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The pension scheme of the City of Zurich is going to put Sfr750m ($520m) in alternative non-traditional investments. With this sort of sum, the Pensions-kasse der Stadt Zurich (PZK) be-comes the biggest pensions in-vestor in such investments, which are much discussed in Switzerland,but little used.

A tranche amounting to Sfr250m has already been allocated to private equity, mainly in the US, and PZK is now searching for opportunities in hedge fund and commodities investments.

PZK director Armin Braun says the scheme will invest 7.5% of its Sfr10bn assets in alternative in-vestments, though the quota available ranges from zero to 10%. The investment programme has not yet started because of the high values in stockmarkets, but it is the the last phase of the fund's new investment strategy, which has been introduced step by step since 1994.

Braun has spent considerable time explaining and educating the members of fund's board about these investments, since they are not finance professionals. A specially designed brochure shows all the nasty risk associated with hedge funds. The board must know that bankruptcies can happen," he says. "If they cannot live with such scenarios, then they should not agree to invest."

In fact , PZK is expecting to lower the risk of its portfolio by such moves. It examined periods of high and rising interest rates, of high inflation, and of crashing stock markets, involving extreme situations that could endanger the solvency of the scheme. PZK's advisers Ecofin in Zurich then tested the long-term behaviour for non traditional investments in all of the periods. This 'stress test' showed that alternative investments brought positive historic re-turns and consequently reduced the losses in other assets in poor times. Although, the historical data for some categories is insufficient, Braun believes that the test is a solid enough basis.

Ecofin has calculated that based on historic figures, non-traditional investments could improve the long-term annual return on the fund from 6.8% to7.1%. The small impact that is made is be-cause of the relatively small proportion of these investments. But in making longer term projections, PZK makes its calculations on the basis of a return of 6.6% pa only. The lower expectations are due mainly to lower interest returns. Braun expects that even with alternative investments the re-turns will be lower than in the past. In his experience, the huge in-flows of money drives investment costs higher and can even make it impossible to invest, as fund managers close their doors to new in-vestors. So that even institutional investors find they are not welcome anywhere.

Braun thinks that the returns on commodities will fall because the cash inflow will reduce 'backward-isation', which has been an important part of performance until now. So the past returns obtained by commodities averaging 9.1% in Swiss franc terms turns out to be only 6% in a more conservatively budgeted forecast. Hedge funds, managed futures and private eq-uity are expected to perform at around 10%.

Overall, the new investments will reduce the fund's fixed income portfolio. But PZK is also cutting back on its Swiss equity holdings, as the index weighting of blue chips, such as Novartis, Roche and Nestlé, is judged to be too risky."

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