Strategy at Denmark’s $15 billion insurer SEB Pension is focused on building a robust alternatives portfolio within a risk-proofing investment approach, the fund’s chief investment officer, Jørn Styczen, explains.
SEB, a defined-contribution (DC) multi-employer pension provider, offers guaranteed and non-guaranteed DC pensions. Assets under management have increased on the back of growth in Danish demand for non-guaranteed products.
A quarter of SEB’s assets are invested in an alternatives portfolio established in 2000, which has since grown to become one of the biggest allocations to alternatives amongst its European peers. It is here, Styczen explains, where he is prepared to spend parts of his risk and cost budgets, using active external management in allocations to distressed debt, senior secured loans, hybrid mezzanine funds, infrastructure and private equity.
Recent strategies include investing in senior secured loans through 2015 and 2016 while being short high yield, in a bid to protect the fund from geopolitical risk.
“2016 was not the best year to be short high yield and long loans, but loans have protected the fund against geopolitical risk and as the yield spreads currently are nil, loans are very attractive,” he says.
Along with loans, infrastructure is also a big allocation within the alternatives portfolio. Here, Styczen prefers value-added opportunities, rather than infrastructure that “just gives income”, like a toll road. He also favours strategies and managers that go one step further than simply “buying the asset”. An example is SEB’s investment with Copenhagen Infrastructure Partners in a new biomass-fired combined heat and power plant in the UK. The plant is set to generate enough energy for 50,000 homes when complete in 2018.
Copenhagen Infrastructure Partners typically taps the mezzanine part of the market; however, Styczen also invests with Global Infrastructure Partners and EQT, where assets are structured more like private equity. SEB received a 30 per cent return from its infrastructure allocation in 2016, due to mature funds “selling assets”. Infrastructure investments have already returned 4.3 per cent in 2017.
Side-cars address fees
The large alternatives allocation makes tackling high fees an ongoing priority. One way to achieve this is through co-investment with SEB’s prime managers, setting up side-car arrangements.
“Our managers increasingly set up a side-car vehicle, whereby we invest, say, $50 million [through] the fund, and $30 million [through] the side-car. It allows us to reduce our fees by 25-30 per cent.”
He adds that because SEB’s total portfolio is already well diversified by asset classes and managers, any loss of diversification from this strategy “is not a problem”.
Styczen says the alternatives portfolio is a stalwart in the face of today’s geopolitical uncertainty and high debt levels, and plans to build the allocation further.
“We have the expertise to commit more to alternatives,” he says. Recalling the global financial crisis, he notes the alternatives allocation withstood the crisis because SEB didn’t have to sell any assets and “all the values came back”.
Along with the 25 per cent allocation to alternatives, SEB has a 25 per cent allocation to listed equities, a 10 per cent allocation to real estate and a 40 per cent allocation to liquid credit, Danish mortgages and government bonds.
Liability management stays in house
Across the fixed income portfolio, SEB has developed a liability matching overlay. This enables managers of SEB’s only active external fixed income mandate to focus on the benchmark.
“When we outsource the fixed income portfolio, we don’t outsource the liability management,” Styczen explains. “We watch it all the time ourselves and adjust our hedge to make sure the duration is in line with our liabilities and expectations. It is much easier for the asset managers if you don’t give them liability targets, you just give them the benchmark.
“Large fixed income allocations are challenging because the returns are so low. This way we can do the duration matching as an overlay.”
The bulk of the equity allocation is indexed, with a derivative overlay, in a low-cost strategy that has allowed the fund largely to eschew active equity management and hedge funds. The exceptions are one active mandate to Danish equities, which accounts for 10 per cent of the equity allocation, plus two active, niche equity strategies.
Styczen has also developed a risk premia program to work alongside the equity allocation.
“Most smart beta or risk premia strategies are correlated to equity; if equity markets fall, you can lose money in a smart beta portfolio, and the strategies are difficult to view as separate asset classes,” he says.
SEB’s solution is to use part of the risk premia program alongside the equity portfolio and replace some equity exposure with short volatility strategies.
“We need something that works better with the equity,” he concludes.
A recent innovation included developing a tail risk-hedging portfolio in response to the geopolitical uncertainty of Brexit and the new Trump administration.
“It was successful but it proved very expensive when there wasn’t any volatility,” he says. “A tail risk hedge doesn’t work if nothing happens.”
Still keen to protect against geopolitical risk, but loath to reduce the equity allocation, and with risk “uncompetitive”, Styczen has now decided to restructure the risk-factor portfolio and add a defensive tilt to make it work alongside the tail-risk portfolio. To this end, SEB is developing a number of defensive strategies that would give a large gain should equity markets fall.
