Timo Löyttyniemi has been in charge of Finland’s state pension fund VER for more than a decade, and given a perspective like this he’s a good judge of when to revitalise an investment approach.
With challenges like rising interest rates, a slowdown in China and uncertainty over European growth, the managing director, who oversees €17 billion, feels like such a moment has arrived. Biting the bullet has meant introducing a new unit within the pension’s alternative investment section to provide the tools needed to benefit from these changing markets.
‘This allows us to conduct more currency hedging and use more derivatives if needed. We are also looking at new products in the field of risk premium, total return and risk parity along with our current hedge fund positions,’ he says.
The ‘position management and diversifying investment’ unit will be officially introduced at the start of January.
‘Currencies will play a larger role in years to come and we have to be ready to make some tactical bets on this side,’ says Löyttyniemi.
‘There has also been enormous development in the product side for risk premia, risk parity and total return and we want to make sure we get all the best ideas from these areas in our portfolio.’
With the pension fund’s investment strategy focused on four channels – fixed income, equity, alternatives and now currency and hedging, Löyttyniemi believes his team is equipped to continue its strong run of form, which saw fixed income losses incurred in 2013 reversed in the following year.
The road to independent thinking
Based in Helsinki, Löyttyniemi joined VER in 2003 following long investment experience which started in 1987 as a financial analyst specialising in the banking and convertible bond sectors.
One fundamental difference between the VER pension fund and other private and corporate pension funds in Finland is that it is not subject to regulation governing solvency. Designated as a buffer fund, its goal is to provide for the Finnish state’s future pension liabilities which are set to peak in 2030. With this aim in mind it has half of its assets run by external managers.
‘We are, of course, supervised by the financial authority and the Ministry of Finance, which can set some investment guidelines, but otherwise we are independent,’ says Löyttyniemi.
‘We have no pure solvency metrics on our day-to-day work and this allows us to be less risk-averse in comparison with other pension funds.’
This is a rare position to be in and local government pension fund Keva is the only other Finnish institution to fall under this rule. This more unrestricted brief allows such groups to adopt contrarian views at times when other big investors may be fleeing the market.
‘In the midst of the 2008 financial crisis we were able to increase our equity investment whereas most of the private pension funds in the market were net sellers at that time. We were a net buyer of equities and also credit instruments for six to nine months after the crisis,’ he says.
Adapt and thrive
In tandem with changing the structure of his alternative portfolio, Löyttyniemi is paying increasing attention to the opportunities available in this asset class.
He currently has around €500 million invested in pure hedge fund strategies and is now looking to increase his exposure to the potential upside of the private credit market.
‘We started the private credit programme two years ago and have invested around €300- €400 million. It’s an interesting area because banks are in turmoil, heavy regulation is affecting their ability to take risks and is putting pressure on their balance sheets.
‘This gives new opportunities for credit players who can loan money to corporations. Our returns last year were 8%.’
Focusing on Europe and the US, Löyttyniemi is building a portfolio comprising a variety of credit risks such as senior loan funds, distressed loans and direct loan funds.
Examples of related strategies he’s invested in include the Oaktree Capital Management Senior Loans fund, run by Armen Panossian and Desmund Shirazi, and the Natixis Loomis Sayles Senior Loans fund.
The main strategy he employs within this market is the use of limited private equity partnerships with other groups to create tailored funds.
‘This year we have committed €150 million to the private credit side, where we have two approaches: funds and direct credit instruments.
‘Nearly all of our alternative investments are limited partnership funds and we are also looking at increasing positions in unlisted direct co-investments in illiquid markets,’ he says.
This year has been something of a success for Löyttyniemi and his team as they managed to turn around the poor performance of their fixed income portfolio which hit negative territory in 2013 to the tune of -1.6%.
However, it returned 3.6% in the first nine months of this year and Löyttyniemi expects it to reach 5% by year end.
‘For the last decade the duration of our portfolio has been relatively long and we only shortened it more recently as rates have been coming down. We had also increased our emerging market debt holdings but last year both these areas were hit as rates did not fall and EMD was facing challenges.
‘This year these trends reversed and the relatively long duration of our overall portfolio benefited us.’
Just over half of the pension fund’s assets (52%) are invested in fixed income, close to 20% of which is in emerging market debt, comprising both local and hard currency plays.
Funds Löyttyniemi uses for his exposure to this theme include PIMCO GIS Emerging Markets Bond, run by Michael Gomez, BlackRock Emerging Market Bond, run by trio Sergio Trigo Paz, Laurent Develay and Raphael Marechal, and Investec Emerging Markets Local Currency Debt, managed by Peter Eerdmans.
