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Huge Returns Raise Risk Alarm at $230 Billion Danish Funds

Frances Schwartzkopff

(Bloomberg) -- The two biggest funds in the world’s top performing pension market just delivered some of their best returns ever. But their results may be a cause for concern.

Part of the reason they did so well was that virtually all asset classes in their portfolios rose in value in the first half of the year. At ATP and PFA, which oversee a combined $230 billion from their headquarters in Denmark, the worry is that the near lock-step movement of bonds and stocks will make it hard to limit losses through diversification, once markets turn.

Allan Polack, the chief executive officer of Copenhagen-based PFA, says that the “diversification models that we have all been working with -- you can question the degree to which they actually work, because this year, bonds and equities have moved in the same direction.” He spoke after unveiling the fund’s best half-year return rate ever.

At ATP, CEO Bo Foged says it’s a situation that demands extra attention to risk management. That includes “asking risk employees an extra time that they’re sure about diversification” and getting people to “do more stress testing, so that one understands what the effect of this could be.”

Last week, ATP reported an adjusted rate of return of about 32% for the first six months of the year, roughly double what’s normal for the fund. Foged says the tandem movement across asset classes doesn’t bode well, especially given fears of a recession. “If it can go up, it can also go down,” he said.

About Denmark’s Pension System:

Denmark’s pension system has long held the title of the world’s best, measured by the level and sustainability of the benefits it provides. Since being included in the Melbourne Mercer Global Pension Index in 2012, it’s ranked first in all but one year.

With a trade war between the U.S. and China, a potential no-deal Brexit and the threat of a recession all on the horizon, pension funds are devoting extra time to shielding portfolios from the worst. That follows years of struggling to adjust to ultra-low interest rates that have driven many funds into increasingly exotic asset classes in an effort to generate extra returns.

In Denmark, where the central bank uses policy to keep the krone pegged to the euro, asset managers have lived with negative rates for seven years. They’re now bracing for more, with one prominent bank CEO in the country recently warning that rates may not turn positive again for another eight years.

Living Below Zero

ATP’s six-month results were a vindication of sorts for the fund, which has maintained a sizable holding of government and mortgage bonds. They constitute just under a third of its investment portfolio and contributed the most to investment returns.

“We’ve talked about rates hitting bottom and the need to change our strategy since 2013,” Foged said. But “there is no easy alternative.”

Polack says his fund has learned to live with the negative yields, particularly after hedging guaranteed pension accounts. But he also says there are many unknowns ahead.

“Our headache is all these things which are up in the air,” he said. These include questions around the kind of monetary policy Christine Lagarde might embrace when she takes over as president of the European Central Bank later this year. Then there’s “of course the trade war: where will that end? What is rhetoric and what will be real changes? And the political environment is pretty toxic, internationally, so there are a lot of headaches,” Polack said.

After delivering outsized returns in the first six months of the year, both PFA and ATP have more money to invest. In normal times, they’d turn to riskier assets. But not now.

“Normally, investment procedure would dictate that you take more risk. You have to re-balance in order to maintain returns,” Foged said. But he says ATP is now taking another look at the impact negative rates are having on his fund’s business model.

“It is incontestable that when one looks ahead, running a pension fund or a bank in a world where there is zero, or negative rates, it is difficult,” Foged said. “It’s going to be harder to earn money in the future. That’s why I say: we’ve gotten returns in advance.”

At PFA, the focus will be on investing in residential properties, Polack said. Around four years ago, the fund began buying up real estate, and this year it’s accelerating that strategy.

“It pushes us into other asset classes,” he said. That’s because it’s somewhat “counter-intuitive” to invest pension money in assets that “you already know are yielding a negative return.”

(Updates to add ATP comment on bond holdings in 8th and 9th paragraphs)

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net

To contact the editors responsible for this story: Tasneem Hanfi Brögger at tbrogger@bloomberg.net, Nick Rigillo

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