Suomi Mutual

Investment grinds to a halt at end of year

Suomi Mutual achieved a satisfactory market-based annual return on investments in the last operating period. The annual return was 5.6 per cent. At the end of October the return for ten months was still 8.3 per cent.

Increasing unease

During 2007 the investment environment became increasingly uneasy. The turnaround in the US economy, which had its origins in the decline in the housing market, accelerating inflation and the mounting problems in the bank sector, gnawed away at market confidence. Equity markets, in particular, fluctuated unpredictably and risks grew. Share prices rose quite steadily in January-February, but March saw the first correction, one that was stronger than usual. However, the market recovered fairly quickly, only for it to dive again in July. Even at this stage confidence in the future and optimism were dominant factors on the markets, so that by the beginning of November the summer peaks had been reached again. After that, however, equity markets went through a really awful November, with almost all the returns for the first months of the year being lost. With December ending up in something of a nil-return situation, the year for equity investors closed with feelings of disappointment and perplexity. The bull market that had lasted five years was coming to a halt.

Overall, the investment environment for 2007 did not support either active risk-taking or outright avoiding risk. Markets showed no clear, year-long trend, and the position at the end of the year was more or less what it was at the beginning. In such an environment passive investing does not work. Only timing sales at the right moment and reducing risk at the end of the year would have made it possible to take advantage of the optimism that prevailed at the beginning of the year and avoid losses caused by the drop in prices at the end of the year. This was a very demanding task and not one that many did with success.

It was also a difficult year for fixed-income investors. Interest rates at the beginning of the year were still on the rise, since the threat of inflation was considered to be the most important of the risks to the economy. Investments exploiting financial leverage suffered. The softness in the equity market at the end of the year and interest rate reductions by the Federal Reserve in the USA drove market interest rates down. Overall, however, a risk-free long-term interest rate produced a much lower return in 2007 than money market interest rates. The spread of the financial crisis from mortgages to all credit-risk debt instruments issued by banks and other financial institutions increased the risk premium payable on these loans and made it unprofitable to bear credit risk. Bonds suffered from the softness in the equity markets. Without actively bearing foreign exchange risk, coming out on top in terms of money-market returns was nigh on impossible for fixed-income investors last year.

The year under review continued to be a good one for private equity investments. Funds were active and conditions still favourable for exiting from investments. For the most part, foreign exchange markets remained calm, although the US dollar showed a clear fall in value against the euro.

The predominant feature of the real estate market in Finland was still the high degree of activeness shown by foreign funds. The demand for real estate exceeded the supply. Competition for good properties was severe, bringing pressure on returns and raising prices. Without financial leverage real estate no longer offered investors a competitive alternative return. For fund investors, however, the year was still excellent.

The start to this year has once again shown that last year’s nervousness on the markets was portentous. January 2008 was almost catastrophic for equity investors. The liquidity of the corporate loan market has fallen and the price of debt instruments has in many places become a matter of theory. Banks have lost their confidence and the position of central banks has become more difficult in the face of conflicting pressures. At the same time they should be able to support the banking system, control accelerating inflation and revive fading economic growth. At the moment it seems that global economic growth will inevitably slow down and that it will be increasingly dependent on the new, rising economies, i.e. China, India, Russia and Brazil.

Targets just missed

The return on Suomi Mutual’s investment operations was 5.6 per cent (6.5 per cent). Denominated in euros, the return for 2007 totalled EUR 367 million (EUR 423 million). The result fell just short of the targeted return of 5.7 per cent, which was derived from the requirements set for the return on technical provisions, competitive customer bonuses and the market-based capital and reserves for 2007. Achieving the target would have required a better result by just under EUR 10 million than the one posted.

A significant proportion of the result was used again on special additional benefits and customer bonuses i.e. increasing technical provisions. In spite of this, the company’s solvency was still high when the year ended and the capacity to bear investment risks was good.

Suomi Mutual’s investment operations performed well in relation to the market. Benchmarks were exceeded in both equity and fixed-interest investments. The annual return on equity and private equity investments was 10.3 per cent i.e. about EUR 212 million. Money-market and bond investments yielded together 2.1 per cent i.e. about EUR 75 million. The proportion of equities in the balance sheet fell during the year from about 32 per cent to around 28 per cent. About a quarter of this was hedged by derivative financial instruments when the year ended. Correspondingly, the proportion of fixed-interest investments rose from approximately 55 per cent to 57 per cent.

The 7.0 per cent annual return set as the target for real estate investments was clearly exceeded. Investments in real estate funds performed particularly well, alone producing a return of close on 25 per cent. Overall, real estate investments yielded a return of 13.3 per cent i.e. almost EUR 64 million, and they accounted for about 8 per cent of the balance sheet at the end of the year.

About 6 per cent was invested in hedge funds at the end of the year. Keeping in mind the nature of the funds’ operations and the targets for them, it was an inexcusably weak year for these investments. The result was unsatisfactory. The return achieved of 3.7 per cent was even under the return for the money market investments. The differences between good and bad funds were unusually big, underlining the importance of the choice of fund. Commodity investments, which had been restarted during the year, accounted for less than 1 per cent of the balance sheet.

Challenging principles for business operations

A few years ago the Board of Directors of Suomi Mutual approved new principles for the company’s business operations according to which the company’s net assets will be distributed to policyholders in the form of special additional benefits. The main principle is that assets will be distributed when a decrease in the company’s technical provisions or an increase in investment returns generate capital that is not needed to cover the risks related to an investment portfolio with a competitive return.

