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Adding extra alternatives

A push towards alternatives and foreign assets has become more pronounced among Swiss pension institutions.

“We started using commodities last year and added hedge funds to our alternatives portfolio this year,” says Daniel Gloor, head of asset management at BVK, the Pensionskasse for civil servants in the canton of Zürich.

Alternative assets, including private equity, now make up 8.1% of the fund’s portfolio, more than doubling last year’s exposure. The strategic quota for 2007 is 8.4%.

BVK is just one example. According to Credit Suisse’s pension fund index for Switzerland, the share of alternatives among the CHF635bn (€386.5bn) in aggregated pension assets in-creased to 4.2% in the first half of 2007 from 3% at the end of last year.

“The use of commodities has tripled to 0.6% from 0.2%,” Michael Brandenberger, chief executive of Swiss consultancy Complementa, says. “With a few exceptions, the larger pension funds started investing in commodity indices from 2005 and now the smaller ones are following. Over the last year, the product offering has broadened and pension funds have more choice.”

Pension funds that had commodities in their portfolio for the whole of 2006 saw good returns from the asset class.

“Equities, especially those listed in Switzerland, performed best followed by commodities and hedge funds,” Brandenberger notes. Similar performance trends were seen for the first half of 2007.

However, BVK was less fortunate. Commodities disappointed as the pension fund only started its investment in the latter half of 2006 when commodities went down.

This year, Gloor expects the 1.7% private equity portfolio to underperform as this asset class needs several years to build up. Similarly, the 3.7% commodities exposure might perform less than the benchmark but better than last year.

“With our 3% hedge fund portfolio we are on track but nothing is certain yet,” says Gloor.

The long-term strategic allocation for the alternatives portfolio is 13% but Gloor explains this will take time. “For example, we currently have 16 different investments in funds of hedge funds to achieve broad diversification,” he says. “In our core/satellite approach we might be looking to add single hedge fund managers but this will certainly take some time because as a public Pensionskasse you need to first convince politicians and raise their confidence in the investment.”

The annual survey of Swiss pension funds by asset manager Swisscanto shows the push towards alternatives is mainly due to public Pensionskassen catching up with their private counterparts. While the exposure to alternative assets among private pension funds remained unchanged from last year at 5.8%, public pension funds increased their usage of these asset classes to 3.4% from 2.9%.

“For our pension funds it usually takes one or two years to get from the analysis and the recommendation to the governmental approval,” Gloor explains.

Diversification is also sought in geographical terms, especially in real estate investments that are not counted among alternative assets in Switzerland. “Currently, foreign property makes up 1% of our investments compared to 16% in Swiss property,” Gloor says. “We want to increase the foreign share to 2% and eventually 4% by 2010.”

Apart from the diversification benefit, the reason behind the shift lies in the restrictedness of the Swiss market. “There is a certain cluster risk in having all your investments in direct Swiss property,” Gloor says. “However, we currently also have the problem that we cannot invest the sum we want in Swiss property to returns we would expect.

“Foreign investors in the Swiss market content themselves with quite low returns, which increases competition.” Last year BVK only managed to invest CHF100m, half of the earmarked sum, in Swiss property. On average, investment in foreign property among Swiss pension funds increased to 1.2% from 0.8% over the last year. “This is certainly a trend that will continue,” says Brandenberger. “New direct investments in property are becoming rarer and real estate funds cost a lot because of high risk premiums.

Therefore, Pensionskassen are looking for alternatives. The tendency is towards global diversification but currently products with a European bias are the most popular.”

Pensionskassen are also reducing their domestic overweight in other asset classes. “Currently around 40% of the equity investments are in Swiss shares but it is getting less,” Brandenberger notes. “Looking at the historic performance of Swiss equities there is no need to reduce the domestic bias but it makes sense to diversify the portfolio.”

“Because of the lower market liquidity, 80% of our Swiss equity mandates are indexed,” says Gloor. “The rest of the equity portfolio, which makes up 30% of the total investments, is divided into 65% indexed and 35% actively managed mandates. “Our main aim is to increase the funding level further over the next years.”

Last year BVK passed the full-funding mark for the first time since 2002 and now stands at 104%.

In 2006 the number of underfunded public pension funds decreased to 9.8% from 10.6% while 2.1% of private pension funds remained below the full funding level both in 2005 and 2006.

For its planned conversion into a foundation BVK needs 110% to include necessary reserves. The implementation of enabling legislation is planned for 2009 but Gloor doubts this will hold. “Depending on the development on the financial markets this will take another two or three years.”

For this year, BVK expects a return of around 5.6%.

Brandenberger notes that final figures for this year will mainly be influenced by the equity markets but he foresees chances for good returns.

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