Covid-19 and exceptional market movements

With the pandemic impacting society in many different ways, 2020 was an extraordinary year during which we were forced to deal with an historically challenging economic environment at the same time that we very swiftly transitioned to working virtually and remotely. Outside of work, too, society has had to adapt, as people can no longer interact socially in the same way as before. Many around us have also personally been affected by Covid-19.

Even though it now feels like ancient history, the year started out with positive macroeconomic development and showed signs of a recovery following a weak 2019. The relatively positive start to the year abruptly changed to panic during the month of March. We saw the stock market plummet as cases of Covid-19 spread across Europe and the USA. The New York Stock Exchange S&P 500 index fell 34%, and the Stockholm Stock Exchange index declined by as much as 30% from its top levels in the month of February.
   The initial force of the impact on the real economy in spring 2020 was brutal. The speed and depth of the economic slowdown vastly exceeded what we saw during the financial crisis, for example. Overall the political system acted quickly and forcefully in response to the pandemic – first, by implementing various restrictions to slow the spread. Then, to counter the negative consequences of restrictions, governments and central banks began at an early stage to introduce various types of support measures. During the year these financial and monetary policy programmes grew more extensive and are today historically large. Owing to the combination of strong support and stimulus measures, gradually improved control over spread of the virus, steadily improved knowledge about Covid-19 and the successive easing of restrictions, the financial markets recovered significantly after the drops in March. 
   In autumn 2020 we saw the start of a second wave of the pandemic, with rapid and extensive spread that continued through the end of the year with undiminished strength. The second wave of the pandemic also entailed the reimposition of new and successively more extensive restrictions. However, internationally the restrictions imposed during the autumn were more targeted than those in the spring and thus far have not been as devastating for the world economy, even though certain sectors have been hit very hard. The record-fast development of vaccines and the seasonal pattern of the virus have nevertheless injected some hope into this very difficult situation. With successful mass vaccinations as we approach the warmer season of year, hopefully a normalisation can begin at least some time into spring 2021. 
   Reflecting back on 2020, it is impossible to ignore the fact that the year entailed quite a bit of political turbulence, which was essentially conveyed in real time via social media. Of course, quite of bit of this was also coupled to the pandemic. Despite this, perhaps most remarkable was the highly unusual events that unfolded following the presidential election in the USA. A type of rhetoric has been used, propagated by conspiracy theories, which is reminiscent of interwar period in Europe and the collapse of the Weimar Republic. That we would experience something similar in the world’s bastion of democracy is both shocking and horrifying.
   On the whole, however, thus far the dramatic events in 2020 have caused considerably less damage to the Swedish as well as the international economy than what most forecasts suggested last spring. The rapid development of vaccines combined with an expectation for continued stimulus measures offers hope for a continued economic recovery in 2021.
   Looking back on the overall changes in asset prices during the full-year 2020, it is quite astonishing given the extreme events that we have been through. An example of this is the growth in the value of AP4’s asset portfolio. We entered 2020 with a portfolio value of SEK 418.0 billion and ended the year with a portfolio value of SEK 449.4 billion (and on top of this, during the year AP4 paid out SEK 7.9 billion to the pension system). On the surface it could appear as a calm year with favourable returns. But this couldn’t be further from the truth!

Structural changes and intensified trends
Following such an historically dramatic economic slowdown that we experienced in 2020, it is natural to expect a significant rebound in 2021. Setting aside the major fluctuations in GDP, the long-term key question is if the pandemic will cause structural and permanent harm to the world economy, and if so, how great this will be. In response to this question, undoubtedly there is no shortage of dark clouds looming, including the risk for permanently high unemployment, a new crisis in the financial system, a stalling of globalisation, increased regional tensions and dramatically higher levels of debt that could pose future structural problems. On the other and more positive side of the scale are factors that, over time, may strengthen the economy’s way of functioning and productivity. Examples of such factors are the acceleration of digitalisation, investments in neglected infrastructure, the transition to a sustainable society and the potential for positive structural reforms. Ultimately much will be determined by the extent to which the resources that will be invested in restarting the world’s economies can be steered to long-term productivity improvements, and whether the leading economies can continue to embrace the belief in the benefit of global cooperation and global economic collaboration. Our current assessment is that the pandemic will certainly leave some hard to heal wounds on the world economy, but that they won’t necessarily be as problematic over the long term as those left by the financial crisis. The financial crisis was caused by a meltdown of the world’s banking system with an essentially defunct credit system for a long time, which parts of Europe have still not recovered from.

