Franz Winkler of PKE in Zurich talks to Fennell Betson
There is no doubt about Franz Winkler’s style at PKE, the Sfr5bn (E3bn) pension fund for Swiss utilities. “I am a stock picker,” he declares. “We choose companies for the longer term. Our approach is to be steady long term holders - so long as the companies are on track, we will have them in our portfolios.”
In 1991, when he joined the Zurich-based fund, which has 11,000 active members, its exposure to equities was low. “This level was increased rising to 50%, which for a Swiss fund is quite high.” But since then, the proportion has fallen dramatically, and looks set to decline even further.
Winkler runs the PKE Selection Portfolio, his equity fiefdom, strictly according to his strongly held views. “Our approach is a sector one, as we do not care about countries.” So the portfolio comprises around 30 companies, divided four or five among the six chosen sectors: consumer goods, financials, capital goods, utilities, high tech and pharmaceuticals. But these two will account for over 50% of the portfolio. “We see big growth long run in both these sectors,” he says. He treats himself very much as an analyst, going to visit prospective investment situations. “This is extremely important for me.” He uses the “triple M effect” when selecting companies - management, markers and money. “The management question is extremely important - is its strategy forward looking? Is the company a leader in its markets? How far and how fast can its advantages be adapted by the competitors?” Once the management and markets aspects are good, the money question is not so crucial. “If the products are selling and margins rising, if the stock is overpriced it does not matter so much. If you buy stock in a lousy company, because it is cheap, you can end up with a lousy company.
“The weightings of the companies are varied according to our views of their prospects,”says Winkler. “So if we think one is too pricey, we might reduce our holding, but should it drop to a level where we are comfortable, we will add more.” In the longer term, the individual holdings would be equally weighted, if the fund had the opportunity to buy each company at the level if would feel comfortable about the valuation.
Although he is a stock holder rather than a profit taker, Winkler does not trust himself or his team to call the shots in the continuously shifting sands of share valuations. “We have an option overlay. In our models we have a fair value figure for each stock. So when we want to reduce our participation, we sell a call option at the price where we are willing to reduce the participation, which does not mean that we go to a zero holding. When in fact we reduce the holding, we then do a short put to buy back again
“So, with the overlay around the portfolio, I can discipline myself and take away the emotional dimension. If the market tumbles, with a short put you have to buy, and if the market shoots up, you have to sell. This discipline has helped us considerably.” Where stocks are not that expensive, the overlay is not used. “For example, in the high tech area we have sold a lot of options on these stocks, as from a valuation viewpoint they are quite extended at the moment.”
The programme is run by the fund, and Winkler believes that with an in-house controller the risks are managed. “If we are short, we make sure we have the cash to buy the holding, so the risk being run is that of buying the company too expensively, or if we are short put, the risk is of selling the company too early. They are the only risks we are running.” In his view, many managers have a hard time selling if the market goes up and buying if the market goes up.
“It does not work very well if there are big market movements. Last year, until we had the setback, we had sold quite a lot through call options through market movements up to the summer. If the market had gone even higher, we would have had a problem. But as the market dropped, we sold a lot which we could buy back in September at half the price we sold it for. At the time we did not even do short puts, because the movement down was so sharp.” That helped return last years, he adds. Overall the overlay strategies have helped, but certainly not every year.
PKE’s portfolio’s normal weighting is 40% equities, having peaked at around 50%, when the fund went overweight. Today, he is much less positive about equities. “I think the risk we are taking for earning each additional 1% is too high. We backed off a neutral weighting and are down to around 37%, but I think it will go further down and perhaps stabilise at 30%. Only once since I joined have we been this underweight in equities.” But there has been no shift in his fundamental allegiances and he affirms his undimmed faith in the longer term performance that will come from equities.
With his distinctive and definite approach to asset allocation, it is not too surprising to find that Winkler has some misgivings about the decision to outsource to a range of external managers around SFr800m. “So far some of the mandates are plus and some minus, and we have not made much money when you add the pluses to the minuses. We would have earned way more, if we had not done this (outsourcing).”
He queries to what extent the emerging markets mandates are necessary. “If you have Coca Cola you have good exposure to emerging markets. So my question is, why the need to do this? So if mandates are not achieving the performance compared to in-house, we have to think twice if we want to have money there.”
He agrees that his approach may have to do more with absolute than relative performance to a benchmark. So if the relevant index is down over the period and the external active manager is “just a half of a per cent better than being down, it does not help us. We have to have absolute plus performance.”
Winkler adds: “The problem is the staying power of a lot of pension fund managers. What we have is long term money which we are measuring against short term and take short-term actions. With long run money, if you are sure you are on the right track then stick to it and it should work out. If you have confidence in the companies, in their products and their management, keep them for the long run and you will be rewarded.”
