By Hamlin Lovell, NordicInvestor
Iceland may be a small economy, but in relative terms it has abundant pension assets of around 150% of GDP. This does not quite match Denmark’s figure of over 200% of GDP, but is still well above average for an OECD country.
Flosadóttir is managing director of three Icelandic pension funds: the pilots’ pension fund, the bankers’ pension fund and the largest supplementary pension fund in Iceland. Taken together they have EUR 1.4 billion of assets and 71,000 members, which is about 20% of Iceland’s population of 364,000 people.
“Since currency controls were lifted in 2016, pension funds have been expanding their foreign exposures. The three pension funds I oversee have 65-70% domestic exposure (with 40-50% in bonds and 20% in equities) and 30-35% exposure overseas. The split varies between pension funds according to how the board sets the Investment policy for the coming year. The pilots’ pension fund has for example seen its foreign exposure rise from 7-8% up to 30% since 2016”, says Flosadóttir.
Domestic allocations are mainly managed actively, but allocations for overseas investments are balanced between passive and active managers. “At the moment the core ratio is 60%-70% allocated to passive managers, and the remaining 30-40% in more active managers”, says Flosadóttir.
The equities allocation has been benchmarked to the MSCI World Index basis, exposure to emerging markets has been in place for many years, and last year frontier markets were added in the allocation spectrum.
Before the great financial crisis of 2008, Icelandic pension funds often hedged their currency exposures for overseas investments. “At the moment we do not hedge currency risk, this is however and option which might be viewed as a possibility in the future”, says Flosadóttir.
“The pension funds discount actuarially their Icelandic Krona (ISK) asset and liabilities at a rate of 3.5% inflation indexed. Historically local government bonds have paid more than this. In recent years the local government bond yields have dropped severely and currently the ten year yield stands around 1%. A situation which partly creates an asset liability unbalance. Non deniable the pension funds have made capital gains on their holdings of government bonds historically, but from a discounting perspective the yield on assets is well below the actuarial discount rate”, she explains.
Naturally many pension funds need to broaden their investment universe to find adequate income as well as for diversification. Just as Sweden’s AP Government pension funds are embracing more alternatives in their search for yield, the mentality in Iceland is tilted towards diversification and volatility mitigation. This focus has gained momentum since the currency controls were lifted.
The asset allocation policy for the mentioned three pension funds has also been broadened out since November 2019, to allow for more diversification in the non-domestic portfolio which is sensible since the foreign ratio has been increasing in the latest years. Part of this is a specific goal regarding foreign alternative investment such as, but not limited to, Private Equity and debt, real estate and infrastructure investments.
Domestic Real Estate
One asset class where Icelandic pensions have added exposure in the last years is real estate, more specifically through direct lending to members. “We have exposure, both through equities and bonds in listed real estate companies as well as through direct lending. We provide mortgages for our members. Some 16.2% of the pilots’ fund is currently in mortgages lent to members. We either charge fixed rates or inflation linked rates plus the inflation rate”. Therefore, the pension fund in effect already owns mortgage backed security type exposure, backed by collateral values in the form of local property in Iceland. Pension scheme members also have personal exposure to property, which has seen the same kind of boom in Iceland as it has in the Nordic countries.
Arion Bank has been a UN PRI signatory since 2016 and assessing ESG is part of the manager selection process.
“The pension fund all have ESG polices which we apply the throughout the entire investment process but with an emphasis on certain areas. We belief that sustainable factors influence risk return profiles in the long term.”, says Flosadóttir.
“For domestic Icelandic companies, the three mentioned pension funds are also doing their own work on non-financial statement analysis of companies, which includes meeting the CEO or CIO person responsible, to push for increased information in the non-financial statement where it is needed. We can take an active ownership view in Iceland, where we have direct ownership and have put a special shareholder policy in place which provides our members and the market with information on our proxy voting and engagement”, she adds. “We seek information from external managers with their guidelines and policies regarding engagement or proxy voting, do not yet set demands, but this is an ever evolving process and might very well change in the future”.
“We do not expect to get involved with impact investing right now, because it tends to involve earlier stage companies that are not on our scope at the moment. That however does not mean that we are not trying to make an impact”, she points out.
The local concept of impact investing might differ from other countries. Since all of Iceland’s electricity is already generated using renewable energy investing in a utility, although undisputedly green, does not make a positive impact in terms of changing anything. “But impact can be made through various channels”, Snædís says, and Icelanders are striving for improvement in terms of their own operations and behavior: In November 2015, Arion Bank was one of 104 signatories to the City of Reykjavík and Festa’s Declaration on Climate Change. This pledges to reduce greenhouse gas emissions, reduce waste, measure what has been achieved, and to regularly report on what has been accomplished. In 2018 the Bank’s credit rules were updated to include provisions incorporating environmental, social and governance factors when evaluating loans. In September 2019 Arion Bank became a signatory to the new UN Principles for Responsible Banking, which were presented in the UN General Assembly. In 2020 the aim is to go one step further and evaluate the Bank’s loan portfolio according to green criteria, set ambitious targets on green lending and adopt a policy on loans to individual sectors from a sustainability viewpoint.
“The unprecedented times we live to day have not left the pension funds unaffected, Snædís says. A diversified portfolio and a cold head are key elements today. “Pension funds play a significant role in Iceland when it comes to the listed and unlisted market, financing of companies and people’s homes as earlier mentioned. And as such aim to be a part of the solution needed in these challenging times.”
The government of Iceland, the Icelandic Financial Service Association, and the Icelandic Pension Funds Association have released a mutual declaration on responses to the coronavirus pandemic. Based on this declaration, Pension funds have set rules on remedies to meet fund members as well as companies who have temporary payment difficulties. The Government of Iceland has also temporarily authorized early withdrawals from supplementary pension savings.
“We have analyzed the possible effects of flow changes due to decreased premium being paid in to the funds and the steps we are taking towards members and companies as a part of the mutual declaration mentioned and are well prepared to meet the challenge. How and when the markets will turn, time will have to tell, until then diversified portfolio, analysis and quality information flow to our members will be our goal”, she adds