large percentage of Danish government bonds and a lot of long-dated German government bonds.

ATP is also a big player in the European and Danish interest rate markets—and this meant it had a very high exposure to certain issuers of sovereign debt and the banking system in general. With a very large hedge portfolio of long-dated government bonds and interest rate swaps, you are vulnerable to new regulation, declining market liquidity, etc., all of which makes it more costly to run the hedging business.

“At the same time, given that interest rates were so low, we thought it would be a good time to enhance investment flexibility,” Jepsen adds.

“So we decided to use this model where we assume that after 40 years, interest rates are not variable, but flat at 3%, which means that no matter what happens to short-term interest rates, the very long end of the curve is the same.”

If the long end of the curve is fixed, there’s no interest rate risk to hedge on that part of the curve, so ATP sold a quarter of its interest rate hedges. Given its size, selling that amount of derivatives wasn’t easy; it had to do so in a way that the markets wouldn’t notice. And the markets are less liquid than they used to be, so the trades had to be staggered across two months. 

“When we built the portfolio, we could buy 1 billion of long-dated swaps in an hour without anyone really noticing. Now we have to do 10% of that per trade because the market’s more illiquid and it’s more costly to run a portfolio,” Jepsen explains.

“To do those trades without the market really noticing was hard work. The team did an extremely good job. Even we were uncertain about whether it was doable.”

Where ATP leads, others are following. PKA’s Head of Fixed Income Inger Huus Pedersen notes that where her peers were characterised by their liability hedging in the past, now there is less focus on it.

“A lot of pension funds put them on in 2001 and 2002, but since then we’ve seen a drive towards market-driven [DC] products, which has reduced the need for liability hedges,” she says. “Similarly, given our sector is robust and well-funded, and in light of the low rates, you’re seeing some take off interest rate hedges.”


And yet all is not perfect in the state of Denmark. While the mood is relatively positive for the year ahead, pension funds are not problem-free. Many cite the ongoing stress of low rates affecting their investments, as well as concern over whether Solvency II-type requirements will lead to problems for some of the more capital intensive alternatives, such as infrastructure.

There is also considerable concern over the poor value of certain assets. ATP is currently underspending its risk budget, with Jepsen waiting to deploy his “dry powder” as and when attractive opportunities arise.

“It would require some form of re-pricing in the markets for us to use the full risk budget again,” he says. “History has shown it’s very important to have flexibility to be a buyer in circumstances where something bad happens in the marketplace.”

And while investors here have a good relationship with their regulator, there are concerns about European-wide regulation and how it will impact their investment decisions.

“International regulation has increased, going against the growth that our politicians would like to see. For instance, some countries have introduced financial transaction taxes, and at the same time you get a green paper about how to generate growth in Europe—that doesn’t correspond,” says Huus Pedersen.

“European Market Infrastructure Regulation (EMIR) is another big, complex piece of regulation, and there’s a lot of important details that haven’t been decided yet. It’s quite costly for us to implement all this regulation, and to some extent, I can’t really see the benefits outweighing the costs when it comes to EMIR. We spend a lot of time and money, and do our members really benefit?”


Why have the Danes become the most innovative investors in Europe? There are certain elements most Danish funds share that contribute to their success and pioneering attitudes.

The biggest driver is their regulator. The FSA, as mentioned earlier, was among the first to force pension funds to calculate their liabilities using mark-to-market values. Introducing a traffic light system—stress tests to highlight the robustness of pension portfolios—was initially grumbled about, then enthusiastically embraced by the Danes, just in time for the financial crisis to hit.

Being in a more robust position after the crisis meant the Danes had the time and freedom to continue to innovate, while many European peers spent hours and resources frantically fire-fighting.

Unlike other European regulators, the FSA is approachable, and is committed to working in tandem with its investors. Its relatively relaxed response to learning that alternatives were becoming a sizeable part of its investors’ portfolios—a letter with suggestions on how to make sure investors were measuring the associated risks appropriately, without laying down restrictions and rules—won plaudits across the board.

Many investors also cite Denmark’s small size, where many people in financial services knew each other from school or university. This old boys’ network has encouraged a level of camaraderie among the investment elite, they say, as well as contributing to a healthy level of competition.

And competition is the third element—the DC market in Denmark is the most competitive in Europe, with pension providers’ contracts up for renewal every four years on average. The local press also regularly reports on the returns of these funds, which despite being called “idiotic” by one investor, is one reason Danish investors are kept on their toes.

In-sourcing sophisticated staff has also led to greater innovation, as evidenced by the ramp up in alternatives investment, and the size of these huge pension funds also encourages more risk-taking, particularly in DC.

Finally, Danish pension trustee boards are, they tell aiCIO, more open to new ideas than in other nations, allowing the CIOs more investment freedom.

ATP’s Jepsen echoes the thoughts of many: “An open-minded board is a prerequisite for doing things differently. Innovation means you’re willing to do things in a different way and that you’re willing to stray from the herd. Not all boards are ready to accept that risk of failure… Our boards give us the freedom to be different.”