The challenges facing some of Switzerland’s largest pension funds on the investment front vary greatly given widely differing coverage ratios.
The Civil Service Insurance Fund for the Canton of Zurich (BVK) is at one end of the spectrum with a coverage ratio at end-July of 95%. Though up sharply on the figure of 91.4% recorded at the end of last year, it still means that the investment strategy cannot incorporate much risk.
“We want to increase our coverage step by step,” says Daniel Gloor, head of asset management at the fund. “The first aim is to achieve a coverage ratio of at least 100%.”
Currently, the fund is part of the directorate of finance but parliament decided back in 2003 that it should become independent and a new law requires that to become independent a fund should be fully funded.
“Within five-to-seven years we hope to have a coverage ratio of 105%,” Gloor continues. “At that point we would aim to become a separate legal entity – although this would change nothing in terms of day-to-day management.”
The improvement in coverage is thanks to significant improvement in the return, which was 6.4% for the year to July compared with 4% recorded for the whole of 2004. “Foreign and domestic equities have performed above the benchmark,” says Gloor. “However, state and other Swiss franc bonds performed below the benchmark because we were expecting interest rates to rise.”
To achieve growth the fund will remain with an allocation to equities of around 26%. “Any more would be against our risk control strategy.”
He adds: “Risk management will be the key focus of our investment strategy for the coming year. With this in mind further diversification - into commodities for example - will be key.”
At the other end of the spectrum is the City of Zurich fund with its stable coverage ratio of 126%. This is reflected in the higher allocation to riskier assets, among them equities which account for 44% of the fund. “We also have a 2.5% allocation to commodities which performed very well,” says Monika Lauber, deputy head of asset management at the fund. “Private equity also did well this first half year.”
Lauber outlines the way ahead: “We are in the process of increasing the allocation to hedge funds and move into emerging market equities and bonds. We are comfortable so we can take risk.” She adds: “We will also move to passive management those areas of traditional active management where active management has not added value.”
A further contrast can be found in the Novartis fund which despite a coverage ratio of 128% had an allocation to equities of just 9% at the end of last year. The return of the fund was 4.6% for the year to July compared with 2.6% for 2004. “Most of the performance for other funds came from the allocation to equities,” says, pension fund manager Gino Pfister. “Nevertheless we remain conservative to protect the coverage.”
A significant part of the pensions landscape in Switzerland, the size of the local market and the lack of movement results in considerable illiquidity and poor diversification. So a need to diversify risk is a clear trend, and real estate is a key part of this development.
In 2003 the Novartis fund moved from direct to indirect real estate investment. “Our investments were too centred around Basel,” says Pfister. “Investing in a fund has improved the risk diversification. More and more funds are doing this which increases liquidity and reduces the cost of entry and exit.”
Over the years the Novartis group as been through a number of mergers and splits. “This is a problem when you have direct real estate investments because they cannot be split easily,” Pfister adds.
But the funds are too illiquid for some. “We invest in a European and a North American fund,” says Lauber at the City of Zurich fund. “These are more liquid than the local funds and we are hoping to increase our allocation. The local funds have limited investment opportunities.” The fund’s allocation to real estate currently stands at 10%.
Meanwhile the Zurich civil servants’ fund has set up a special investment vehicle, an Anlagestiftung, to invest in foreign real estate. “We need more diversification in this sector,” says Gloor. “But it is a long-term project and we have to wait four-to-five years until we start to earn something from this.” Currently the fund has an 18% allocation to real estate.
Regulations limit investments in foreign assets to 30% of a total portfolio but given sufficient coverage and sponsor guarantees a fund can apply to the local state administration for an increase of this and other limits.
Pension funds are also worried about demographic issues. The problem is made more acute in Switzerland by historically low interest rates for locally issued – and particularly government – bonds. “In the long run we expect interest rates to be higher than they are now,” says Pfister. “If they remain low for long there will be a problem meeting the pension obligations and the challenge of longer life expectancy.”
Gloor agrees on the life expectancy issue, although is keen to stress that the ratio of active members to pensioners is still favourable at four to one.
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