Last and this year have been marked by the third stage in the implementation of the up-dated legislation on occupational pension (BVG, BVV2 Ordinance in German, respectively LPP and OPP2 Ordinance in French). It is the first time since the introduction of an ad-hoc legislation on pensions in Switzerland, in 1985, that the legal framework was thoroughly revised, with far reaching consequences for investments, too. Here are the major changes:
❑ Detailed rules regarding the creation and management of pension schemes for specific group of employees;
❑ Possibility of offering tailor-made investment schemes and solutions to small groups of pension fund members: This is a step in the direction of more individualised investment formulas, although the authorities have confirmed their reluctance to promote fully fledged individualised solutions in the framework of the second pillar - equivalent to 401k plans in the US- to avoid excessive management and product distribution costs to employees;
❑ More stringent rules for group insurance schemes: These are likely to promote competition from independent providers in the market segment of group insurance schemes for small and middle-size companies, a market segment still very much dominated by Swiss insurers;
❑ Stronger emphasis on education among trustees, including investment matters: The revised legislation recognises the importance of education for pension trustees and aims at improving their knowledge in investment matters;
❑ Improved information to employees, scheme members and retirees;
❑ Transparency and accountability in pension funds reporting: The new legislation has made compulsory more stringent accounting and reporting rules - all assets have to be booked at market values, building and using specific reserves has been standardised - which allow a systematic comparability among funds and enhance transparency in investments;
❑ New rules on ethical behaviour in investment matters: The need and adequacy of such rules - but possibly their practical limits, too - were demonstrated by the so-called Swissfirst scandal.
Tax rules influence investments implementation by pension funds
Over the last few years, changes in the fiscal framework had as well a dramatic influence on the way Swiss pension funds implement their investments. Contrary to non-domestic institutional investors, all Swiss pension funds - and even the first-pillar Swiss Fund for Retirement and Disability (AHV-Sicherheitsfonds) - are subject to the Swiss stamp duty when acquiring and selling securities directly.
Most larger pension funds have addressed the issue in two ways, in order to save taxes:
❑ some have simply transferred assets managed in discretionary mandates to mutual funds, therefore providing a strong support to the mutual funds industry;
❑ others have created their own, in-house institutional funds with the technical assistance of domestic fund providers and global custodians.
As a consequence, a much larger proportion of Swiss pension assets is now managed in mutual or institutional funds, whereas collective investment trusts for pension funds (Anlagestiftungen, fondations d’investissements), still subject to less favourable tax conditions, have suffered.
Most pension funds achieved outstanding performances in 2005 with average performance in CHF terms of around 11%,largely boosted by impressive returns in domestic and non-domestic equities, direct and indirect real estate, private equity and commodities. These results contributed much to a significant improvement in pension funds financial equilibrium, measured by the so-called ‘coverage ratio’. In the private sector, the relevant ratio is now on average close to 108%, around 98% in public sector funds, which are allowed to run a technical deficit, though for these more stringent regulations are expected in 2007.
Reserves for asset fluctuations - to compensate for asset losses due to adverse market conditions - have been rebuilt since 2003, to reach 10% at the end of 2005, but are still below the target rate of 15%.
At the same time, many pension funds are much concerned by the level of the so-called ‘conversion rate’ - the rate used to convert the final value of individual assets in a pension annuity - which they feel is too high, hampering their financial equilibrium. Overall, the financial equilibrium of most funds is now satisfactory, but not yet fully sufficient.
In the first half of 2006, average securities performance - equities, bonds, and cash - was slightly below 0%, the total fund performance being improved by the positive returns of domestic direct real estate. Strong market performances of stocks and bonds in July and August improved overall performance - probably up to 4% or 5% in total at mid-September. Nevertheless, the authorities have decided to keep for 2007 the level of the minimum technical interest rate - used in compulsory pension plans to compute the final value of individual savings accounts - at 2.5%. Swiss pension funds asset allocations do not move much over the years and change only gradually.
On average, the allocation is made up of five asset groups: cash (5% of total allocation), domestic and non-domestic bonds (less than 40%), equities (30% - among which non-domestic now exceed domestic ones, a remarkable trend), domestic direct and indirect real estate and mortgages (less than 20%) and non-traditional investments (7%). Over the last few years, alternative investments have gained ground, mainly commodities, private equity and - newly - international indirect real estate, but their overall share is still small. Hedge funds, the largest alternative asset class, have delivered poor performance.
There is much interest and demand for plain and enhanced indexing, while the trend for international investments - equities, bonds in foreign currencies, real estate - goes on unabated, often complemented by currency hedging or currency overlay solutions.
In July of this year, the Swissfirst scandal burst in the Swiss pension scene like thunder and lightning in a clear blue sky - and has remained in the media and the political headlines ever since. Swissfirst is a small bank created at the beginning of the 1990s, a significant part of its business being made up of block trading - ie brokerage - in Swiss small and midcap stocks on behalf of Swiss institutional investors. In September 2005, the bank merged with another one, to become the ‘new’ and larger Swissfirst bank.
To bring together a majority of shareholders votes, the bank CEO appears to have contacted a number of its major pension fund clients, to require them to sell all or part of their holdings in order to make the merger possible. When it went through and was made public, the bank’s shares rose sharply, bringing a nice profit to its private shareholders … but not the pension funds who had sold their stakes. Although the involved pension funds did not suffer a direct loss - actually, most of them had brought the stock at a lower price and did even achieve a gain - some media claimed the opportunity loss to the funds and their members, estimated to be around CHF30m (€18.9m), was unacceptable and documented poor business practices among Swiss pension funds.
Actually, more than the occasional opportunity loss suffered by the funds - pension managers can hardly be blamed for selling positions in a small cap when circumstances arise which may influence the stock price - it is the fact that some pension managers with close ties to Swissfirst seem to have made a fortune that provoked distrust.
The suspicion has emerged that some managers may have benefited from kickbacks or insider tips to practice front or parallel running. Although comparable situations are exceptional, a cloud of suspicion is now surrounding the pension community.
The running investigations and indictments will show if something indeed went wrong, what and to which extent. At the same time, the likely consequences of the scandal can already be sketched - whether anyone is eventually found guilty or not.
The pension fund supervision, now mainly in the hands of the Cantons, will be strengthened, standardised and centralised. Claims for enhanced transparency among pension fund managers may even lead to full disclosure of individual bank accounts - which would not support the recruiting of new trustees. At the same time, requirements for improved trustee qualifications and professionalism will lead over time to more pension fund mergers and to a reduction in their number. With some 2,500 registered funds, the average size of Swiss pension funds is relatively small.
More significant threats are the loss in public confidence - which might disadvantage institutions of the second pillar with respect to the first financed on a pay-as-you-go system. There could be a flush of new pension legislation, which will inevitably lead to higher administration costs, to the disadvantage of fund members. Also, loud and revived calls for full pension individualisation will be heard, which would hit single fund members in the form of excessive costs and would most probably imply a radical change in the nature of the system.
Graziano Lusenti is an accredited Swiss pension actuary, investment consultant and managing partner, Lusenti Partners, based in Nyon, firstname.lastname@example.org. The firm is organiser and editor of the Swiss Institutional Survey (www.institutionalsurvey.ch)