Caution is a killer
A gruelling start means Mikko Koivusalo of Finland's €34.5 billion pension fund Varma Mutual has every reason to be pessimistic about the investment markets, but he doesn’t believe in running scared.
by Atholl Simpson on Dec 24, 2012 at 08:01
Starting out in finance was a baptism of fire for Varma Mutual’s Mikko Koivusalo. Now investment chief for Finland’s €34.5 billion pension fund, the country’s largest private sector pension company, Koivusalo kicked off his career in 1991 when he joined the Postal Savings Bank.
That year Finland experienced its worst ever banking crisis following a debt-fuelled economic boom.
Koivusalo experienced the damage first-hand as a credit analyst for the Finnish bank. Character building it may have been but learning on the job in this environment can have its negative side, making your whole approach to investment overly cautious, he says.
‘When you learn to see the negative side it is always easy to put the most pessimistic prediction on the table and that might kill too many investment proposals.’
This point has particular resonance for many of today’s fund managers who may have cut their teeth during in the aftermath of 2008.
The challenge is not to let the past hold you back so you miss opportunities, says Koivusalo.
‘You end up hoping you haven’t been too cautious with your decisions because when you are investing for the long term you can’t afford to be too pessimistic – especially when you are investing in equity or private equity and that kind of very high return asset.’
The Helsinki-based manager, who is currently head of capital market investments, joined what is now known as Varma Mutual in 1997, shortly before two of the country’s largest pension groups merged into the present form.
He leads a team of about 30 that manage the majority of their assets in-house, including fixed income, and carry out fund selection for their external manager portfolios.
The Finnish pension system’s structure and regulation means Koivusalo is able to invest across all international markets. But while his portfolio is broadly diversified he still has a large domestic allocation.
Around 40% of his assets are invested in Finland, a requirement of being one of the country’s largest pension funds, but he’s gradually reduced this allocation since he joined in 1997.
‘We had a very domestic-focused portfolio around 15 years ago but there have been a lot changes in regulation that have enabled us to diversify our portfolio internationally and direct it more towards equity-type investments.
‘There have been a lot of changes but they have all given us more diversification and more international exposure than our pension system had in the old days.’
This international exposure is where his use of mutual funds comes into play. He uses them for areas where his group doesn’t have in-house capabilities and when they need specific resources, such as a local presence.
‘This is particularly the case in the emerging markets or when you are looking at a particular niche,’ he says. ‘For example, in the US when you are looking for certain small or mid-cap exposure.’
Emerging markets and US-focused funds are the main targets for inclusion within the external portfolio and Koivusalo insists they must be institutional, established funds that have liquid structures. Among those he currently has in the emerging market portfolio are the Aberdeen Global China Equity fund, managed by Euro Stars AA-rated Asia expert Hugh Young, and the Templeton Asian Growth and Templeton Asian Smaller Companies funds, both run by emerging markets legend Mark Mobius.
He also holds the Nordea Russia and Fidelity Asian Special Situations funds.
Mikko Koivusalo graduated from Helsinki’s School of Economics in 1988 with a degree in accounting and spent three years as an auditor. In 1991 he joined Finland’s Postal Savings Bank, the same year the country entered its worst ever banking crisis. He stayed there for nearly seven years as a credit analyst before joining Varma in 1997. He was soon put in charge of the pension fund’s alternative investments and helped develop its private equity and hedge funds portfolio before he was appointed in 2005 to the role of head of capital market investments.
Picking the winners
There are three attributes a manager must have to make it onto Koivusalo’s list: skill, experience and professionalism.
This final one is the most important; without professionalism a manager’s skill and experience count for little, says Koivusalo.
‘How they can explain their portfolio, how the fund is diversified, how the single biggest investments are justified and how the portfolio has been constructed are all important,’ he says.
‘Also, they need to be able to explain why there is a difference between their fund’s performance and that of the index.’
Professionalism also shows in how the fund is presented. At times Koivusalo has met managers and their representatives who forget they are dealing with sophisticated investors for whom the devil is in the detail.
