Denmark funds told to drop focus on short-term returns

The watchdog overseeing one of the world's most successful pension fund industries says its managers are focusing too much on quarterly returns.

The $650 billion retirement-savings sector of Denmark, which, together with the Netherlands, tops global industry rankings, may now be facing regulatory action as the Financial Supervisory Authority in Copenhagen makes clear it wants funds to shift focus to investments that meet longer-term targets.

"Pensions are the source of income for people who have very little else, so it's important to view them not as the whipped cream on top of the cake," Jesper Berg, director general of the FSA, said in an interview.

Mr. Berg said talks are now planned that will involve parliament and representatives from the pension fund industry to address the FSA's concerns. Governance will be a key focus of those talks, he said.

Denmark's pension fund industry has long stood out as one of the world's best, when it comes to ensuring retirees will have enough to live on. But in recent years, funds have responded to ultra-low interest rates by revamping portfolios, relying increasingly on risky, less liquid assets to squeeze out extra returns.

"Denmark is at the forefront in terms of countries shifting toward a more market-based pension and life system," Mr. Berg said. As other countries follow, pension portfolios across Europe will be filled with securities that "look a lot more like asset management products," he warned.

Pension funds have been phasing out guaranteed-return products, which limit investment options and put more capital at risk. Now, most offer so-called market-based products that give funds more investment flexibility while pushing the risk of market swings on to savers.

Mr. Berg said he wants pension funds to adopt a mindset in which the focus is on "what income stream can we generate, what risk surrounds that income stream, and how are investments made with that in mind."

Likening pensions to rye bread — the coarse but nutritious Danish food staple — Mr. Berg said funds need to remind themselves that hard-earned savings have to carry a "large share of the population" through "the last years."

The Danish FSA is already conducting an investigation into how pension funds are valuing their alternative assets, which tend to be unlisted, and harder to buy and sell than stocks and bonds. That also makes them hard to price, raising questions around their book value.

Mr. Berg made clear that funds that invested in alternative assets because they're hard to price will be in the FSA's crosshairs.

"I would hate if investments in alternatives were driven by their accounting properties" and especially so if they are "assessed according to some accounting standard that implies a greater degree of stability than is the economic reality," he said.

The warning is "very closely tied to our thinking that pension funds should start from defining what they want to do in relation to the income stream they generate and the risk around that income stream, rather than accounting stability, which is fictitious," Mr. Berg said.

There's not a lot of regulation or experience elsewhere on which Denmark can draw, Mr. Berg said.

Most European rules are about ensuring companies meet guarantees they've issued, so "we are sort of out in the green field," he said. He suggested legislation might ultimately be required to bring about the necessary change in the industry.