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“We absolutely have a lot of fixed-income exposure, and we have it for two reasons. One is that we hedge our pension liabilities in one portfolio, which by nature is huge—our members have been promised a certain amount in the future, so we need to match that in order to hedge uncompensated interest-rate risk. The other is that we have a large return-seeking portfolio that includes a sizable allocation to fixed-income assets. This portfolio is an absolute-return portfolio—basically, the more money we make, the better we are able to pay higher pensions for our members. Portfoliowide, we use a risk-factor approach. We split it into five pieces: Equities, credits, commodities, inflation protection, and rates. Traditionally, in risk terms, equities dominate the risk. If they do well, funds do well. Risk, really, isn’t well-balanced throughout a traditional portfolio—so, we’re trying to come up with a portfolio that performs well in all markets. Risk parity is one way of putting it. This rethinking usually involves a lot of bonds—but they have to be good bonds. We don’t invest in much else than German and Danish bonds. Why do we have these? Because we want them as a hedge to those risky assets if the economy turns south. Some bonds act like equities in some markets—the peripheral bonds of Europe, for example, show us how some perform in cases of systemic turmoil. However, Danish and German bonds, we believe, will increase in value and, don’t forget, our liabilities are denominated in Danish Kroner. For hedging our liabilities, we use interest rate swaps denominated in Danish Kroner and euros. The Kroner is linked to the euro—but we’re not part of the European Union. The Danish fixed-income market isn’t big enough for us, so we largely use rate swaps. Infrastructure? I think that in many ways we like it for the usual reasons: It’s a long-dated asset, and it has an index-linked-bond nature insofar as it is safe, long-dated, and you get inflation protection to a degree. We categorize it as an inflation-protecting asset; we buy it because we think it can do well in rising inflation. Indeed, we only go into infrastructure assets that will protect us against inflation—toll roads are great examples of this. Normally, the amount of traffic will be fairly independent of the business cycle. It may be surprising at our size, but we don’t have an internal deal team on infrastructure. We are really trying to keep a core, small team in our head office. We do [outsource] some other asset classes; in fact, in money terms, most of our work is done in-house. We just tend to outsource the specialized areas. The benefit? I think there is a tremendous advantage in having a very small main office. Private equity is less than 5% of our portfolio but, if we ran it in-house, it would take up management resources, and you run a risk of spending too much time on the details, losing the bigger picture. Looking forward: What we spend a lot of time thinking about is this very flat distribution of probabilities of where the economy could end up. Many things could happen—inflation, deflation, stagflation—so how do you go about that problem as a large institutional investor? The whole concept of having a robust approach where you ensure the protection of money—just as much as focusing on the return on money—is so important.
aiCIO Editorial Staff