2 Chapter 2 - The Danish Pension Fund Sector
2.3 The Actual Portfolio of the Danish Pension Fund Sector
30 Having outlined the legal environment in which the Danish pension fund sector operates, the purpose of the next section is to look into how the pension fund sector invests. Hence, how the total investment is allocated across the different asset classes in the portfolio. The section includes an estimation of how the Danish pension fund sector performs.
31 2.3.1 Data on the Actual Portfolio
As mentioned in section 1.5.3 Overall Conditions of the Thesis, data from the annual reports of the eight pension funds of interest is applied for the analysis of the actual investment strategy of the Danish pension fund sector and the split among the assets held in the portfolio. An overview of the portfolio allocation on sector level is not available, why it is constructed from data of the individual companies. The data is available for a five year period; 2006-2010. This is commented on in section 1.5.2 Data Review.
In a statutory instrument on financial reporting for pension funds25, the Danish FSA requires some standards for the disclosure of different key figures (Announcement Regarding Financial Reporting for Insurance and Pension Funds, 2011). In the specification of assets and their return measured in market values, a classification is made including seven subgroups26. From this, a slightly different split has been made for this purpose. This is done since several of the eight companies, additionally to the above mentioned specification, present their portfolio in this more simplified way to the stakeholders. Furthermore, this current split is appropriate with respect to data availability in modelling the optimal portfolio.
The sector invests approximately 8 % of its total capital in property. Unfortunately, a proper index for property return developments in market prices is not available. Therefore, it is not included, either in the actual or the theoretical optimal portfolio. It is acknowledged that this is not satisfactory with regards to validity of the analysis. Investments in affiliated companies have been excluded however, these investments count for almost nothing (2% in SEB Pension and 0%
in all others).
To estimate the actual portfolio on sector level, data from Skandia is aligned to make all eight pension funds comparable and enabling construction of a united depiction of the sector. A description of the alignment, general information and further elaboration on the data set is accessible in appendix B - The Commercial Pension Fund Sector. In general, data is based on a number of assumptions, e.g. in relation to market shares in the sector, to reach a joint data set
25 This statutory instrument is in force towards insurance companies and pension funds (de tværgående pensionsselskaber) (Announcement Regarding Financial Reporting for Insurance and Pension Funds, 2011).
26 The seven groups are divided by investments: Property, affiliated companies, total other investments, total bonds, secured loans, other financial investments, derivative financial investments to hedge (Announcement Regarding Financial Reporting for Insurance and Pension Funds, 2011).
32 which is as true and fair as possible. This is done to get the most accurate actual portfolio. See appendix D - The Actual Portfolio sheet Skandia.
The actual portfolio is divided into several groups and the structure is as follows:
- Danish equity includes direct investments in listed as well as unlisted individual Danish companies. This group also contains investments in mutual funds, equity funds etc.
- Foreign equity includes direct investments in listed as well as unlisted individual foreign companies. Investing in foreign equity markets secures portfolio diversification. This group also contains investments in mutual funds, equity funds etc.
- Government bonds are not necessarily Danish, however no further split is specified in the annual reports of the pension funds.
- Mortgage bonds are, like government bonds not solely domestic investments opportunities. In this thesis the category also includes a group named “other bonds”27. - Inflation-linked bonds are bonds in which the return is adjusted for inflationary
tendencies.
- Corporate bonds are issued by companies to raise capital. This group contains investment grade as well as non investment grade bonds. The Danish pension fund both invests in these bonds domestically and abroad. Investments in emerging market bonds are further included in this group.
- Others contain other financial investment assets, investments in derivative financial instruments for hedging purposes, and secured loans.
The above grouping of assets in the portfolio is the outset for the optimal portfolio to the extent possible. Further elaboration on this will be made in section 4.1 Data for the Theoretical Portfolio Optimisations, where the optimal portfolio will be presented.
27 This one is not defined or further elaborated upon. Neither, it is included in the optimal portfolio.
The asset grouping in the actual portfolio held by the Danish pension fund sector is the outset for the opportunity set in the Theoretical portfolio optimisation.
33 2.3.2 Asset Allocation of the Pension Sector’s Portfolio
Figure 2.3.2.1 illustrates that the allocation among the different assets in the portfolio on sector level has not changed to a large extent over the period of interest, 2006-2010.
