Swedish Pension Fund Boosts Exposure to Emerging Markets

The chief investment strategist of Sweden’s AP2 tells how the so-called buffer fund uses a quant model to run its portfolios.


Tomas Franzén, chief investment strategist for the Second Swedish National Pension Fund, or AP2, traveled to New York City at the end of June to speak about pension plan innovation at a convocation of retirement industry gurus from around the world. He found time to sit down for a one-on-one session with Institutional Investor during a break at the first Investment Innovation & the Global Future of Retirement conference put on by Pensions & Investments.

As head of investment policy and strategic asset allocation at AP2, Franzén, who has been with the fund since its 2001 start, is enthusiastic about the success of the pension scheme over its dozen years of existence. AP2 was created through a bipartisan effort to bolster and protect retirement benefits in a pension system that covers the Swedish population. As one of four “buffer,” independently run funds of roughly the same size (with AP1, AP3 and AP4), it has been a veritable laboratory of new investment ideas.

From the outset, AP2, now at 246.7 billion Swedish kronor ($38.7 billion) in assets, was designed with a quantitative investment model that uses mathematical calculations and signals to identify assets and asset prices that are over- or undervalued. The internal portfolio managers use these signals to over- or underweight equities in the fund. To save on asset management fees, internal fund management is responsible for a full 75 percent of the total portfolio. Half of AP2 assets are allocated to equities; 33 percent to fixed income; and 16 percent to alternative investments, which include hedge funds, real estate and private equity. The alternatives make up most of the externally managed funds.

A lot of the action in the past year has taken place in the emerging markets, starting with AP2’s pulling back Skr11 billion in both fixed income and equity assets from external managers and placing them with the pension fund’s quantitative team.

Franzén and his team had determined that with four of the 10 largest economies in emerging markets, this portfolio needed to grow as well. To keep costs low, they decided to bring much of the asset management in-house. But in a year in which the MSCI emerging-markets index was down 3.84 percent, raising the allocation required convincing the board of trustees.


“We went to the board and asked to invest more,” says Franzén, who has a bachelor of arts degree from the University of Stockholm and holds a financial analyst certification from the European Federation of Financial Analysts Societies, or EFFAS. “The risk premium had exploded,” he adds.

The board agreed to raise the emerging-markets allocation by 2 percent in both equity and fixed income, bringing the total to 13 percent, with 9 percent in equity and 4 percent in fixed income. “Talk about trying to be contrarian!” he quips, adding that this was a strategic — not tactical — decision based on long-term return expectations.

Moving assets in-house required a major technology effort. The quantitative team members had to oversee connections to emerging-markets bourses in 23 countries to enable them to trade the MSCI emerging-markets index themselves, says Mathias Eriksson, senior trader, cash equities at AP2. April 17, 2013, was a red letter day for the investment team when in 16 hours the first portfolio of almost Skr5 billion was invested in 511 companies in 21 emerging countries, including South Korea, India and Brazil. By the end of 2013, there were 638 investments with a value of Skr14 billion. Fund officials have also begun to invest in emerging-markets government debt in-house.

“We’ve built up a large knowledge of trading in emerging markets,” says Eriksson. Although the group follows the MSCI index fairly closely, “in all of our mandates, our goal is to beat the benchmark,” he says.

In addition to its new in-house emerging-markets equity and bond portfolios, AP2 has established a beachhead in China with its first $200 million direct investment quota from the Chinese State Administration of Foreign Exchange. These investments will be externally managed through Singapore-based APS Asset Management and Cephei Capital Management in Hong Kong.

In terms of the Swedish pension’s design, “AP2 is a unique ‘paygo’ system,” says Keith Ambachtsheer, director emeritus of the Rotman ICPM Board Effectiveness Program at the University of Toronto’s Rotman School of Management. Paygo means it is self-financed, with no government input. The system was designed by Ole Settergren, now director of research at the Swedish Pensions Agency and an AP2 board member, after the Swedish Parliament decided in 1998 to reform the pension system. The four buffer funds were created to provide assets to the primary Swedish pension fund during serious market downturns or peaks in the retiree population. The funds receive 8.5 percent of salaries, with contributions split evenly between employers and employees. The contributions are then distributed in four even portions among the four AP funds.

Whereas some regions of the world — the U.K. and Ontario in Canada, among them — are struggling to reform or enhance their pension systems, the Swedes have gone about it in a unique way. The 2001 pension reforms that created the four AP funds incentivize people to work longer and thus make more contributions into the system, on both sides of their working lives, says Franzén.“Young people are encouraged to skip the backpack years,” he explains, “and [older workers near retirement] on the other end choose to stay on.”

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