Richard Bruyère presents the results of Image & Finance’s latest research covering the institutional market in Switzerland
With more than CHF1.2trn (€976bn) in institutional assets at year-end 2012, including both pension institutions and insurance companies, Switzerland is a major asset management market in continental Europe. Like other markets, it faces unprecedented challenges due to the current financial environment – such as zero interest rates – as well as the need to reform second-pillar pensions.
These challenges and evolutions are highlighted in our latest research report analysing business development opportunities for third-party asset managers in the Swiss institutional market. The panel of the 2013 Image & Finance market research encompasses 168 institutional investors, including:
• 113 pension institutions (including public and private pension funds as well as collective and common foundations);
• 15 investment foundations (excluding real estate investment foundations);
• 40 insurance companies (either regulated by FINMA, the health authorities or by canton).
These 168 institutions collectively manage over CHF1.06trn. They delegate a quarter of their investments to third-party asset managers (CHF270bn in total).
After real estate, where next?
As in the rest of the developed world, the decline in interest rates over recent years, especially in domestic bonds, has been the major structural factor for institutional asset allocation.
Since the onset of the European debt crisis three years ago, sovereign debt classification has been redefined drastically across major developed countries. This has led to the rarefaction of risk-free assets among the fixed income world. Even though Swiss government bonds may not offer the same depth as US Treasury-bonds or German Bunds, they do qualify as risk-free.
As a result, yields currently available on these issues are touching zero. In light of these evolutions, Swiss institutional investors have had to adapt their strategic allocations in their quest for yield.
The straightforward answer has been to use domestic real estate as a substitute for bonds. This asset class, as a proportion of total investments, has significantly increased in all segments, and especially at investment foundations. So strong has the appetite for real estate been that some pension institutions are pleading for a relaxation of BVV2/OPP2 investment constraints. It is worth noting that the Swiss government recommended maintaining the current allocation limits in the 2011 report on the future of the second pillar*.
Unlike their European counterparts, which have piled into US or euro credit, high yield and emerging debt, international fixed income diversification has not been particularly helpful for Swiss institutions. This is due to the ever-increasing strength of the domestic currency.
Indeed, Swiss equities and local real estate have been the best-performing asset classes over the past decade for Swiss currency investors. However, as both markets are characterised by a relative lack of depth, a sense of ‘overheating’ seems to be dawning in the institutional market. ‘Where next?’ therefore appears as the key question today.
In the real estate sector, the relative scarcity of supply in the domestic market has led institutions to look for other investments:
• While core demand has been focused on the residential market, the lack of availability means that investors are more and more looking at commercial real estate or mixed products;
• New products have been launched, such as mortgage investment groups that attract growing pension inflows;
• International diversification is still not perceived as an adequate substitute as real estate investments are primarily domestic.
In addition, institutional demand is quite likely to grow further in asset classes such as:
• Emerging markets (both debt and equity);
• Convertible bonds;
• Infrastructure, renewable energy and microfinance;
• Insurance-linked securities.
On the other hand, a revival in alternative investments (particularly funds of hedge funds) is very unlikely.
Finally, it remains to be seen whether Swiss institutions will replicate the strategy of their European counterparts and follow the ‘private debt’ (loans, private bond placements) diversification trail.
Pension funds in the line of fire
With almost CHF800bn in assets, pension funds represent the largest institutional market segment for asset managers. They are facing more administrative and regulatory burdens.
As a result, the two major trends that characterise the Swiss pension institutions market are likely to continue.
• Consolidation: In the Swiss pension fund market, the consolidation process is likely to go on as the administrative and responsibility burdens keep increasing. These act as a deterrent for small companies, which prefer to liquidate their previously autonomous pension fund and outsource it to collective foundation schemes or insurance companies.
The Swiss pension fund landscape is therefore likely to become less fragmented. To some extent, consolidation is positive for asset managers, because it reduces unit client acquisition cost, and offers more potential for standardised solutions (such as indexing) and niche products. On the other hand, size will become more of an issue for asset managers. Larger pension institutions are more likely to select asset managers with higher levels of assets under management and a broader range of expertise. Consolidation should also play on the pricing of asset management services, which has been in the eye of the storm for the past three years.
• Focus on cost control: The question of the relative cost efficiency of Swiss pension institutions has taken centre stage over the past three years. In the referendum of 7 March 2010, the Swiss people rejected a proposal to lower the pension conversion rate. One of the reasons for this outcome was the controversy that erupted during the campaign about second- pillar costs and, more particularly, asset management costs.
A number of high-profile reports have shed light on this issue since 2010. Their conclusions have strengthened the case for passive investments, unanimously viewed as less expensive than active asset management. In addition, they have highlighted the inadequacy of a significant allocation to alternative investments.
Driven by investment consultants, the conversion to index-tracking at pension institutions should therefore remain widespread.
Another consequence of this debate is increased transparency expectations with regard to fees and pricing structures (rebates) from asset managers and intermediaries.
In light of the above, the capacity of asset managers to adapt to local specifics and market developments appears key in their ability to compete for assets. There is room for growth and profitability in the Swiss institutional market, provided asset managers build the required on-the-ground presence, promote a clearly differentiated offering and take a long-term view to success.
Richard Bruyère is president of Image & Finance, an INDEFI Group company
* ‘Bericht Zukunft 2. Säule’/ “Rapport du Conseil fédéral à l’attention de l’Assemblée fédérale sur l’avenir du 2ème pilier”, December 2011.