A consequence of the PKE selection strategy is that the country allocation has been an irrelevance. “The country selection we have, depends on the stocks in the portfolio and because of this we have been overweight in the US, compared with the MSCI. This was not our intention, it just happened when we added up all our stocks. It also happened to be the market to be in for the past few years.”
When the PKE portfolio was started, there were no sector indices, so Winkler reckoned that the portfolio had to make sure that it at least did better than a global index, and the MSCI was chosen. “We said that if we did not beat that index over two to three years, we would stop!” If things had not worked out, the fund could have bought the index. Now, they are quite confident about out performing it. “If you really do your homework on a long run basis, you should have no problems in beating the index, as there are so many bad apples in the index,” he says.
The big outperformance within the portfolio came from those companies that did particularly well, which Winkler refers to as his “gorgeous stocks”. “We had some awful companies, that did not perform the way we expected. Every company in the portfolio is tracked against the in-dex to see if it outperfoms the index over the period. All companies, with one exception, were over the index in the time frame. If every company is above the index you will be fine.”
On the question of the volatility within this portfolio, Winkler expresses surprise that it was on the low side. “I thought since we were taking huge bet sin a number of stocks, the volatility would be great. But we were living at a time when a lot of investors took to the large cap stocks. The volatility was low as they were going in one direction - pretty steadily upward.” But he found that when the market went down the portfolio outperformed the correction. “In those circumstances, everyone wants to have the good companies and they were bought on the downturn, being seen as good buying opportunities.
“This did help to keep volatility on the low side, though this situation may not remain the same. But I am not focused on the volatility, as we have to make money in the long run. In fact, I think the goal is absolute performance.”
He thinks it is essential to have a substantial volatility reserve within the fund. “I would argue that we need a 20 to 25% volatility reserve in order to have an aggressive strategy, with the rest of the surplus being distributed to members.”
So far the fund has had no negative years of return since 1991, though there were years when the index was down. “The worst year was 1993, when the index was down and we were 7.7% positive.” So financially the fund is a healthy position and last year the overall contribution rate was reduced from 15% of pay to 10%. “For this you get 80% of final salary, fully indexed.”
The scheme has noticed the impact of greater life expectancy among its 6,000 pensioners. “Each year, people are living upwards of one month longer. In eight years’ time people are living a whole year longer and this has to be paid by the fund,” acknowledges Winkler.
The external managers are split among six satellite mandates, covering the Sfr800m: US small cap (UBS Brinson and Prudential Investments); European small cap (Flemings, Robeco and Morgan Grenfell); emerging markets (Flemings, SEI Investments and Templeton); Asian Pacific Rim (Nikko Global, SG Yamaichi and Guyerzeller Bank); commodities (Wellington and Prudential Investments).
In addition, there are two venture capital mandates with Hamilton Lane and Advent. This is a relatively new departure for PKE with a commitment of Sfr150m being made, but only around Sfr55m or so drawn down, as the investments are made. “For us, this is a new territory and we have to see what happens. Does it have lower volatility and higher returns expected?”
Winkler said PKE decided to go with partnerships rather than funds, which he regards as investment for a lifetime, compared with the limited period set down in a partnership. “There is a clear cash flow programme, as at the end of day the partnership will be liquidated.” He also thinks that the costs with funds can be exorbitant. “You pay too much commission for handling cash.” Now, quite a few fund promoters are coming to Switzerland, often with high commission structures.
PKE’s real estate and mortgage portfolio is around the normal benchmark for pension funds at 12.5 to 15%. “For bonds our normal weighting is 35%, with the duration there a bit below our bench mark.” On the custody side the main services are provided by Credit Suisse, with Northern Trust looking after for emerging markets and some other areas. “By the end of this year we may just have one custodian.”
Credit Suisse provides the investment performance figures as well as carrying out attribution analysis. “We would not want this done on an in-house program. Because if you make a mistake you are killed!” He says the aim is to be very transparent about everything that is being done. “We want everyone to see what we are doing.” It was with this motivation that PKE made its move to put its performance data on to its website. Next year the annual report will be put on. “We have been overwhelmed by the response.” Currently, English and French language versions of the site are under construction.
Another plan is to put all the fund’s real estate department’s empty apartments on the net with a picture of how it looks. “So people do not have to go and see the apartment every time, people will only come to the real estate department when they are really interested. This will help cut advertising costs down and help with ‘house calls’.”
Ultimately, Winkler sees potential for the internet being a trading instrument. In the long run there will be much competition coming from the net. “You may have trades through the net or pension funds doing cross trades direct on the net. I think it will change things dramatically in the longer term.”
For PKE, the hope is that the restructuring within the Swiss utilities sector will mean that energy or water companies will decide to come in under the fund’s umbrella. “Our aim is to give the best performance at the lowest cost for the money they pay,” says Winkler.