Pension funds with US$680b finally find missing link

A view shows the Palais Garnier opera house with a banner that reads ''Paris opera on strike'' and another banner that reads ''The culture in danger'', after 20 days of strike against pension reform plans in Paris, France, December 24, 2019. REUTERS/Gonzalo Fuentes

COPENHAGEN: In Denmark, where institutional investors have been living with negative interest rates longer than anyone else, the authorities just took a big step.

Danish pension funds, the world’s best managed along with their Dutch peers, will finally get a 30-year government bond. When it starts trading next year, funds managing a total of $680 billion in assets will get the missing link they’ve long needed: a long-term, AAA-rated asset at a positive yield. That’s quite a novelty these days.

The new bond will give the industry a "crucial point on the curve, ” said Christian Lage, chief executive officer of PFA Asset Management, which is a unit inside Denmark’s biggest commercial pension fund in Copenhagen.

"We’re following it closely, ” he said in an interview. "Not only with regards to what extent we want to invest in it, but also how it’s being priced. It has an impact on a lot of different things when we price long-term exposures.”

Denmark’s central bank first cut its benchmark rate below zero in mid-2012. Almost eight years later, the county has had negative rates longer than any other place on Earth. The distortions wrought by a policy intended to keep the krone fixed to the euro are particularly pronounced in the pension industry.

The art of generating long-term, stable returns so Danes can retire comfortably has become increasingly difficult. Pretty much everything safe generates a negative yield. Assets that generate positive yields tend to come with a good deal more risk.

The Danish debt office, which is a unit inside the central bank, hasn’t issued a 30-year bond since 2008. That’s forced pension funds to extrapolate a key anchor point in the interest rate curve that helps them determine the value of both assets and liabilities.

Not having a real number at the 30-year point was problematic. The calculations used could muddy price-setting, particularly given the uncertainty of how and when central banks might extricate themselves from negative rates.

Lage says that "what is a bit hard for the industry is that, if the interest rate curve -- the govvie curve -- ends at a 20-year point, what is the fair price for a 30-year asset?”

About PFA Asset Management

* The company is a unit of PFA Holding, a pension fund owned by its customers

* PFA Asset Management has about 442 billion kroner ($66 billion) under management

* Clients include PFA customers, other professional and non-professional investors in Denmark

Dealing with long-term negative rates is an issue affecting much of the rich world. Real investment rates of return, net of expenses, were negative last year in the member countries of the Organisation for economic Co-operation and Development. With few exceptions (Sweden stands out), most central banks have signaled a willingness to cling on to stimulus.

Denmark’s government debt market is considerably smaller than the country’s roughly $500 billion covered-bond market, which is the back bone of the Danish mortgage system. There are plenty of 30-year covered bonds. But they’re far from ideal as an anchor point in the yield curve.

That’s because the securities are callable, which means borrowers have the option to buy back their debt. That can happen not only when rates go down, and homeowners try to lock into lower rates; but also when rates go up, and borrowers try to reset their mortgages at lower bond prices (and reduced debt values).

"The duration on mortgages is fairly short these days due to the optionality and prepayment mechanisms, ” Lage said. That means government bonds become "very central” and "when we miss guidance far out the curve, we lean toward how assets are being priced in Europe.”

"It’s in the interest of the full financial sector to have as trustworthy a back-end anchor point as possible, ” he said. "It’s very important that the central bank continue to be fully aware of their responsibility and keep up the good job in issuing longer debt, so we’ve got a fairly precise idea where the back-end of the curve is priced.” - Bloomberg


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