The board of Keva, the local government pension institution in Finland, has decided that the risk level in its investment portfolio will be increased in the future. The decision has been taken to enhance long-term real returns.
Since 2017, pension expenditure in the Keva system has exceeded pension contributions. Thus, the pension expenditure has been partially funded out of the investment portfolio. In the future the role of investment returns in funding the pension expenditure will increase further. However, contributions will still continue to provide the majority of funding going forward.
Keva’s investment portfolio has performed well in the past. Realized real return since portfolio inception (in 1988) is 3,6 % p.a. in money-weighted terms (4,8 % p.a. time-weighted) meaning that 46 billion out of the current 64-billion-euro portfolio are investment returns.
For a pension institution’s investment portfolio, the number one risk is so called long-term shortfall risk, i.e. the risk that the portfolio does not generate adequate real returns. If this risk is realized, contribution rates will have to be hiked. Strategic planning exercises regarding the investment portfolio have shown that the level of shortfall risk is uncomfortably high, endangering the returns needed to maintain a steady contribution rate.
As a remedy, the board has decided that the investment portfolio risk level will be markedly increased in near future. As the portfolio risk level is increased, long-term expected real returns also go up.
At Keva, the decision-making regarding investment risk has formally been organized such that the board sets an overall anchor risk level for investments. Keva’s investment organization then manages the investment portfolio within a deviation mandate around this anchor risk level.
In practice, the decision taken by the board means that the equity weight of Keva’s reference portfolio will be gradually increased. The reference portfolio is the instrument through which the board conveys its risk level decisions to the investment organization. The actual portfolio will follow this path to a higher (equity) risk level, but the steps taken may differ in terms of timing, magnitude and composition within the deviation mandate.
While these moves will lower the long-term shortfall risk, portfolio returns will be more volatile going forward. Short-term portfolio volatility, however, is of a secondary consideration and simply a direct consequence of managing long-term shortfall risk.
Additional information:
CEO Jaakko Kiander, p. +358 20 614 2097
CIO Ari Huotari, p. +358 20 614 2205