Stockholm (HedgeNordic) – Pension funds play a vital role in safeguarding the financial futures of millions of individuals. Equities serve as the cornerstone of institutional portfolios due to their significant potential for long-term growth, ability to hedge against inflation, capacity for diversification, and potential for income generation. Veritas, a Finnish pension fund responsible for managing €4.3 billion in assets, employs a comprehensive range of strategies and investment styles to construct its equity allocation, guided by its solvency framework.
The pension fund’s investment team adopts a diverse set of approaches, carefully weighing active versus passive management, external versus internal management, and systematic versus discretionary strategies. This multifaceted approach allows Veritas to optimize its equity allocation in a manner that aligns with its solvency objectives. “The amount of risk that we can bear in the portfolio comes directly from the solvency framework that we need to follow as a pension company,” explains Tapio Koivu, Portfolio Manager at Veritas. “Equities are typically the biggest risk contributor in the portfolio, and the solvency framework defines how much equity risk we can have.”
“It is not just about getting the equity weight right; it is also quite important to decide where you want to be in the equity market.”
While the solvency framework provides the big picture for asset allocation, there is room for fine-tuning based on the team’s allocation views and assessment of the attractiveness of different asset classes. “The solvency framework defines the absolute upper limit for the equity allocation, but we have more room to be active below that upper limit to try to adjust the equity allocation appropriately based on our views,” says Koivu. “It is not just about getting the equity weight right; it is also quite important to decide where you want to be in the equity market,” he continues. “In recent years, there have been significant variations in equity returns among different regions, sectors, factors, and more. At times, choosing the right equities exposure becomes more important than determining the equity weight.”
Internal Management: Discretionary versus Systematic
As of the end of the first quarter of 2023, Veritas Pension Insurance had 31.6 percent or €1.35 billion of its investment portfolio allocated to listed equities. A sizable portion of this equity portfolio is managed in-house, primarily focusing on local Finnish equities and select European stocks. For investments outside Finland, Veritas utilizes external vehicles, including passive exchange-traded funds (ETFs) and actively-managed funds.
“Domestic equities are not less risky than global equities, but there are other benefits to investing in them.”
“It’s fair to say that we have certain home bias, especially when comparing our portfolio to a global benchmark,” begins Koivu. “Domestic equities are not less risky than global equities, but there are other benefits to investing in them.” One of the main reasons for managing a sizable portfolio of Finnish equities in-house is the ability to engage in discussions with company management to promote its own ESG agenda. “We can easily follow up with Finnish companies, share our own views and suggestions if appropriate. In that sense, overweighting the home market is justified.”
From a risk management perspective, Veritas recognizes the importance of building a well-diversified equity portfolio across regions. “But there’s no one simple formula for deciding the exact right amount of exposure to local or global equities,” acknowledges Koivu. Despite the relatively small universe of Finnish listed companies, the investment team at Veritas conducts thorough stock picking to build its portfolio of Finnish stocks. “We conduct traditional bottom-up stock picking. The universe is relatively small, so we know most companies quite well after following and analyzing them for a long time,” explains Koivu. “Even though we engage in pure stock picking, we need to pay attention to specific features of the market to maintain appropriate sector weightings, for instance.”
In contrast to the in-house approach for Finnish equities, Veritas relies on a more quantitative process to invest in the broader European market due to the market’s size and the team’s capacity. “Direct investments in European stocks are mostly driven by a quantitative process rather than a qualitatively-driven fundamental analysis in Finland,” according to Koivu.
External Management: Active Versus Passive
Veritas aims to establish a robust and diversified structure for its equities portfolio by combining in-house investments, outsourcing certain investment activities, and leveraging various investment instruments. This strategy allows Veritas to achieve optimal diversification and benefit from the expertise of both internal and external investment professionals, ensuring a well-rounded equities portfolio. “The decision on whether to internally manage or use external actively-managed funds or passive ETFs depends on several factors, including costs,” begins Koivu. “In some areas, it is cost-efficient to manage investments in-house, but that requires the necessary capabilities.”
“The decision on whether to internally manage or use external actively-managed funds or passive ETFs depends on several factors, including costs.”
Investing in emerging markets, the US, and other markets presents different challenges. “In emerging markets, we need to find specialists who understand those markets, dive deep into them, and have the necessary resources to cover them,” says Koivu. “As a relatively small organization, we cannot handle everything ourselves. When it comes to investing in global markets, the most significant and challenging decision revolves around allocation, ensuring that we are allocated to the right places.”
For exposure to US equities, Veritas primarily relies on low-cost passive ETFs. Koivu notes the struggles of many active managers to outperform benchmarks in the US market due to its efficiency and market structure dominated by a few large companies. “The decision between active or passive management is based on our belief in the value creation potential of active management in specific markets.”
“The decision between active or passive management is based on our belief in the value creation potential of active management in specific markets.”
Veritas also uses an active approach to selecting the right exposure even when using ETFs. “When investing in ETFs, we don’t merely invest in the S&P 500, EuroStoxx 600, or MSCI Europe. Even though it’s passive, we actively select different passive instruments to achieve the desired exposure,” explains Koivu. “We can also use factor-based ETFs that differ significantly from the market benchmark. In summary, we have the tools to adjust our portfolio as markets change. Different periods and market environments require different solutions, and we strive to be flexible investors with the readiness to change.”
Veritas takes a regional approach when building and assessing its equities portfolio. Within each region, the pension fund employs various approaches to build equity exposure, whether through in-house investments or external management via funds or ETFs. “Our job is to find managers who do a good job in their own universe or area. It is then up to us to select the right mixture of different managers, passive instruments, and individual equities to ensure that the overall portfolio reflects our own view and thinking.”