Investment strategy at Finland’s €42.9 billion ($48.1 billion) Varma is shaped by a large hedge fund allocation and a growing risk premia strategy. It’s not a trendy mix but it earned the country’s largest private pension insurance company a return of 4.7 per cent last year.
The Helsinki-based fund combines more than 100 external manager relationships with a 25-strong internal investment team, headed by chief investment officer Reima Rytsölä.
At the end of last year, the portfolio was split between fixed income (30 per cent) equity (44 per cent) real estate (9 per cent) and a 17 per cent allocation to other investments, the bulk of which lay in hedge funds – an uncommon move these days but one that paid off.
In fact, hedge funds have continually proven their worth since Varma launched the portfolio in 2002. Since 2003, hedge funds have returned 6.7 per cent, compared with 5.8 per cent for the overall portfolio. Over a 10-year period, the overall portfolio has returned 4.8 per cent, compared with 5.8 per cent for the hedge fund allocation.
Risk premia
There are a handful of new themes in the works as well. Rytsölä, who joined Varma in 2014 from Finland’s Pohjola Bank, plans to extend risk premia strategies to long-only equities. The fund already uses risk premia as an overlay to traditional cross-asset strategies, he explains.
“Risk premia is a big theme for us and something we have investigated for some time. [However], long-only strategies seem to have a pretty decent risk/reward [ratio] and are fairly cost effective, too.”
He adds that the risk premia strategy will focus on liquid, developed markets.
“The balancing actions required in risk premia investment create a fair [number] of transactions,” he explains. “You don’t want to be in a position where you need to do a lot of transactions when there are large beta spreads, or there is an illiquid market.”
Finnish exposure
Varma’s equity allocation includes a sizeable 35 per cent chunk of the overall portfolio to Finnish equities. Although Rytsölä acknowledges it is a “large proportion”, he counters that the biggest companies trading on Finland’s stock exchange are global businesses, resulting in an ultimately small exposure to Finland. The Finnish equity allocation is actively managed by Varma’s expert internal team.
Add Finnish loans and Finnish real estate in other portfolios and roughly 25 per cent of Varma’s total investments are in Finland – about €10.8 billion ($12.1 billion).
The equity allocation also includes 7 per cent to private equity funds and 2 per cent to unlisted equities through co-investments, bar a few outright holdings, including a Finnish housing company and a forestry group.
The fund’s approach to active management is targeted; for example, Rytsölä has withdrawn from all active management in US equities, “because of the relatively poor performance of external managers” at adding value. Now the fund prioritises “straightforward passive, externally managed US equity portfolios”.
“We work on the basic principle that if the market is inefficient or illiquid, active management, either internal or external, can create value. But you really do need to know the market to add value. That is why we do the Finnish market ourselves. It has illiquid features, so active management makes sense.”
Mulling the current investment climate, Rytsölä is encouraged by opportunities in emerging markets, where he believes key economies are in good position to withstand the tailwinds of US monetary policy.
“Emerging markets will be affected by US monetary policy and whether the Fed tightens more than the markets have anticipated; they are sensitive to dollar liquidity,” he says. “At the moment, it looks fairly good. Emerging market economies are in better shape to take tighter Fed policy than they were in 2013.”
All emerging market allocations are outsourced in active strategies and the fund does not hedge its local currency exposure in emerging markets, although it does hedge its dollar-denominated risk.
Hedge funds
Varma’s hedge fund allocation is about 15 per cent of its assets, in a portfolio designed to create better returns than fixed income but with a lower risk than equities.
“We do realise it is an expensive asset class but the fixed income market is running out of steam and a decent return is difficult,” Rytsölä says. “The credit spreads are so tight and interest rates are so low, the future running yield is not that good.”
Initial investments were in funds-of-hedge funds, but this has since evolved into direct investments with single manager funds; about 90 per cent of Varma’s hedge fund investments are direct, with the remainder in funds of hedge funds.
The portfolio is diversified across several managers and strategies, including macro, statistical arbitrage, event-driven, long-short, opportunistic credit and fixed income arbitrage.
Manager selection and all the 45-odd relationships are run by Varma’s three-strong team. It involves “a lot of travel” to the US and Europe, reflecting the portfolio’s North American and European bias, and global reach.
“It is difficult to capture these kinds of opportunities ourselves,” Rytsölä says.
ESG integration
The hedge fund portfolio also stands out for its environmental, social and governance (ESG) integration, where manager governance and transparency have become crucial investment criteria.
Indeed, ESG is another big theme at the fund, which has measured the carbon footprint of its investments and in 2016 published its first climate policy, targeting carbon reduction across asset classes. In that year, the carbon footprint of Varma’s listed equity investments declined by as much as 22 per cent. There were also carbon footprint reductions in corporate bonds (-25 per cent) and real estate (-8 per cent).
This result was achieved by focusing on low-emissions industries and avoiding emissions-intensive industries such as energy and mining. Climate change mitigation is the focal point of Varma’s responsible investment.
Over the next five years, Varma aims to reduce the carbon footprint of listed equity investments by 25 per cent, listed corporate bonds by 15 per cent and real estate by 15 per cent.
The fund is also part of the UN Principles for Responsible Investment working group promoting responsible hedge funds. The group has launched a due diligence questionnaire to help these funds focus on ESG factors.
“Varma’s goal is to actively promote the responsibility of hedge funds through international collaboration,” says Jarkko Matilainen, the fund’s director of hedge funds. “Managers must now pay even greater attention to responsibility aspects.”
The fund recently produced its first integrated annual report and corporate social responsibility report.
“We have done a lot in ESG integration but there is still a lot to do,” Rytsölä says. “It is a step-by-step process.”
