Question of controlling
Unlike in other European countries where investment consultancy is a tough sell, its practitioners in Switzerland are in heavy demand among institutional clients.
According to rough estimates, consultants advise more than two-thirds of Swiss pension funds, which collectively have €320bn to invest.
And often such mandates are not just for a single project but are for the long term.
But while the Swiss environment can seem enviable compared with other European markets, what is the wind beneath the Swiss consultants’ wings? To a large extent it is so-called ‘investment controlling’ (IC).
A retained mandate, IC entails analysis of performance data with respect to investment goals, frequent evaluation of the investment strategy, risk management and compliance with legal requirements.
“There are several key elements,” says Beat Zaugg, head of investment consulting at Watson Wyatt in Zurich, Investment strategy. “These include compliance, including mandate, investment guidelines and regulation; mandate performance; manager watch, including qualitative monitoring of the organisation, its processes and people; and cost control.”
While Swiss pension funds, or Pensionskassen, employ capital market professionals, their boards have come to believe that in order for them to best meet their liabilities, nothing beats professional advice from the outside. This does not mean that professionals at the funds only perform the physical task of investing. But while they may be involved in controlling the portfolio, the funds’ boards prefer, and are willing to pay for, additional security. “Precisely because they lack the know-how, investment controlling is a crucial service for many Swiss pension funds,” says Michael Brandenberger, chief operating officer at St Gallen-based Complementa. “From a cost perspective, it makes more sense to buy the service externally than to hire specialists.”
And IC is widespread. Industry experts say that Complementa and its leading domestic rival PPCmetrics have a few hundred running mandates for the service and they put pension fund demand for IC at around CHF300bn (€190bn). Most other Swiss-based consultancies provide IC, including foreign firms Watson Wyatt, Mercer and Aon Chuard and smaller Swiss players like Ecofin and Lusenti-Partners.
Andreas Reichlin, managing partner at PPC metrics in Zurich, observes that IC is the best way to prevent a conflict of interest at a pension fund. “Controlling internally is not recommended
if the same people are involved in both managing the assets and controlling them,” he says. “The independence, specialisation, experience and overview of the markets are compelling reasons for external investment controllers.”
BVK, a pension fund for Zurich-based civil servants that has €11.3bn under management, agrees with the two consultants’ assessment of why the service has become so entrenched.
“A public fund like ours simply cannot offer the kinds of competitive salaries that are offered to investment professionals in the private sector,” says Daniel Gloor, head of portfolio management at BVK. “Beyond that, professional controlling with respect to performance measurement and benchmarks requires an extensive database which is a lot cheaper to procure externally.”
BVK has retained Complementa for IC since 1991 and Gloor says that the consultant has fulfilled the fund’s expectations every year since then. He adds that while IC can help to maximise BVK’s returns, that is secondary to the primary goal of meeting its liabilities.
Brandenberger also notes that investment controlling is crucial to Swiss schemes for legal reasons. “If anything goes wrong at a fund, controlling makes it easier to see what the reasons were and this can help reduce legal liability,” he says.
Regulation in Switzerland is considerably lighter than in neighbouring Germany. Whereas German Pensionskassen face such investment restrictions as a 35% cap on equity investment and a 5% ceiling on hedge fund investments, those in Switzerland follow the ‘prudent man’ rule, defined as investing as would a prudent man of discretion and intelligence seeking a reasonable income and the preservation of his capital. This relative absence of regulation, and the possible security that goes with it, makes it crucial for Swiss pension funds to get their investing right. This is an ideal environment for IC. However, IC’s predominance can also be a trap for a consultant. And this is one reason why the Swiss market is not as ideal as first appearances might suggest. By agreeing to control a fund’s investments, a consultant takes on an enormous responsibility. They will, for example, actively participate in investment committee meetings – a scenario that is almost unheard of for a German consultant.
As Aon Chuard recently found there is a danger that if things go wrong at a fund the consultant could be sued.
Last summer, a Swiss parliamentary committee partly blamed Aon Chuard for a reckless investment strategy at BLVK, a pension fund for teachers in Berne. According to the committee, in the late 1990s a forerunner of Aon Chuard advised BLVK to adopt an aggressive stance toward equities. This strategy led to disaster when markets crashed in 2000 and the scheme is still trying to close a deficit equalling one-fifth of its CHF5.4bn in assets.
The committee said the fund was chiefly to blame for the disaster and recommended BLVK take Aon Chuard to court. The consultancy rejected any responsibility and BLVK has not taken further action.
Nevertheless, competition in the IC sector is fierce. Zaugg points out that global custodians are adding to the pressure by offering IC-type services.
The custodians’ move is clever. Acting as the clearer for a Swiss pension fund, the custodian has full knowledge of all financial transactions, making it attractive for the fund
from a cost perspective for the custodian to analyse the data with respect to risk management and investment goals. However, industry experts note that custodians do not yet pose a threat to the consultants’ IC cash cow. “Swiss pension funds are still going with the consultant for IC, because the fact is the quality of reporting is often very poor,” according to an asset manager who does not wish to be identified.
But the cosy Swiss environment could be disturbed by an external challenge. Earlier this year German consultant FERI announced its intention to enter the Swiss market during 2006. Although it is not yet clear how this will be done – whether through opening a local office, acquiring or partnering a Swiss consultant or by sending consultants from Germany – industry experts say that IC would have to be part of its arsenal if it wants to establish itself in Switzerland.
Conversely, the limited number of Swiss schemes has led Complementa and PPCmetrics to consider entering Germany, whose Pensionkassen market is about €100bn larger than that of Switzerland. And a central plank of their expansion plan is to offer IC to German pension funds.