The woman running the AP1 fund — a $36 billion investor that forms a key pillar within Sweden's pension system — is adopting a strategy to gird for what she says will probably be a decade of meager returns.
Teresa Isele, who's been in charge of AP1 since late last year, says the ultralow rate environment has forced the fund to cut its midterm return target to 3% from 4%.
To adapt to the grimmer outlook, AP1 is taking a number of big steps. Key among them is a decision to abandon the active investment strategy for foreign stocks that it's relied on so far. It's a decision that's given Ms. Isele, who's 37, the leeway to get rid of four of AP1's six portfolio managers.
"We saw that we hadn't reached the very ambitious targets we'd set up," Ms. Isele said. After those cuts, AP1 now has 63 people working at the fund, "which feels like a good level, at the moment," she said.
"We have very few in-house resources and must pick very carefully the areas where we can create returns," she said. "We concluded that we couldn't do that in the U.S. and Europe, as those markets are simply too big to cover."
Sweden's pension industry stands out in Europe, after the Swedish central bank took the momentous decision to end half a decade of negative rates late last year. But the more normal monetary policy environment has done little to lift the prospects of the country's pension industry. When it comes to the outlook for returns, Ms. Isele says AP1 has "low expectations on most asset classes" for the coming 10 years.
The Riksbank's December hike to zero from -0.25% was a "step in the right direction," but there's "absolutely" still a risk the central bank will be forced to resort to negative rates again, Ms. Isele said in an interview at her Stockholm office. The policy decision also has significant ramifications for the currency.
"It was, of course, a good thing for the krona that the repo rate was lifted,'' Ms. Isele said. "But we still see it as extremely weak from a historic perspective." For that reason, AP1 sees "potential in the krona."
Other Swedish pension funds are also making changes to adapt to tougher times. On Monday, Alecta, which manages $96 billion, said it was raising premiums to cope with an aging population and lower returns.
Ms. Isele has run AP1 as acting CEO since her predecessor was fired in September for breaching internal trading rules. As AP1's former legal counsel, Ms. Isele will keep the position until a decision is made on a permanent successor. She's built her new strategy together with Mikael Angberg, a veteran of Goldman Sachs and Pacific Investment Management Co. who's been AP1's chief investment officer since 2013.
"It was a joint decision of our chief investment officer and me to initiate the reorganization which we then carried through with support of the entire management and our board," Ms. Isele said.
Years of low rates have left markets "very highly valued," and this year is still likely to be pretty good, Ms. Isele said. But after that, she sees an "elevated recession risk" over the coming decade, which is why AP1 is now bracing for a setback in the stock market.
The fund has placed 35% of its total assets in alternative investments, as part of an effort to spread risk and prepare for future crises.
"Diversifying risk means you can handle pretty much anything, and we are well diversified and well equipped," she said.
But AP1's fixed-income portfolio — the fund is required to keep 20% in debt — is "losing money at present," Ms. Isele said. The conditions for generating adequate returns just "aren't there," she said.
"Long term we'll see an upward movement," she said of the interest-rate outlook. "But not in the next few years."
"For quite some time now, central banks have been successful in keeping markets floating," Ms. Isele said. But, "We don't see that continuing forever," and "that will, of course, also affect asset prices."