Löyttyniemi’s portfolio also taps global high yield markets through two Nordea funds: Nordea European High Yield, run by Torben Skødeberg and Sandro Naef of Danish boutique Capital Four; and Nordea US High Yield, managed by Dan Roberts of MacKay Shields.
Löyttyniemi says he has recently cut back on government bonds, which today account for 33% of his bond exposure, and has opted instead to boost his money market holdings to 25%.
A key factor in his approach to fixed income now is how to prepare for the rise in interest rates. Here, diversification through emerging market debt, high quality government bonds from core developed countries and credit instruments are proving vital, he says.
‘We have various dynamic asset allocation strategies so we can shorten the duration in our fixed income portfolio if we feel it is necessary. But we have experienced a long run of 20-30 years of falling interest rates so I wouldn’t be too aggressive either in changing our view because there have been many false starts.
‘If there is a risk of rates going higher we can act on that but in the long run a rise is going to be good for pension funds. If low rates last too long it hits returns, but if they go higher it will hurt once and then going forward we will benefit.’
While 2013 was challenging for his fixed income exposure, the equity portfolio produced outstanding results, reaching 18% by year-end. However, Löyttyniemi is well aware that this was a market anomaly and the portfolio has returned to single digits for 2014, albeit at an average of 9%.
For equities returns to go higher, Löyttyniemi believes we need more sustainable global growth, underpinned by the Chinese economy growing at a faster pace and a spillover from the strong US economic performance. But is any of this likely to happen?
The IMF has already decided to slightly lower its forecasts on global growth for 2014 to 3.3% and for 2015 to 3.8%, a move acknowledged by Löyttyniemi.
In terms of the US, he’s had to review his outlook for this year but is hopeful for the following one.
‘We were expecting some positive knock-on effects from the US to other economies this year but it hasn’t happened and that is perhaps something we are eager to see in 2015.’
But the key to a better economic environment can be found in central bank initiatives, he says.
‘The aggressive measures by central banks are meant to increase economic activity. These stimulus packages combined with strong US growth figures should lead to an improvement in 2015. But we all know that the world economy is struggling and there are fears of deflation. One sign of that is the falling oil price, which, while helping economies, is also fuelling concerns. But I am positive on the economic cycle.’
His approach to core equity markets such as the US or Europe focuses mainly on enhanced index funds such as State Street’s Europe Enhanced Equity and North American Equity, as well as regular index funds including BlackRock North America Index Sub Fund, Vanguard European Stock Index and Japan Stock Index funds.
Active vehicles still have their part to play in these areas, especially when it comes to specific sectors or investment styles.
For example, he is tapping small caps via Fidelity European Smaller Companies, managed by Colin Stone, as well as Montanaro European Smaller Companies. Another Fidelity fund he likes and has been backing for a number of years is Anas Chakra’s long/short equity fund Fidelity FAST Europe.
However, he reserves particular praise for more uncharted territory. ‘If I wanted to pinpoint one investment from the last 12 months it would be our exposure to frontier markets which we entered in 2013 and which has produced returns of nearly 100%. We have taken some profits from those investments.’
Löyttyniemi says the size of the state pension fund he oversees lends itself to the use of mutual funds and Ucits vehicles, as they can offer an efficient and timely approach to key markets.
‘In a very crammed market there can be clearing and settlement issues and in these cases we’d rather use mutual funds than invest directly.
‘In some strategies we employ a number of mutual funds and in others we might use just two or three. Right now our net money inflow is negative for the pension fund. This means there can’t be an increase in our fund positions so if we want to add something new we have to sell something.’
As with all fund selectors, Löyttyniemi’s team carry out thorough due diligence on any managers they are homing in on.
‘Choosing when to use external managers is a question of cost, and about when to buy the expertise and diversification. It depends on our needs and whether there is something that fits well into our portfolio.
‘Sometimes we might want liquidity, or absolute returns. At other times we might need a pure play like small caps or high yield. Of course, it’s important that the asset manager is a respected name and has good risk controls in place.’
CV: Timo Löyttyniemi
1987 – 1990 Financial analyst, Unitas Securities
1990 – 1993: Vice president, KOP Bank
1993 – 1996: Director and partner, Merita Corporate Finance
1996 – 1999: Managing director, Norvestia
1999 – 2003: Head of capital markets, Mandatum & Co
2003 – Present: Managing director, VER pension fund
This article originally appeared in the December issue of Citywire Global magazine