Strong result based on long-term asset management

AP4 commendably navigated the exceptionally turbulent market situation during 2020 and generated a return of 9.6% after costs. Active management also continued to be successful and made a return contribution of 2.4 percentage points above the benchmark index for the year.
AP4’s favourable historical result is due in large part to its ability to leverage the large latitude that exists in the buffer funds’ statutory mandate. Thus for example the buffer funds have unique conditions to act long-term and thereby have the opportunity to fully take advantage of the potential in investments through their ability to withstand large market movements and low liquidity where it favours long-term returns. It is precisely this ability to act long-term that has been an enormous asset for us in the very difficult, disordered and turbulent market that we experienced during the first half of the year. For example, we began buying equities in connection with the first major drops to maintain our asset allocation. We also had conditions to invest in corporate bonds when prices of these fell indiscriminately in March, when the market in its hysteria could not manage to differentiate between the various issuers.
   Our long-term approach also gives us conditions to act as a stable and responsible owner, which is always important, especially during such an extremely difficult and uncertain situation as that created by the pandemic. We took our responsibility such as by engaging in proactive dialogues with companies and with owner groupings on companies’ needs for capital, which resulted in AP4’s participation in several new issues to support long-term sound companies. It is also gratifying that the Swedish government and Parliament, in response to the extreme situation, showed flexibility by temporarily allowing the AP Funds to acquire higher maximum ownership stakes in Swedish companies in order to better be able to support them during this difficult period. Up until summer 2021 the AP Funds may now own up to a 15% stake – previously 10% – which gives us better opportunities where needed to support the companies in which we are a long-term major owner.

AP4’s contribution to the climate transition
Climate change is one the greatest challenges of our time, and AP4 underpins its asset management activities on the Paris Agreement and the more ambitious Swedish environmental objective to achieve net-zero greenhouse gas emissions by 2045. Our low-carbon strategies, which we began implementing as far back as 2012 and have subsequently developed year for year since then, took additional steps in 2020. One challenge we encounter in refining our methods is access to data of sufficiently good quality. Up until last year we were forced to rely only on historical data that has not always been pertinent. In 2020 it became possible for us to complement our models with data that is more forward-looking and thereby has the potential to significantly increase our ability to forecast. More specifically, our strategies for selecting companies in the global equities portfolio now also include data on whether the companies are considered to be aligned with the Paris Agreement and on their ability to manage pricing of carbon emissions. During 2020 we also broadened our application of low-carbon strategies to our entire internally managed global equities portfolio. This means that the target we set in 2015 ahead of the Paris summit – that the entire global equities portfolio would be managed based on strategies that result in a lower carbon footprint – has now been achieved.
   During 2020 AP4 also built up an internal group for fundamental thematic global equities management. Based on AP4’s thematic sustainability analysis and quantitative company analysis, this group conducts fundamental company analyses and equity selections in AP4’s global equities portfolio. In an initial step the energy sector has been analysed, which has resulted in an extensive restructuring of that sub-portfolio.
   Ensuring that the currently ongoing climate transition will be implementable over the long term requires that it is possible to unite societal and economic development that is perceived to be socially acceptable. Responsible use of fossil fuels within the framework of the remaining CO2 budget – mainly conventional oil and natural gas – will therefore continue to be a precondition for a successful transition to a climate-neutral society. It is for this reason, among others, that AP4 continues to have a certain level of ownership infossil fuel–based companies. However, we put strict demands on the fossil-based companies we own.
   They must conduct their operations with targets and ambitions that are deemed to be compatible with a transition according to the Paris Agreement and also preferably have a substantial and growing share of investments in renewable energy production. The latter is important, as several fossil fuel–based companies in the future will be among the largest investors in the world in renewable energy and will thereby be positioned to play a key role in the climate transition. With considerably more concentrated ownership in energy companies, we will also be able to further intensify our active ownership initiatives to contribute to ensuring that the positive development continues in the companies that we have ownership in. With said measures, during 2020 AP4 reduced the carbon footprint in its holdings by 15%, which represents yet another step in the long-term work we have been conducting since 2012 to reduce climate risk in our portfolio. We have cut carbon emissions in half from our investments in equities, which are now less than half of what they are for a broad global equities index. Our target is to once again halve the carbon footprint from the current level by 2030 with a view to have net-zero emissions by 2040 at the latest. Our historical reduction of the carbon footprint and our targets are more ambitious than those set out in the Paris Agreement.