From figure 2.3.2.1 it is seen, that the main portion of the investments are allocated to bonds, primarily mortgage bonds. The Danish equity market has accounted for a very small portion of the investments, especially declining after the strike of the financial crisis. The same tendency is seen in the foreign equity market. Investments in equity have ranged from constituting approximately 12% of the total investment in 2008 to around 27% in 2007. By implication, approximately 70% was invested in bonds in 2007 whereas at the other extreme, about 81% of the portfolio in 2008 and 2009 was held in bonds. These changes, in the asset allocation were expected from the economic outlook the different years.
As stated above, the actual portfolio is estimated from market values as of 2006-2010. This is only an approximation of the portfolio allocation hence investment strategy referring to section
6,81% 6,82% 2,84% 2,45% 2,99% 4,38%
16,01% 19,19%
9,01% 11,00% 12,60% 13,56%
25,76%
13,25%
15,23% 17,12% 19,36% 18,15%
30,25%
37,36%
46,87% 44,07% 39,80% 39,67%
8,69% 8,09%
7,35% 7,50% 6,83% 7,69%
7,99% 10,93%
11,39% 12,21% 14,15% 11,33%
4,48% 4,37% 7,31% 5,65% 4,26% 5,22%
0,00%
10,00%
20,00%
30,00%
40,00%
50,00%
60,00%
70,00%
80,00%
90,00%
100,00%
2006 2007 2008 2009 2010 Average Portfolio
Share of Portfolio
Year and Average Portfolio
Others Corporate Bonds Inflation-Linked Bonds Mortgage Bonds Government Bonds Foreign Equity Danish Equity
Figure 2.3.2.1 Asset Allocation in the Pension Fund Sector, 2006-2010 and Average
Source: Own contribution, based on data from annual reports of the eight pension funds, 2006-2010.
34 1.5.3 Overall Conditions of the Thesis. The use of market values in estimating the actual portfolio implies that the proportions invested in the different assets vary with the specific conditions in the different markets. Therefore, the actual portfolio, estimated for this purpose, does not perfectly reflect the investment strategy of the sector. However, in lack of more accurate information and based on explorative interviews of how this problem is dealt with in other analyses on this sector, this way is found the best possible.
2.3.3 The Average Actual Portfolio
As previously stated in the introduction to this chapter, estimating a portfolio of comparison for the optimal portfolio derived later in this thesis is necessary and an important factor to carry out the analysis. From the portfolio allocation data of the individual pension funds, a weighted average has been calculated to obtain the most accurate view of the sector’s actual portfolio28. For calculations and estimation of the actual portfolio, see Appendix D - The Actual Portfolio.
The return data is based on yearly return before tax on pension returns on policyholders’ savings (N1F) on portfolio level (Announcement Regarding Financial Reporting for Insurance and Pension Funds, 2011), referring to section 1.5.3 Overall Conditions of the Thesis. This data covers the same five year period from 2006 to 2010.
The actual portfolio of the Danish pension fund sector including the expected return, the standard deviation and Sharpe ratio looks as follows in table 2.3.3.1.
28 Data on the market shares is based on numbers from 2009 (The Danish Insurance Association, 2011). It is acknowledged that these can be different from the ones in the remaining years from which the asset allocation data is based upon.
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The sector has, on average, allocated 17,94% to equities and 76,84% to bonds. The share in equities has, on average, been divided with one fourth in Danish and three fourth in foreign equity, approximately. The table also shows that the average annual return on the pension sector’s portfolio is 3,75%. The standard deviation on the actual return is 5,25%, revealing the volatility of returns on the funds’ investments. The Sharpe ratio measuring the performance of the portfolio is 0,11. This measure will be described in section 3.4 Performance Measures. It will be elaborated further upon in the comparison between this actual portfolio and the theoretical optimised portfolios.
In this section, the outset for the further analysis of the investments of the Danish pension fund sector has been presented. How the sectors’ actual portfolio is comprised and how it performs has been presented. This actual portfolio will serve as the point of comparison to the optimal portfolio which will be modelled by use of the theoretical model developed by Fischer Black and Robert Litterman (1992).
Asset Class
Danish Equity 4,38%
Foreign Equity 13,56%
Government Bonds 18,15%
Mortgage Bonds 39,67%
Inflation-Linked Bonds 7,69%
Corporate Bonds 11,33%
Others 5,22%
Total 100,00%
Expected Return 3,75%
Standard deviation 5,25%
Sharpe ratio 0,11
Actual Portfolio
The Danish pension fund sector’s portfolio has a Sharpe ratio of 0,11. The sector allocates 17,94 % in equities and 76,84% in bonds.
Source: Own contribution, based on data from annual reports of the eight pension funds, 2006-2010.
Table 2.3.3.1 The Actual Portfolio
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