Alecta, which manages the retirement funds for a quarter of Sweden’s population, has announced that it is planning on including passive equity to the asset allocation of its defined benefits plan. This follows a strategic review, started last December but undoubtedly heavily influenced by events earlier this year.
In contrast to most asset owners, Alecta runs a concentrated, active equities book, which included holdings in three US regional banks: SVB, Signature Bank and First Republic Bank. In March this year, their simultaneous collapse resulted in significant losses for the plan, leading to the departure of its head of equities and CEO.
Now, Alecta has announced that it will be including an allocation to passive equity in its defined benefits plan (but not its defined contribution plan), in order to create more stability and decrease volatility. In addition, it indicated it will be reducing its maximum weighting to companies outside of the Nordics.
The inclusion of a passive allocation should reduce concentration risk and increase alignment with the stated strategic/policy benchmarks. It’s not too surprising that the inclusion of three systematically connected stocks raised questions regarding its concentrated active management approach, and associated risk management. At the same time, the announcement to retrench into Nordic companies raises the question of whether one factor exposure (US regional banks) is being replaced with another (Nordic regional).
The shift to passive has been observed in other pension funds for some time now, so Alecta isn’t the only asset owner making the shift. It’s however worth considering that passive exposure doesn’t devolve one of risk. Depending on the mix of benchmarks selected, and methodologies employed, passive investing can still result in return and risk concentration, think of peak-level Nokia in Nordic benchmarks, or Samsung in Korea.
Beyond risk considerations, cost and net returns are equally important. The lower embedded fees and operating costs of a passive sleeve allow for accessing beta at a reduced cost. Here again however, as with the earlier discussed consideration of internally vs externally managed assets, it’s important to remember that there’s no one size fits all answer. High levels of information efficiency in certain markets, such as US large caps, may indeed have significantly raised the hurdle for active managers to outperform. Other less mature markets, including ones dominated by higher levels of retail investors and lower information levels, might remain conducive to active management. Therefore a holistic, detailed analysis of the portfolio structure, risks, fees and incremental operational costs are crucial to determine the balance of active vs passive investments and the level of effectiveness and efficiency.