‘When you have worked for a long time in the investment industry, sometimes the presentations are very simplified and they just put all the positive details on the paper.
‘But whenever you carry out really thorough due diligence you can often find a very different picture to the one paraded in those simple presentations.
‘All those who have been selecting funds day to day have had such disappointments.’
Once the manager’s professionalism is verified the focus is on their experience and what added value they bring.
‘If we go far away from Finland we want to know if this manager is the local elite or a really qualified investor in their investment area.
‘Managers must have a good track record because outsourcing investments is quite expensive so you are really relying on predicting their returns – that they can make something extra or have stable absolute gains.
‘There must be something special there otherwise it is much cheaper and easier to invest in common indices.’
He does include some ETFs within his equity portfolio, with the vast majority of them focusing on the US market. Among them are the Invesco PowerShares QQQ, BlackRock’s iShares Russell 2000 Index fund and the SPDR S&P 500 ETF.
For his US mutual fund exposure he currently holds the UBS Equity USA Growth fund, which was managed by Lawrence Kemp until his departure from the Swiss group in November, and the Goldman Sachs US Equity Portfolio fund.
Varma was established in 1998 when Pension Sampo and around two thirds of Pension Varma merged, creating Finland’s largest earnings-related pension plan. With assets of €34.5 billion, it caters to approximately 70,000 entrepreneurs and employers and handles the earnings-related pension cover of some 870,000 people.
Before being named its head of capital market investments, Koivusalo was in charge of the pension fund’s alternatives division.
When he joined, the foray into private equity was in its early stages and he helped build up its exposure to this sector before turning to hedge funds in 2002.
Today the pension fund has over 15% of its assets focused on the alternatives sector with all its private equity and hedge fund exposure channelled through funds.
The experience he gained from selecting managers in the alternatives arena was easily transferable to the broader portfolio, he says.
‘Whether you are investing in mutual funds, private equity or hedge funds the skill base and the key person’s capabilities and their long-term returns are essential.’
But he upholds the same principle with fund managers as he does with fund selectors – professionalism is vital.
‘Normally it is pretty easy to find quality,’ he says, ‘the most important issue is you require very focused organisations that are conducting that selection and manager monitoring day-to-day.’
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After many years meeting and analysing managers, Koivusalo and his team have gathered their own in-house information on the people they are dealing with.
‘You have to have the resources to do that and the time to do it professionally.
‘It is not a part-time job, it’s full-time and you have to be very experienced. You need professionals selecting professional funds.’
Near zero interest rates, global uncertainty and a chronic lack of political leadership – it is not an easy time to be a long-term investor.
For Koivusalo, being an asset allocator in today’s markets means that despite his positive long-term outlook for equities, his cautious side is leading the decision-making process.
‘Our type of long-term pension investor should aim for real returns but these are currently hard to come by. The big structural debt problems in the US and Europe move markets with every central bank decision.
‘As a long-term investor it’s tough to make any far-reaching predictions.
‘Because of global economic problems our equity exposure has been lower than normal for our type of long-term pension investor over the last couple of years.
‘In the long run we still believe equity investing will offer returns compared to low interest rate levels.’
One issue on everyone’s mind, says Koivusalo, is the US fiscal cliff. A resolution would be one of the most positive things that could happen to the market in the short-term, he says.
‘If politicians would agree on how to deal with the fiscal cliff it would boost the whole market and that would change a lot of things in a short period of time.’
Inside track on Scandinavia
‘One key advantage about Scandinavia is the fact that its banking sector is in very good shape. Finland had a very deep banking crisis in the early 1990s and we learned our lessons,’ says Koivusalo. ‘But also in Scandinavia banks were concentrating on very basic issues. They did not have any of those complex government bond portfolio problems. ‘However, our countries are very export driven and demand is going down so that has implications for the region.
‘The home market is small, the companies are strong and the banking sector is very healthy but the export market plays a much bigger part in the economy compared with some other European countries. So there are challenges ahead,’ he says.
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