Institutional investors, including Sweden’s national pension funds AP1, AP2, AP3 and AP4, are searching for ways to increase their returns and minimise risks. For most of them, moving away from plain vanilla assets, diversifying their portfolio and increasing exposure to private markets have been a way to achieve this. However, data for the first half of 2021 from the AP pension funds reports shows that Swedish equities, followed by the foreign equities, have been among the top-performing asset classes when it comes to driving investors’ returns.
A key reason behind this is the rapid recovery of the stock markets, which has been driving the performance of equities investments. In fact, the AP4 report states that “global stock markets gained more than 11% during the first six months of 2021, and the Swedish stock market grew by more than 22%”. The strong performance of the Stockholm Stock Exchange has positively influenced the returns of the domestic equities.
How have equities driven returns for AP funds?
Investing in domestic, developed markets or emerging markets equities comes with different opportunities and challenges. High transaction costs, taxes on foreign holdings, government regulations and home bias are among the reasons that some investors might prefer to invest domestically, rather than diversifying their portfolio in new geographies. However, the risk profile of each investor must also be taken into account.
The four aforementioned pension schemes have gained exposure in both Swedish and foreign markets, which has resulted in strong returns over the first six months of the year.
More specifically, the AP1 Swedish equities portfolio has generated returns of 19.6% for the first six months of 2021, being the third-best-performing asset class after private equity funds (22.8%) and hedge funds (17.1%). Developed markets equities and emerging market equities have been the fourth and fifth-best-performing classes, respectively, delivering 13.5% and 10.8% over the same period. However, the total equities portfolio, including Swedish, developed markets and emerging markets, has returned 15.4%.
What is interesting about the equities portfolio is that its carbon footprint has been dramatically lowered. In fact, the AP1 report mentions that “AP1’s decision to stop investing in fossil-based holdings reduced our financial risk and reduced the carbon footprint of our equities portfolio by a full 46%”. AP1 announced in March 2020 that it will no longer invest in fossil fuels.
The equities portfolio has also been significant for the performance of AP2. More specifically, Swedish equities have been top in terms of delivering returns (22.3%), followed by developed markets equities (17.2%), emerging markets equities (14.8%) and alternative investments (14.5%). According to the pension fund’s report, “the stock markets performed strongly driven by expectations of good earnings growth in the future”.
The trend has been the same for AP3, as Swedish equities have been the best-performing asset class (18.9%). The total equities portfolio, which includes Swedish and non-Swedish investments, returned 15.2%, followed by alternative investments (14.7%). The AP3 report states that “higher long-term returns offered by equities come with an elevated level of risk”. On top of that, it mentions that “investing across different geographies, sectors and companies is an excellent way to capitalise on economic growth and new innovations”.
The pension fund’s largest holding of foreign-listed companies in 2020 included Apple, Microsoft, Amazon, Alphabet (Google) and Nestle. As for the Swedish-listed companies, its five largest holdings are Sagax, Volvo, Investor, Atlas Copco and Telefonaktiebolaget LM Ericsson.
Swedish equities have also outperformed when it comes to returns for AP4, delivering 18.8%, followed by global equities (12.5%) and real assets (10.6%). Its report states that the pension fund "has started buying equities to maintain its asset allocation, following the large initial decline in stock markets in spring 2020". This has been a good move for the investor, given the “rapid recovery of the stock markets in 2020, which has subsequently continued with a favourable performance during the first half of this year”.
The report also mentions that the pension fund has disinvested from a number of companies “whose plans and goals are not considered to be aligned with the Paris Agreement’s goals”, following an analysis of “AP4’s holdings in the utilities sector, which led to an extensive restructuring of holdings in the portfolio”.
Foreign markets dominate the equities space
Despite the home comforts offered by the Swedish market and the strong returns of Swedish equities over the first half of 2021, the majority of AP funds have increased their allocation to foreign equities more than they have their domestic equivalents since 2017.
Apart from AP1, which has significantly increased its allocation to Swedish equities since 2017, there have not been major changes in the allocation for the rest of the investors. However, this does not apply to foreign equities. Some pension schemes have decided to increase or decrease their allocation to foreign equities, or to change the asset mix within their global equities portfolio.
To start with, AP1 has increased its allocation of foreign equities to 35.8% as of June 2021, up from 32% in 2020 and 24.9% in 2017. The foreign equities portfolio comes from developed market equities and emerging market equities, with the investor also increasing its allocation to developed markets since 2017, while simultaneously disinvesting from the emerging markets. More specifically, the pension fund has reduced its exposure to emerging markets equities from 14.2% in 2017 to 7.5% in June 2021.
AP2 has also reduced its exposure to emerging markets but not by the same margin as AP1. The fund had invested 10.7% of its portfolio in emerging markets as of June, down from 11.1% in 2017. Its allocation to developed market equities was 22.2% in June 2021, the same as it was in 2017, although there have been some increases and decreases over this period.
AP3 has also increased its allocation to foreign equities since 2017, and its foreign equities allocation is almost three times bigger than its exposure to Swedish equities. More specifically, it had allocated 35.1% of its portfolio to foreign equities and 12.7% to Swedish equites as of June 2021, while the allocation was 31.4% and 12.9%, respectively, in 2017.
Nevertheless, while AP4 has more foreign equities when compared with Sweden's other pension funds, it is the one that has been slightly reducing its allocatiion in this asset class, going from 40.8% in 2017 to 39.7% in June 2021.
Investing in equities has provided an opportunity for the four AP pension funds to increase returns following a difficult period caused by the outbreak of the Covid-19 pandemic. Swedish equities have outperformed the returns of developed market and emerging market equities, but investors keep investing in non-Swedish equities as a way to diversify their portfolios and minimise risk. Nevertheless, the pension funds would be well advised to increase their allocation to private markets, particularly private equity, infrastructure, real estate and private debt, as these asset classes provide strong opportunities for diversification and high returns.