This content is from: Corner Office

The Big Problem with Sweden’s Buffer Fund Shakeup

A benchmark to other government pay scales as opposed to industry standards for Sweden's pension investment professionals could cost the AP Fund top talent.

Back in 2012, Gordon Clark and I were invited by the Swedish Ministry of Finance to provide a governance and management “gap analysis” for its AP Buffer Fund system. As consultants to the official "Buffer Fund Inquiry" (BFI), we spent a few weeks traveling around the country meeting all the funds (boards, management and staff) and responsible politicians. The idea was to get a deep understanding of how the system functioned. It was truly a remarkable experience, and both Gordon and I left with a significant appreciation for the AP Funds and their extremely professional corps.

In the end, we submitted a report that was included in the final Buffer Fund Inquiry Book (see page 555) that highlighted some of our findings and detailed our suggestions. And, two years on, it seems the Swedish government has finally digested the massive tome and has now decided to act. In fact, The Pension Group (which consists of five parties represented in the Riksdag) has just published an Agreement that details what the government plans to do with the AP system.

Spoiler: I’m rather concerned.

But before I get to why I’m concerned, let me start with the good news and tell you what the Agreement does that’s positive and aligns with our suggestions:

*The AP Funds will finally get a formal sponsor that can run asset-liability studies and set a rate of return target. This will greatly facilitate clarity of mission and objectives, which was sorely needed.

*The AP Funds will be consolidated down to three funds, which will drive scale economies.

*The AP Funds will enjoy an easing of the investment restrictions that have been quite burdensome to date.

*The AP Funds will be encouraged to collaborate with one another instead of compete with each other.

And there were a few other positive recommendations. Unfortunately, none of that will really matter if the following suggestion by The Pension Group actually makes it into law. According to the Agreement, the resourcing of the investment teams should be placed in the hands of bureaucrats at the new sponsor-level organization rather than in the hands of the professional boards sitting on top of the individual funds.

Worse still, the Agreement goes on to say that the AP staff should NOT be benchmarked to industry standards but instead should be benchmarked to other government pay scales. Here’s the blurb:

“The regulations for the funds should ensure that ... conditions are created under which the fees and salaries paid to the funds’ staff, in the long term and taking into account labour law factors, are in line with the salaries and fees paid to employees of other government agencies with similar activities, such as capital and debt management at the Riksbank, the Legal, Financial and Administrative Services Agency and the National Debt Office...”

Are. You. Kidding. Me? When I read the above paragraph, I picture asset managers in NYC and London doing this. It’s just such a backward policy. Why would you not benchmark these people against the private sector? Or at least peer organizations around the world? Why would you prefer paying 10x to Wall Street for the same service?

Consider this: One of the AP funds has an internal team that generates more alpha in a single portfolio than the entire cost of their organization. And when that team is given a government wage? It’s gone. Is that cost-conscious?

I really shouldn’t be that surprised by this turn of events. It’s something we noted in our official report; that there was a “preoccupation with costs that may impair recruitment of the most talented individuals; this is particularly true for those that have skills and experience outside of conventional asset classes; these types of skills are especially important given the risks incurred by each fund.”

That was our official submission. What we said in our in-person presentation to the BFI was far less varnished: we told them they were underpaying these people; that they’d managed to get away with it because so many of the AP employees are Swedes that want to live in Sweden (i.e., they are the ‘grounded’ in the green, grey and grounded), but we told them that they would be wise to increase salaries and compensation to levels that matched more closely industry and peer standards.

That, however, is not what’s being proposed. In fact, the government would seem to have chosen to go the other direction. So I’m fairly frustrated. Why? Because the actions of these politicians could result in a less secure system. Put simply? this "reform" could actually do harm.

But it's not too late yet. How can they avoid breaking their own pension system? It’s fairly simple: Instead of making any resourcing decisions at the level of the new “sponsoring agency,” The Pension Group should delegate authority to the boards of the various AP funds on how much to spend internally and externally to achieve their objectives. Since the cost is being netted against returns, the boards should be motivated to only spend on those things that boost returns.

Why would you do it any other way?

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