In line with the principles for the business operations, Suomi Mutual’s annual investment-return target is market-based. The targeted return for technical provisions is sought from the fixed-income markets and correspondingly the targeted return for the solvency capital to be retained in the company from equity markets. The investment risk must never be allowed to exceed the risk-bearing capacity in pursuit of the targets.

New decisions, measures, plans, targets and changed circumstances always mean challenging changes to investment operations. The structure of the investment portfolio and operational targets and procedures must be adapted to a changed situation. Last year operations were characterized by the adjustment to an investment environment that had become increasingly uncertain.

In real estate investments the portfolio was further securitized. Direct investment was restricted by extremely fierce competition for good properties and, unlike in the previous year, there were no new building starts. Leasing, however, was successful and the proportion of vacant premises fell considerably. Overall, there were no major changes in the real estate allocation during the year.

Revolution in investment operations

The main objectives and tasks in Suomi Mutual’s investment operations have remained unchanged in spite of changes in the structure of the investment portfolio and balance sheet. The company’s investment operations have been managed with the long term in mind, securely and productively, but to a great extent on its own terms. Return has meant the return on the investment assets and risk has mainly meant the fluctuation in the value of the investment portfolio. In practice, apart from some brief exceptions, the emphasis has been on seeking a return on the investments and using the capital as effectively as possible, because the company’s solvency, i.e. the capacity to bear the investment risk, has been stable and good. The reality is, however, that the company’s technical provisions have constantly contained a considerable interest rate risk that the company has not yet been able to take into account in terms of its effect on the company’s solvency.

At the beginning of 2008 Suomi Mutual transferred in its internal accounting to the fair-value principle for valuing the technical provisions in accordance with the new and future official regulations (a new Insurance Companies Act and Solvency II). The change is extremely important, and it will have a material effect on the control of and targets for investment operations. Beside the pure pursuit of a return, the role of fixed-interest investments in particular as hedging for the interest rate risk included in the technical provisions will be emphasized in the future. On the other hand, the change in the value of the technical provisions will become a component that will have a direct bearing on the company’s result. It will be possible, and it must be possible, to make a profit with it. In the future, therefore, the interest rate risk will have to be managed as a single entity in which the active interest rate risk will be determined as the net risk between the investment risk and the risk of a change in the value of the technical provisions. Likewise, in addition to the traditional investment return, the change in the value of the technical provisions must be kept in mind in the pursuit of a return.

Investment plan guides operations

The investment operations of Suomi Mutual are guided by an investment plan approved by the Board of Directors. The plan approves the return and liquidity targets for investment, which are derived from the nature and structure of technical provisions. The method for measuring and calculating the risk-bearing capacity and investment risks is also determined in the plan.

To secure adequate diversification, the plan includes confirmed maximum and minimum amounts for each asset class. The investment plan also defines the principles for managing foreign exchange and includes a description of the investment organization and its operational powers.

About one third of the company’s investment portfolio, i.e. about a tenth of the total balance sheet, is held in equities in Finnish listed companies. In domestic equity investments, Suomi Mutual’s aim is to utilize its local and company knowledge so that the investments are mainly concentrated on equities that provide a higher than average return within a minimum of a few years.

The concentrated investments are set out so that each individual investment is significant to the company’s overall result. For this reason, Suomi Mutual aims to be actively involved in the administration of these companies, and thereby also participate in increasing their net asset value.

Suomi Mutual’s Board of Directors and internal experts are responsible for investment planning, strategic steering and the selection and supervision of cooperation partners. Pohjola Asset Management Ltd provides the accounting and reporting services as well as most of the risk management and portfolio services required by the investment operations of Suomi Mutual. Pohjola Property Management Ltd is, either on its own or together with its subcontractors, responsible for operative functions related to the maintenance and administration of Suomi Mutual’s real estate properties.

Suomi Mutual has outsourced, either entirely or partially, to companies outside the OP-Pohjola Group, such tasks as the selection and monitoring of private equity investments, indirect real estate investments, and investments in absolute-return funds. Some of the mutual funds investing in the emerging markets and in small-cap companies are funds offered by OP Fund Management Company or its cooperation partners, others are offered by outside providers. Suomi Mutual aims to find the most suitable asset manager with the optimal knowledge for each mandate.

Major Mutual Fund Investments		Market value Dec 31, 2007 EUR million
1.	OP-Corporate Bond Prima Fund	217
2.	Aviva Global Convertible Bond Fund	157
3.	R2 Crystal Fund	154
4.	Evli Alpha Bond	153
5.	OP-Corporate Bond Fund	126
6.	R2 Absolute Return Fund	126
7.	Fidelity Emerging Markets Fund	112
8.	UBS (Lux) Institutional Sicav – US Equity Growth	101
9.	OP-Cash Manager Fund	95
10.	OP-Bond Index Fund	88
11.	IXIS Loomis Sayles Senior Loan	88
12.	Pimco Global Investm Grade Credit Fund	82
13.	OP-Euro Index Fund	81
14.	ABN AMRO Latin America Equity Fund	75
15.	Nordea Pro Euro Money Market Fund	72
16.	FIM Russia	68
17.	OP-Euro Plus Fund	60
18.	Nordea Euro Money Market Fund	59
19.	FIM Euro High Yield	52
20.	Invesco Japanese Equity Core Fund	49