By Hamlin Lovell, NordicInvestor

Nordic Investor interviewed Majdi Chammas, Head of External Management at Första AP-Fonden, who has spent 17 years at the AP fund, to gain insights into its distinctive approach to global manager selection.

“AP1’s overall equity allocation has a very large home bias, being heavily overweight Sweden. It is also overweight emerging markets relative to MSCI World. Some 95% of the developed market equities book is run internally, including Swedish equities, which are managed on a fundamental basis including small caps. All of the emerging and frontier markets allocation is run externally”, says Chammas.

Active Management

Nearly all of AP1’s external managers are active to varying degrees. “AP1 does not prescribe any specific level of tracking error or active share. But if you visualise a spectrum of active management ranging from indices, to index plus/enhanced index/closet trackers, to benchmark aware, to benchmark agnostic, to absolute return, ultimately culminating in hedge funds, the AP fund has a barbell approach, focusing on passive index plus, benchmark aware, benchmark agnostic and absolute return products”, he says.

“We view these as offering the sweet spot in terms of cost versus alpha. On the passive and semi-passive side, we find some very good quantitative strategies for very low cost, which give us beta exposure very efficiently and provides us with the liquidity we need given our size. On the benchmark aware/agnostic side, we find most bang for the buck from managers that deliver good alpha given their level of fees”.

One EM mandate is passively managed for reasons of cost and liquidity. If asset allocation changes, it is quicker and easier to add or reduce exposure through an index, than through an active mandate that may take months to design and negotiate, and which could be capacity constrained in some cases.

“The external management team is of course aware on the TE levels the different constituent managers have, but the portfolio is not constructed with a TE target in mind. The AP funds are asset owners, with an absolute return target. We need to keep this in mind at the same time as being aware of the absolute risk level we have in the portfolio”, he says.

“Ideally, we would like all mandates to be actively managed for many reasons”. One is risk concentration. “In emerging markets, six companies have the same market capitalisation as the 20 smallest countries in emerging markets, so a market cap weighted index has a huge risk concentration in those companies.  As an asset owner with an absolute return target, it is important to be aware of this risk concentration inherent in passive solutions”.

Evolving ESG

“ESG is a very important reason for active management everywhere; nine out of ten ESG issues arise from our passive mandates”.

AP1’s guiding star is now to be a role model for ESG investing globally, since new guidelines applied in January 2019. 

Negative screening remains a small part of the ESG policy. Certain sectors and companies are excluded, such as those making controversial weapons, tobacco, tar sands and thermal coal. “Since AP1 is part of the Swedish Government, it naturally observes sanctions including EU Sanctions that may preclude investment in certain companies”, he adds.

The exclusion list is published online here . It only contained 29 companies as of June 2019, including a cannabis producer.

“Apart from excluded activities, the exclusion list should be seen as a failure list, because it means we have failed with engagement.  We have a strong preference for active ownership compared to exclusions, but sometimes you have to make a statement and exclude if your efforts are unsuccessful after multiple years of engagement”. The AP Funds have their own engagement programmes and they do co-operate in markets outside Sweden through the Ethical Council.

AP1’s ESG approach is evolving and all managers will need to raise their game over time to satisfy its aspirations. “ESG reporting is for example still at a very early stage. Managers are struggling with how to measure and report and need to be more creative. Carbon reporting is only one angle of ESG. We would like to see a more holistic approach. We also want to see performance attribution of ESG integration”.

AP1 is working collaboratively with managers, as well as other investors, to help them enhance their processes. “AP1’s goal is to encourage managers to improve their way of doing business – for the benefit of both AP1 and all other investors. The opportunity to share evolving knowledge about ESG is seen as a bonus of running money for AP1”, he declares.

None of the long only external managers are currently based in the Nordic countries. Some of the managers, including the quantitative ones, tend to be larger but there are also some smaller specialist boutiques. AP1 has seeded innovative strategies run by larger, medium sized and smaller managers including BlackRock, Osmosis Investment Management, Shenkman Capital.