Sweden's AP1 fund, which oversees about USD 35bn in assets from its base in Stockholm, is one of six state pension providers tasked with overseeing investments for the country’s labor force. Chief Executive Officer Johan Magnusson says AP1 has consistently allocated about 5 percent of its portfolio to hedge funds over the years. But they’re now expected to deliver a very different service.
"We've been investing in hedge funds for many years now but they haven't really delivered the returns we've seen on other assets," Magnusson said in an interview. "We used hedge funds with a focus on CTAs (commodity trading advisors). Today, we do similar strategies internally." Finding money managers to help with AP1’s new strategy "has taken quite some time," Magnusson said. "But now we are pretty
much done with the transformation. We are rather picky and have co-workers that are great at choosing the right funds. But to be heavily invested in hedge funds, that hasn’t been a good thing, seen over a longer period, as it’s been very good to own equities."
Magnusson says the hedge funds that AP1 now uses provide a "not very high, but stable return." Pension firms in the Nordic region have been dropping hedge funds after years of meager returns and high costs. The current ultra-low interest-rate environment has forced the industry to
keep expenses down as much as possible, and emboldened many firms to do more of their investing in-house.
But AP1's approach shows that some pension firms in the Nordic region are still turning to the hedge fund industry, albeit for different reasons. Magnusson says that the funds AP1 used in the past "normally had a higher liquidity than others," but the current group of managers is "more diversified" and "generally, with less liquidity."
Meanwhile, pension funds in Sweden have been given more freedom to invest in riskier assets. New rules this year gave the industry more flexibility to buy non-listed assets and eased fixed-income requirements. At the same time, they now only need to hold 20 percent of the portfolio in bonds, down from 30 percent. Legislators are also discussing how to continue updating the investment rules. As the investing guidelines for Sweden’s pension industry are adjusted, AP1 is buying more unlisted assets. Magnusson also says that the "modernization" of legislation is paving the way for new co-ownership structures.
Three of the Sweden's AP funds recently announced they were starting a joint investment company called Polhem Infra, to target investments in unlisted Swedish infrastructure projects. To get the new vehicle started, the funds are each investing SEK 3bn. The goal is to build the firm using at least a 50 percent leverage while tapping other co-investors,
"If this works well, Polhem Infra can become a really big company in 5 to 10 years"” he said. Despite new rules that allow the pension industry to take on more risk, Magnusson says he would "like to see even greater flexibility on what we are allowed to invest in.", "Today, in order to buy infrastructure, it should technically be considered to be real estate. That excludes, for example, investments in railways," he said. The AP1 CEO also says he wants to do more in private equity, which he still thinks can be an attractive asset class, despite high valuations.
"We have about 6 percent of our portfolio in PE, so I don't expect that part to grow much,”"he said. "But I think we can make it cheaper, for example by co-investing with others to a larger extent than we do today." Magnusson says his investing stance will remain defensive.
On the margin, AP1 is keeping a lower risk compared to its "normal" portfolio, he said. "If the stock market continues to rise, this means that our returns won’t be as high," he said.