By Hamlin Lovell, NordicInvestor 

Laegernes Pensions investment assets lost 10.4 pct in 2022, but outperformed its benchmark by 2.1 pp (percentage points). On a 5 and 10 year horizon LP has outperformed its benchmark by 1.2 percentage point on an annualised basis.

The outperformance compared to its strategic benchmark (SAA) was broad based, coming from different asset classes and risk factors and driven by top down macroeconomic and broad market views, as well as more strategic and bottom-up selection of private equity and infrastructure investments.

Lægernes Pension, which is an independent pension fund owned by its members, has been managing Danish doctors’ pensions for 77 years since 1946. The core pension fund manages DKK 112 billion, a bank offering asset management services runs another DKK 11 billion, and external mandates mainly within healthcare take total assets to DKK 127 billion.

In 2021 and 2022 Laegernes Pension was named the best Danish Labour Market Pension fund based on 5 years returns, low costs and high customer satisfaction among its members. Based on preliminary figures of peers’ performance Laegernes expects to live up to its goal of being in the top third of performance after 2022 thanks to successful strategic decisions and active management. “Our strategic asset allocation (SAA) in 2022 resulted in lower exposure to interest rate duration, and higher exposure to inflation compared to 2021,” says CIO, Soren Nielsen (pictured above). Inflation exposure has come mainly from inflation swaps.

“Tactical asset allocation (TAA) has contributed about 0.7 pp of the 2.1 outperformance, again from being underweight of duration in H1, where LP also had a successful overweight to inflation. The benchmark had exposure of 25 pct. to bonds and swaps and in H1 we were underweight of bonds and swaps by 7-8 pp.  ” adds Nielsen.

The 2022 return was close to the target from TAA, though returns do vary: “Our goal is to add an average of 1 pp per year through active management and here TAA combined with manager selection is key. But it can sometimes be negative and we do not expect to benefit from active management every year,” explains Nielsen.

Another positive decision was exiting Russian hard and local currency exposure in a timely manner, just a week or so before the invasion. “The consensus among the majority of experts was that there would be no war and no harsh sanctions either. However, historically we had bad experiences with frozen assets. As we know today, the conflict between Russian and Ukraine escalated to war and also resulted in very harsh sanctions and the fact is that many investors today have stranded assets in Russia. We succeeded in selling all our emerging market bonds in Russia, which would have been marked down to zero if we had stayed invested. Ultimately, it would have caused significant losses to the members,” says  Nielsen.

More mature private equity

Illiquids overall were flat to positive in 2022 for Laegernes, in contrast to the sharp write downs reported for some unquoted assets in the Nordic region, including some FinTech related firms such as Klarna.

This steady performance was not due to “stale pricing” issues that can sometimes explain flat performance for less liquid asset classes. Danish regulations require Laegernes to value its unlisted assets more often than many asset managers or asset owners, which may value such assets quarterly, bi-annually or even only once a year. Laegernes’ illiquid investments are valued monthly by an independent valuation committee. “It has made a lot of adjustments – primarily write downs – but has also increased the valuations of some assets in the months where the listed proxy had had positive returns. Some investments are valued with reference to listed proxies, though this is more complicated for infrastructure. Regulators and auditors closely scrutinize the valuation process, and the internal managers at Laegernes give regularly input about manager specific events to the independent valuation committee,” says Vice CIO and head of illiquid assets, Jan Willard (pictured below). Based on the fourth quarter 2022 public market recovery, some of the private equity valuations might even have been increased, but Laegernes has decided to use a combination of best estimates from its partners and 3rd quarter reported figures adjusted for in-and outflows.

Private equity performance for the year has been near zero, in part because it is overweight of growth equity, which is less leveraged and therefore less interest rate sensitive than traditional buyouts. “In addition, despite some cyclical weakness, some companies have continued their growth trajectory and we had positive net distributions (dividends minus capital calls) in 2022. The growth equity program started investing in 2016, is now in a more mature phase and has started making some exits at prices above book value during turbulent year of 2022,” says Willard.

Immature infrastructure

The infrastructure portfolio has also performed well. “There is a huge weighting in renewable energy, which has benefited from higher merchant electricity prices, especially on shorter duration PPA fixed price contracts. “Longer PPA contracts” already in place are less impacted by merchant/price curve shifts. The key electricity markets exposed to are in Germany, elsewhere in Europe and the US,” says Willard. The infrastructure program is making distributions. Shipping exposure has also been beneficial where multiple exits have been completed.

If the private equity portfolio has done well partly due to being in older vintages, conversely the infrastructure portfolio has performed strongly in part thanks to its immaturity. “We are overweight greenfield infrastructure, taking development and operational risks, but we have less interest rate risk than is seen in brownfield infrastructure, usually held in core and core-plus infrastructure portfolios. For some of our infrastructure assets, discount rates have changed materially, some only increased from 5.5 pct to 6.5 or perhaps 7 pct.,” explains Willard.

Laegernes has been steadily increasing its illiquid allocation over the past 8 years. Private equity has gone from around 2.3 pct. allocation to above 7 pct today. Infrastructure has been built up from zero to a share of around 7 pct. since 2013.

Inflation-linked rents

There has also been some positive exposure to inflation through commercial real estate, which has generally benefited from rising rents that are mostly expected to rise further based on recent inflation data. For instance, rental income rose significantly during 2022. There are however a few exceptions, such as retail shopping centres, which may not be able to demand that level of inflationary rent increases from tenants who are still suffering from the shift to e-commerce.

The negative side of inflation is of course that higher interest rates can reduce some asset valuations. Laegernes has some small residential property exposure, which has seen valuation reductions of around 10-15 pct..

Warehouses and distribution centres have been least impacted by higher interest rates.

The broad asset allocation decisions have been positive, but not every single part of the portfolio has been helpful in 2022. The in house equity sector selection model, which goes long and short of various sectors, had a challenging year. “It uses a business cycle model, which forecasts leading indicators based on demand, and this did not perform well amid supply chain disruptions due to COVID 19 and the war in Ukraine. However, this was a small loss of DKK 86 million versus overall outperformance of active management of 2.2 billion in 2022 and has had a positive return attribution measured over a longer time frame,” says Nielsen.