Stockholm (Ekonamik) – Given the volatility that has characterised global financial markets since the beginning of the month, we were interested to hear the perspective of the Swedish pension funds. We were fortunate to catch up with Pontus von Essen, Senior Portfolio Manager at AP7, whose equity fund has a consistent track record of outperforming its benchmark.
Von Essen’s background is in macro trading and active pension management. He has worked primarily on the buy side but has also had roles within sales and trading at investment banks. His interests focus on the investment process and how to build the most efficient structure possible for those investments – what is sometimes called structural alpha.
At AP7 he works close to the CIO, Ingrid Albinsson, to deliver on strategy and structural initiatives. His responsibilities include AP7’s hedge fund investments, its activities in foreign exchange markets as well as its fixed-income fund. He is also involved in the work AP7 does to improve our systems and infrastructure. “When I was contacted about the role I was a bit unsure of the fit,” he says. “I have always been focused on actively managing money, including investing in illiquid private structures and applying option-based overlays.
On the other hand, AP7 has been a strong proponent of passive, index-based investing. But after some discussions, it became clear to me that the strategic developments at AP7 would lead to plenty of fascinating new developments. The new hedge fund mandates we are now procuring together with a new prime brokerage setup that will lead to lower costs, better processes and new possibilities are some examples of the exciting work we are doing.”
Diversification is a Key to Success
“Our equity fund has taken several strategic initiatives to improve returns as well as diversify risks,” von Essen explains. “We have invested in Private Equity, hedge fund strategies (through managed accounts) and have applied leverage to the portfolio.”
According to the portfolio manager, diversification is not only achieved across asset classes but also geographies and capitalisations. “Recently, we have also diversified our liquid, long-only portfolio into more emerging markets, small-cap stocks and risk premia strategies, designed to, over time, improve the risk-adjusted returns.”
“AP7 invests mainly through public procurement processes,” says the portfolio manager. However, von Essen is keen to highlight AP7’s control over the investment research process. “We rely on external consultants for the operational due diligence, but we keep the investment due diligence mainly in house and always make the investment decisions ourselves.”
The Need for Political Clarity
“The most important drivers of the equity market are, as always, future earnings as well as discount rates,” the portfolio manager says. “The growth in earnings seems to be very low or even negative, but on the other hand rates have declined a lot which brings discount rates down and multiples up.”
However, von Essen argues things could change. “In a scenario with more political clarity, we will see markets rally and companies start to reinvest. Rates will probably be slower to rise again given that central banks are now in accommodative mode. On the other hand, if we do not have a crash in markets, we might not see the political will to reach those trade-deals. From a tactical perspective, I think “the pain” in the market is on the upside right now due to many investors having taken down risk due to uncertainty.”
Preparing for All Market Environments
“AP7 operates along a strategic framework of trying to deliver the best risk-adjusted return possible under the investment restrictions we have,” he says. As a pension fund, AP7 does not have the flexibility to completely reshuffle its funds’ balance sheet in reaction to evolving market conditions. “We do not change the portfolio in a tactical time frame. Instead, we try to build a better strategic framework that can work in all market environments.”
However, there are some adjustments that AP7 can make, according to the portfolio manager. “One part of this is the process for adjusting the leverage level. Due to how we perceive market valuations and opportunities, we now operate with a reduced leverage level compared to the long-run average.”
Keeping an eye on Short Term Liquidity
“Aside from all the usual variables that are correlated to economic growth and earnings I am now very focused on the developments in the short term funding markets in the US,” von Essen says, discussing the market pressure points he keeps an eye out for. “The global banking systems have changed due to regulations together with central banks overturning their asset purchases recently, which took away some liquidity. The effect of these changes is very complicated and uncertain for most market participants, but they can have great ramifications if funding dries up.”
The trade war and its effects seem to be the other concern on his mind. “Another interesting variable that I follow is high-frequency shipping data globally,” von Essen concludes.
Image courtesy of Pontus Von Essen