Continued strategic focus on alternative investments, sustainability and an updated system platform
AP4 conducts cost-efficient asset management – something that was once again noted by the yearly international cost comparison conducted by CEM Benchmarking. We have a sufficiently high level of funds under management to be able to effectively leverage the economies of scale that exist in asset management without for that part having so much capital that it limits our flexibility. AP4’s cost level is only about 45% of the average level among a relevant international comparison group of similar pension funds. We achieve cost efficiency through our implementation style involving mainly internally managed assets, but also on account of the fact that AP4 has lower costs for corresponding services, such as asset management fees, than the pension funds in the comparison group.
   AP4 thus conducts efficient asset management and will also continue to maintain a strong focus on keeping its costs down as much as possible. Despite this, we are now currently in a phase in which we are conducting initiatives in three strategically and entirely necessary areas. In 2019 the AP Funds were given new investment rules which allow for a larger share of investments in unlisted assets. We are therefore in the midst of a process in which we are adding competence and resources to this area as well as increasing the pace of investment particularly in real assets such as sustainability-promoting infrastructure. We are also strengthening our resources in sustainability. One example of this is the aforementioned focus on thematic, global equities management, however, additional resources are also needed to remain at the forefront in areas such as sustainability reporting and advocacy work. Finally, we also need to make further investments coupled to the modernisation of our IT platform and digitalisation of our operations.

Awards for AP4
As I mentioned from the onset, 2020 was in many ways an historically challenging year that put a great strain on everyone as individuals and for most professional categories. For us at AP4, the changes in value that took place in the portfolio were jaw-dropping and also clearly underscored the very extreme conditions under which we handled the continuing management of AP4’s portfolio. On top of a difficult asset management assignment combined with our swift adaptation to remote and virtual ways of working, we also managed to strengthen parts of our operations. During the year we conducted meaningful development initiatives and important projects throughout our organisation.
   Seeing the results of our annual employee survey made me very happy and proud. It showed good progress and very positive results overall as well as for the various parts of our operation. The strong outcome is a favourable assessment of the entire organisation and all of AP4’s employees, but also proof that we handled the tumultuous 2020 in a commendable way. We have all had to adapt and develop our ways of working and meeting forms, and actively contributed to a high level of engagement and energy level.
   Further confirmation of our solid work can be found in the five awards that we won at the 2020 IPE Conference & Awards. AP4 has won many fine awards over the years, which helps inspire and motivate us to continue being a global model for pension funds. It is we together who generate our favourable results, and I feel very privileged to work for AP4. 
   In closing I therefore want to offer my warmest thanks to all of AP4’s employees, who successfully worked together in 2020 for our societally essential mission at the same time that we worked intensively to adapt our operations to future challenges.

Stockholm, 18 February 2021
Niklas Ekvall, CEO