Ukraine crisis begins to hit pension coffers

Pension fund executives across the globe are turning a serious eye to the crisis that is rumbling on in Eastern Europe, as its effect on investment performance starts to hit home.

But while some are adjusting their portfolios, others are only keeping watch on the situation that continues to unfold across Russia and Ukraine.

The effects of the annexation of Crimea by Russia and other political decisions made by Russia have shown up in the MSCI World and MSCI Emerging Market indexes, which have fluctuated since mid-March, when the issues started to take hold.

The MSCI World has gained 1.4% since March 1, while the MSCI Emerging Market index gained 4.9%.

Add to that Standard & Poor's Financial Services LLC lowering of Russia's long- and short-term foreign currency sovereign rating to BBB- status — which the ratings agency attributed in part to “the tense geopolitical situation between Russia and Ukraine, (which could lead to) additional significant outflows of both foreign and domestic capital from the Russian economy and hence further undermine already weakening growth prospects.”

When contacted by Pensions & Investments in late March, a number of pension fund and money management executives said it was too early for them to comment on any detrimental effects. Now, however, some say their investments have started to suffer.

“Our exposure to Russia will be close to zero in the medium term,” said Timo Ritakallio, deputy CEO of Finnish mutual pension insurance firm, Ilmarinen Mutual Pension Insurance Co., Helsinki, which has e33 billion ($46 billion) of assets. The fund's current exposure to Russia is 0.2%, he said, which has already declined from 0.3% as of March 31, 2014.

While exposure was low already, Mr. Ritakallio remains concerned about the effects of the crisis on the Finnish economy, and on Finnish-listed companies. In the fund's first-quarter update, he wrote: “The crisis will create difficulties, especially for Finnish companies operating in Russia as well as for companies engaged in exports to the country.”

In a telephone interview, he said the biggest risk is that the crisis escalates further. “This is a question of political and geopolitical risk,” he said. “More and more investors will see that to invest in Russia means taking a huge political risk. Responsible investors hate these kinds of risks — that is the key issue.”

While other institutional investors say they, too, have low direct exposure to the market, they remain concerned about the potential negative effects on their investments.

“We have an allocation of around 5% to two emerging markets managers, both with global emerging markets mandates,” said Peter Wallach, head of the £5.8 billion ($9.9 billion) Merseyside Pension Fund, Liverpool, England. “One is underweight Russia and has been long term. The other moved from a small overweight to underweight by the end of March, and lost about nine basis points in relative performance in that time. However, it was underweight by the time Crimea was annexed.”

The fund has about a 0.2% exposure to Russia overall. In terms of changing that allocation, Mr. Wallach said that decision lies with the money managers. Any decision to change the allocation is “not particularly material at the moment as Russia is a small part of the benchmark” — about 5.4% of the MSCI, he said.

“If political connotations develop, it might become more significant,” he said, “if politicians decide, for example, that our exposure to Russia conflicts with government policy of sanctions against the regime. But we are not there yet.”

Norway's 5.156 trillion Norwegian kroner ($866 billion) Government Pension Fund Global, Oslo, reported its first-quarter results at the end of April, and said it had holdings of Russia government bonds worth 24.3 billion kroner at the beginning of 2014.

“Geopolitical uncertainty led to the weakening of the ruble, and the Central Bank of Russia raised its rates in an effort to stem the decline,” officials wrote in the fund's financial report for the three months ended March 31. “This resulted in a return of -9.7% on the fund's Russian government bonds.”

Equities overall outperformed the benchmark by 0.1%, according to the same report, but “investments in the U.S. and Russia made the most negative contribution” to this performance. The fund had a 0.6% equities allocation to Russia as of March 31, down from 0.7% three months earlier, according to the report. A spokesman declined to comment.

Other institutional investors contacted by P&I said their exposure to Russia was not significant.

Anders Hjælmsoe Svennesen, Hilleroed, Denmark-based co-chief investment officer at the e80 billion Danish pension fund ATP, said the fund has about e40 million allocated to Russian government bonds. “That is a very low proportion of the portfolio that is invested ... in Russia.”

However, he said the fund is run with an environmental, social and governance policy in mind, and so executives at the fund “are following” the situation. As long as the Danish government and the United Nations do not alter their guidelines on investment in Russia, the executives will just keep a close watch.

The $145 billion Florida State Board of Administration, Tallahassee, had about $375 million in global equity exposure to Russia as of March 31, according to unaudited numbers provided by a spokesman for the fund. He said there was no direct exposure to Ukraine, and that, given the size of the fund, any impact from the Russia exposure “would be minimal.”

Meanwhile, the $183.3 billion California State Teachers' Retirement System, West Sacramento, has a total investment exposure of $528 million to Russia and Ukraine, “a very small percentage of our ... portfolio,” said a spokesman for the fund. “We are not making any significant changes in our investment strategies at this time.”

Some pension fund officials said that while direct exposure might be insignificant, indirect investments are more of a concern. Merseyside's Mr. Wallach said funds might find they have more exposure to Russia “through a shareholding in BP PLC or one of the other oil majors than through any emerging markets allocation. Twenty percent or so of BP's assets are Russia-based, and that is not insignificant.”

Pensioenfonds Zorg en Welzijn, Zeist, the Netherlands — the Dutch pension fund for the care and welfare sector, which has e142 billion of assets — provided a statement through a spokesman for PGGM, the pension fund's money manager. “PFZW has little exposure to Russia (about e1 billion),” wrote the spokesman in an e-mailed comment. “Indirect effects can be more substantial. You can think, for example, of investments in Germany and Austria that could be hit by developments in Russia.”

Others see the Ukraine situation as a positive. One executive at a U.S. endowment fund said while collateral damage was his greatest worry, “market dislocations are a source of great opportunity.”

That feeling is shared by Antony Barker, director of pensions at the £8 billion pension fund for Santander U.K. PLC. “Everything in pension fund land is relative — 12 months ago we were suffering the aftershocks of (the Cyprus banking crisis) — so if anything, real yields have increased and liability values have fallen over the year,” he said.

“We continue to seek value from a multiple "risk-on' approach, with most new investments biased away from public or quoted markets. Given our long-term perspective and liquidity, we will always see uncertainty as an opportunity, rather than a threat, and (we) will be net investors.”

Mr. Barker said the fund has exposure to Russia through direct and indirect investments, “and it's because of the multifaceted nature of the risk exposure that we won't be making any hasty decisions on a few specifics.” n