Surging equity markets generated a double-digit return for the 26 billion ($35.5 billion) Ilmarinen of Finland last year. Now the fund aims to boost its exposure to emerging markets at the expense of “old Europe” equities, says Timo Ritakallio, deputy CEO and investments chief at the pensions company, and further globalise its real estate and private equity portfolios. Simon Mumme reports.
“Last year was extremely good for us,” Ritakallio says, reflecting on the 15.8 per cent return posted by Ilmarinen for 2009. But the fund’s best annual result to date followed a year of sharp underperformance in which it learnt two lessons that have been echoed by the investment committees of large institutions around the world: diversification was more effective in theory, and too much complexity in portfolios can create headaches when markets turn south.
The crash of 2008, however, has not deterred Ilmarinen from listed equities. The fund manages an $11 billion equities portfolio, and expects this asset class to be the long-term outperformer, “even though the last 10 years haven’t been so good,” Ritakallio says.
Fully 80 per cent of Ilmarinen’s assets are managed internally, and its investment team, which covers all asset classes, operates without the guidance of an asset consultant. Seeking opportunities in equity markets, it fund has decided to raise its allocation to global emerging markets beyond the current 15 per cent within its equities portfolio. These new investments will be managed by external mutual fund managers, and be funded by its exposure to “old Europe” equities, such as Italy, Spain, Germany and France, Ritakallio says.
“Emerging markets were relatively stronger than what we thought two years ago. They have already regained very quickly.
“In emerging markets we are using mutual funds, because we think there is still room to achieve good performance through active management. The markets aren’t so efficient and you can get an information advantage.”
Ilmarinen believes active managers add consistent value only in less efficient markets. This view underpins its $1 billion exposure to US public equities, which is invested through passive exchange-traded funds, because the US market is too efficient to warrant active management, Ritakallio says.
The fund also aims increase its exposure to real estate, which it uses primarily as an inflation hedge, from the current level of 11 per cent to 15 per cent, a target allocation below many of its domestic competitors. Two-thirds of this portfolio will be will be comprised of direct investments in Finland, and the remaining in listed instruments globally, for which It is assessing opportunities in Europe and Asia.
“We are thinking about what is the right way. It isn’t good from our point of view to make foreign direct real estate investments because you need to know the market well.
“We have had real estate investment funds, but their performance hasn’t been good. Last year it was terrible. It was -20 per cent.
Co-investing with other pension funds offshore is also an option, Ritakallio says. So is investing in listed real estate investment companies, “because many of them after the crisis are still trading clearly under their net asset values”.
The fund also plans to increase its private equity allocation from 2.5 per cent to 4 per cent. “Every year in the next five years, we should make new private equity investments of between $550 million to $700 million.”
Presently, its private markets team is mulling European mid-market buyout funds that can exploit the opportunities often generated during recessions, and also funds oriented towards Asia. It invests in more than 100 private equity funds, and prefers direct allocations to managers to funds-of-funds to avoid extra layers of fees, Ritakallio says.
During the financial crisis, Ilmarinen was disappointed by the performance and opacity of complicated investments, and took the view that “it’s better to invest in less complex products.”
In 2008, its external hedge fund managers delivered a -15.5 per cent return. For Ilmarinen, this further validated its aim to increase the proportion of hedge fund strategies managed in-house while culling some of its investments with external managers.
In the last four years the fund has staffed an internal hedge fund team to run tactical asset allocation (TAA) strategies. This team now manages about $2 billion, or 1.6 per cent of the fund’s capital. More money remains with external managers – 2 per cent -Â but this is unlikely to increase.
Ritakallio says the TAA team “can use similar strategies that hedge funds use. From our point of view, it’s more liquid, and liquidity is one problem with hedge funds.
“It’s also very transparent – we always know our risk level. And the costs are much lower, even though we have to invest a lot in information technology systems and risk management.”
All six members of the hedge fund team are based in Helsinki. “They have hedge fund backgrounds. It has been quite easy during the crisis to get very good professionals from London and Frankfurt,” Ritakallio says, adding that the most recent recruits were Finnish nationals who wanted to return home.
Ilmarinen’s European equities investments are managed internally. Fully 40 per cent of total equity portfolio is invested in the Finnish market. “Some say it’s high. That’s true and not true at the same time,” Ritakallio says.
This is because the Finnish economy is driven by exports, he says, and “Finnish companies are some of the most globalised companies” earning a major slice of their revenue from international markets.
He says about 50 per cent of the turnover gained by the biggest 40 listed Finnish companies is sourced from Asia. “Therefore equity risk isn’t 40 per cent, it’s closer to 10 per cent.”
“From our point of view, it’s much easier to see what’s going on inside Nokia. And only 1 per cent of Nokia’s turnover comes from Finland.”
Ilmarinen’s asset allocation at March 2010:
Fixed income: 55.5 per cent
Equity: 30 per cent
Real Estate: 12 per cent
Private Equity: 2.5 per cent
Hedge Funds: 2 per cent
