Full speed ahead
A €2.6bn pension fund will look after CERN's scientists long after they have finished their minute inspection of the universe using the Large Hadron Collider. Nina Röhrbein visited Christian Cuénoud, the fund's retiring administrator
Situated near Geneva, where it spans the border between Switzerland and France about 100m underground, the Large Hadron Collider is a gigantic scientific instrument created by the European Centre for Nuclear Research (CERN). The particle accelerator is used by physicists to study the smallest known particles - the fundamental building blocks of all things.
It is an international project, exempt from the rules of Swiss authorities, and this is also reflected in the way its pension fund is run.
Although officially based in Switzerland, receiving contributions and paying out benefits in Swiss francs, it is anything but another Swiss pension fund.
Right from its foundation in 1956, the CERN pension fund was a separate capitalised fund but without a separate legal identity. It also comprises the pension fund of the Munich-based European Southern Observatory (ESO), with each organisation guaranteeing the benefits acquired under the system.
Its international position means CERN employees are not covered by one specific national security system, and so the pension fund needs to be able to accommodate both their first and second pillar pension.
It pays out 2% of the final reference salary per year of employment, meaning that after 35 years, retirees would receive a maximum of 70% of their final reference salary.
The pension fund recently underwent changes to its governance structure.
Until September 2007, it used to have 10 permanent board members topped with 10 alternates.
This has been downsized to 10 members only, who meet six to seven times a year and report to the Council of CERN Member States. In 2007, a representative of the pensioners joined the board as well as two external experts, currently one from Switzerland and one from the UK. Other members include representatives of the staff association of CERN (2) and ESO (1), the management of CERN (1) and the member states (2 for CERN, 1 for ESO).
The pension fund's investment committee consists of five people - the general manager of the pension fund, two external experts and one representative each of management and of the staff association - and meets every two months.
An actuarial committee responsible for managing the liabilities of the fund has been decided upon but has yet to be created.
According to Christian Cuénoud, retiring administrator of the CERN pension fund, the change in the governance structure was necessary to increase the efficiency and transparency of the fund. "As the members of the CERN Council, the final guarantors of pensions are not professionals in the pension fund business, it is important to get the best professional advice possible," he adds. "To some extent, a smaller board also takes decisions more easily and effectively."
However, in terms of managing its money, the pension fund is not too different from other Swiss or international pension funds.
It manages its European bond and equity portfolios as well as its commodities, private equity exposure and currency overlay internally.
The management of all other asset classes such as European and US small cap, Japanese equities, European large caps and corporate bonds is outsourced. It also has advisers for its commodities and private equity investments, the latter of which tends to be done through direct funds. "So far the fund has been very successful with its private equity investments, which concentrates on medium-sized companies, both on the venture and buyout side," says Cuénoud.
Fixed income portfolio makes up 40% of the fund's strategic asset allocation. Equities make up another 40%, real estate 13% and alternatives 7%, topped up with some cash.
Internally managed European government bonds worth CHF700m form the majority of the fixed income portfolio, while CHF190m make up the externally managed corporate bond portfolio. Although the scheme substantially added to its corporate bond portfolio in early 2009, it is currently still underweight corporate bonds.
"Despite the fact that we pay out the pensions in Swiss francs, we have no Swiss bias," says Cuénoud. "Most of our assets are euro-denominated, even in our CHF532m direct real estate portfolio, where the French share is larger than the CHF140m Swiss one. We are very much in favour of direct real estate, as property funds have more of an equity bias. We mainly invest in commercial real estate but also own some forests and a farm in the UK."
The scheme has invested in private equity since 1993. Absolute return strategies were introduced in 2003 with the aim of lowering the volatility of the overall portfolio. And so the strategic benchmarks set for alternatives are 10% absolute return strategies, 2% private equity and 2% commodities.
But the scheme has always been a great believer in tactical asset allocation.
"Our tactical approach has enabled us to outperform the Swiss pension fund average by 75bp annualised over the last seven years," says Cuénoud. "For that purpose, the fund mainly uses derivatives without leverage.
