Fixed income holdings accounted for over a third of the assets
Fixed income assets such as government and corporate bonds accounted for over a third of the investment assets at year end.
Fixed income assets
At year end, the market value of the fixed income portfolio amounted to SEK 107.1 (103.8) billion, equivalent to 32.1 (33.8) percent of total assets.
In an environment with very low, and even negative interest rates, the return of AP4’s fixed income assets amounted to 2.0 (-0.1) percent.
Global macro management
AP4’s Global macro management is responsible for the management of all fixed income securities and currencies, and it is actively managed with the goal of creating a higher return than the index.
Investments in government bonds are limited to the European countries, the US and Australia.
Investments in corporate bonds should have a BBB rating or higher. AP4 has a strategic overweight in corporate bonds.
The management evaluates and invests in green bonds when they meet AP4’s criteria for sustainability and profitability. Read more on pages 19 and 21.
AP4 hedges portions of the foreign assets. Currency management works in part with the management of AP4’s currency-hedging portfolio and in part with active currency trading. AP4’s currency exposure, the proportion of assets in foreign currencies not neutralized by hedges, amounted to 26.9 (27.0) percent of the assets at year end.
Fixed income holding by issuers
Corporate bonds accounted for just under half of fixed income holdings, Dec. 31, 2016.
Fixed income holding by rating category
AAA-rated bonds accounted for three quartes of AP4's fixed income holdings, Dec. 31 2016.
Interview with Bengt Lindfeldt, Head of Global Macro of AP4 and Torbjörn Kronblad, Senior Manager Global Macro of AP4.
"Zero interest rate environment," what does that mean?
- Today, some bonds trade at a negative interest rate in several countries, such as Sweden, Germany and France, says Bengt. Negative interest rates mean that those who buy bonds, and as such lend money to governments or companies, must pay to lend capital.
Why use negative interest rates?
- The last few years have been characterized by low global growth with overcapacity in the economies, high debt and falling inflation, adds Torbjörn. Central banks have tried to stimulate increased consumption and growth with the help of sharp interest rate cuts, but this has not been enough.
-As a result some central banks - notably in Japan, the euro area and in Sweden - tried more unconventional monetary policy, and to buy back government bonds prematurely, and lower the key interest rate to a negative rate,
continues Torbjörn. Central banks hoped that these
unusual measures would encourage increased consumption and investments, which in turn would help boost economic growth.
What are the consequences?
- A positive short-term effect of falling interest rates is that the bonds will increase in value, says Bengt. The problem is that there are no returns when re-investing in today’s zero-interest-rate environment in the western economies. Another short-term positive effect with negative interest rates is that it weakens a country’s currency, which initially favours the country’s exports and thus growth.
- One problem if interest rates are extremely low for longer periods is the increased risk for unprofitable investments, says Bengt. An example of this risk is housing prices, which are increasing given it is cheap to borrow, potentially
creating a so-called real estate bubble that could burst with sharp price declines when interest rates normalize and begin to rise again.
- Another problem with excessively low interest rates is that investors need to increase their savings to achieve their capital target, which means less money left for consumption and investment.
What actions has AP4 taken?
- AP4 has chosen to have a low proportion of fixed income securities in the total portfolio. By law, however, AP4 must have at least 30 percent of the portfolio invested in fixed income securities with low risk, says Torbjörn. AP4 has decided to increase investments in equities, real estate and alternative investments.
- Within this portfolio, we have increased the proportion of corporate- and mortgage bonds, which gives a slightly higher rate of interest than government bonds. When the Riksbank and the ECB successively introduced negative interest rates, we sold bonds with a negative rate. We have a minimal proportion of bonds with negative returns given our long-term target is 4.5 percent real return.
- To sell bonds with low interest rates short-term has, however, cost money because the interest rate on bonds with short maturities has fallen further. Another strategy has been to sell bonds in markets with negative interest rates and buy in markets with higher interest rates, says Bengt. This works provided that the cost of protecting the investment against adverse currency movements are not too high and that the interest rate differential between the two countries lasts.
- Moreover, we have shortened the fixed income portfolio’s duration; that is, we increased the proportion of short-term bonds in the portfolio. It slightly reduces the risk of AP4 losing capital when interest rates increase to more normal levels.
What happens in the future?
-The most important question is when, and how, monetary policies will normalize. Since a bond falls in value when interest rates go up, we would not want to invest in bonds when interest rates start to rise again.
- Another important issue is how other asset classes, such as equities and real estate, will react to rising interest rates, concludes Bengt. If interest rates increase slowly while economic growth strengthens, the normalization of economies is likely to go smoothly with retained values of equities and real estate. However, if interest rates increase quickly, there is a risk that asset prices fall and growth slows. It would be a risky and undesirable development. Sweden has had both soaring property prices and increased debt. Our economy is therefore vulnerable to falling housing prices.