By Hamlin Lovell, NordicInvestor

This article is a part of our 2021 Nordic Insurance Report. The full report can be found here

NordicInvestor interviewed Jani Partanen, Chief Investment Officer & CFO at Pohjantähti Keskinäinen Vakuutusyhtiö. Pohjantähti (which means North Star) runs EUR 240 million, mainly allocated to external managers.

The Pandemic: Remote Working, Volatility and New Manager Engagement

“The main problem with working from home is that it is too efficient, with meeting after meeting and powerpoint presentations all day long. The operational side has worked well enough for liquid strategies. For private equity, the need to print and sign many documents did cause some delays of weeks or months in 2020, but now this is all being done remotely”.

“We have maintained our annual investment plans before and after Covid. The investment committee discusses major things, not single investment decisions”.

“We have had less meetings with new managers, but this is partly because our strategy even before Covid has been to concentrate liquid asset management of credit and equity in OP-Asset Management and Mandatum Asset Management. We would normally have had more manager meetings”.

A Lower for Longer World – Strategic Asset Allocation

The firm’s asset allocation is 65% in fixed income, 7% in listed equities, and the rest in alternatives: illiquid credit, private equity, real estate and infrastructure. 

Rebalancing from Government and Investment Grade into High Yield and Private Credit

“Over the past five years, our biggest asset allocation change has been within fixed income: we have been moving from government and investment grade bonds into more high yield. We now have 11-12% in liquid high yield, and 6-7% in private credit. The allocations are global but the main focus is in Europe. But we cannot go too far into illiquids because we need to keep around 65-70% in fixed income due to the regulatory framework”.

“Private debt can be split into several different sub-strategies with different return targets: we have some lower risk legacy private debt in real estate debt with a return target of 4%; five or six funds looking for more opportunistic strategies; and we also have some trade finance strategies with a return target of 3%”.

“We have invested in one trade finance fund of fund. The main reason was just low SCR charge, but returns – at least after USD hedging – have been a bit of a disappointment for us. It seems that low duration investment grade debt is more attractive for us”.

“We are afraid of default risks, but so far performance has been better than expected. We have reduced exposure to companies without a credit rating because we are afraid of default risk. We are more invested in high yield index names”.

Real estate and infrastructure

“Around 10% is in direct real estate holdings is mainly in Finland. Our European infrastructure has a return target of 4-6% and we plan to keep it for 10 years, because one of our biggest risks is reinvestment risk. If we find a good asset we want to keep it”.

Private Equity

Private equity includes exposure to some of the largest and smallest managers in the region. “In private equity, we have a fund of funds run by Mandatum Life which gives us access to big buyout names such as EQT, which we could not normally invest directly with because our normal ticket size of EUR 2-5 million is too small. We also have some smaller more opportunistic allocations to local Finnish private equity managers, which have been making 15% or more per year over the past few years. Our main partner over ten years has been Korona Invest. We have invested in three of their funds and are now moving onto the fourth”.

Liquidity and Cash Management; Zero interest rates available with smaller banks

“We have about 10% in cash and money markets, partly due to the Solvency II regulations. We will probably not go over 10% in cash. We have managed to avoid negative rates because our normal ticket size for a single fund or bank deposit is a maximum of EUR 5 million, and we can find smaller banks who will hold this cash with a zero interest rate. We would have to face negative interest rates with larger banks”.

Active versus Passive Management

Everything is actively managed but listed equities is a mix. “Listed equities follows a core/satellite approach with passive indices used for major US and European markets while active managers are used in small caps and emerging markets”.

In house versus external management

Asset allocation, manager selection (to around 10 managers) and cash management are carried out in house.

ESG

“We have our own corporate ESG policy including its ESG investment policy. ESG reporting is partly carried out by OP, using MSCI data. OP and Mandatum also carry out corporate engagement partly on behalf of us. We think OP has a good ESG policy”.

Exited local currency sovereign debt due to lack of transparency 

“Transparency is a key challenge in ESG for alternatives and for sovereign debt. We need to know where and what we are invested in. A lack of transparency was one reason why we exited emerging market local currency sovereign debt. For us ESG is not only about picking single names but is also about asset allocation decisions”.

Regional differences are another possible concern, since it remains to be seen if European policies will be adopted elsewhere. “Europe has been thinking about ESG issues for longer than US. Now the US is also waking up to issues. The risk is that the US would write different polices to Europe”.

ESG also needs to be coordinated with other regulations: “solvency II also needs to leave enough flexibility for us to develop ESG”.

Solvency II Framework and Reforms

Like all insurance companies in Finland, Pohjantähti uses the standard Solvency II model, and Partanen would like to see reforms.

  • Interest rate and credit risk modelling need updating

“Solvency II rules on interest rate and credit risk were written years ago in a totally different environment when interest rates were 4-5%. Nobody then believed rates could become negative and even at zero rates, it is not attractive to invest in long term government bonds”.

“The main question on interest rate risk management is whether it is cheaper to use cash or derivative instruments to switch duration from assets to liabilities. This is also operationally important. Our volumes are quite small and we have to consider the total costs of building up the process (from Finnish accounting rules and Solvency 2 views) for derivative instruments or just using cash bonds.”.

“Now the regulations are pushing us to take more credit risk. We would prefer to take more equity risk”.

A more flexible framework overall could be welcome. “The Solvency II regulations should consider regional differences between Northern Europe, Central Europe and Southern Europe. If there’s some ambiguous Solvency 2 details, like using volatility adjustment, national supervisors construe the rules more rigorously in Northern Europe. When rules are followed exactly, there could be room for more risk taking in normal market conditions. The main risk is that standardized rules will not be good for everyone”.

“The EIOPA proposals for reforming the way Solvency II measures interest rate risk are good, but it may take many years of negotiation to change the rules. We have seen these discussions for many years already, but are still in the same framework”.