"At 1.2% we are currently slightly under-invested in commodities. We took a tactical view on our asset allocation and substantially reduced the commodities portfolio at the beginning of 2008. We gradually reinvested in commodities in 2009, achieving a higher than 20% commodities return in 2009 as a result."
The pension fund's equity allocation consists of 13% European, 14% North American, 7% Pacific and 6% emerging markets equities.
"Since the beginning of March 2009 we have been increasing our equity allocation and are overweight North America and Europe but underweight Japan at present," says Cuénoud. "With 6.2%, we are also overweight emerging markets. This tactical game has helped us achieve a performance of 11%-plus since the beginning of last year."
Cuénoud says the negative performance of 19% in 2008 mainly arose from the fund's equity allocation although it had been reduced from as early as the second quarter of 2007. "It was a straightforward decrease in the value of our equity portfolio," says Cuénoud. "We suffered no other side effects as sub-prime portfolios, collateralised debt obligations (CDOs) and credit default swaps (CDS) were not part of our strategy.
"But the landscape for pension funds has changed as a result of the crisis. We have to look again at the way we invest and the risk we take, while at the same the time it has become more difficult to generate big returns."
Generating large returns is particularly important as the pension fund's five-year rolling return stood at 2.1% at the end of 2008 - compared to its long-term return target of 5%. "But I am still confident that an annualised return of 5% can be achieved over the long-term, especially by taking appropriate tactical views," says Cuénoud.
To achieve this target, the pension fund is in the process of trying better to secure the downside risk of the portfolio by implementing a hedge strategy, which would result in an asymmetric risk profile that can still provide a decent performance, according to Cuénoud. "Because even with an 11% return in 2009, we can only increase our 63% funding ratio by some 2%. In reality, this underfunding can only be addressed with a rise in regular contributions, special contributions or a change in pension fund regulations. We are currently in the middle of establishing a long-term plan to address this.
"In consideration of the fund's situation it was already decided in 2005 that the pension fund no longer automatically adjusts pensions to the cost of living," continues Cuénoud. "Instead it must take into account the financial position of the fund. In other words, if the funding ratio is below 100%, pensioners will not get their full set of indexation rights until the plan recovers to a full funding level. However, to avoid a sharp cut in pension benefits, an under-indexation floor has been put in place which restricts the loss in purchasing power by pensioners to a maximum 8%. Other measures, which could be taken in the future, are, for example, raising the retirement age to 67 or using 1.8% accrued pension rights rather than the current 2% per annum."
The pension fund regularly composes a risk report, which is then given to the investment committee.
"We have improved the report recently in order to have a better view on value at risk (VaR) although we know that VaR does not take into consideration extreme situations like the ones of 2008," says Cuénoud. "We have also appointed a risk manager and work with our custodian in order to assess and also decompose the risk. Around 60% of our total risk originates in our equity portfolio, which makes up only 40% of the allocation. Currency is another factor of risk, as are price changes in the bond portfolio, which we manage with the help of our risk manager."
When it comes to its currency overlay, the scheme has different policies. Sterling and the yen are each hedged at 50%, the dollar is hedged at 70%, whereas the euro can be hedged between 0% and 100%. At present, the fund applies a 35% hedge against the euro.
"The euro and Swiss franc tend to be more closely related and stable, therefore, they do not need the same hedging policy as the other currencies," says Cuénoud.
The fund's most recent asset liability management (ALM) study was undertaken in 2006-07. At that time the firm delivering the study proposed the implementation of new strategies such as absolute return upon which the fund decided to gradually introduce 10% of absolute return strategies to its portfolio.
"In the meantime the crisis made all ALM models more or less useless," says Cuénoud. "We asked our ALM advisers for an update and were advised to become a bit more tactical in our asset allocation - that is why it was decided to increase our asset allocation in equities at the beginning of 2009 instead of moving more towards absolute return strategies."
The scheme's next ALM study is scheduled for 2010. In the future, the fund is likely to revisit its assumptions and to explore new asset classes and techniques.
"Perhaps we will increase our allocation to private equity, commodities or other non-conventional strategies," adds Cuénoud. "Our main challenge now is to add alpha in a sustainable way."