No longer running like clockwork
Like the country itself, the Swiss pension system has in the past been perceived as independent, prosperous and relatively unaffected by the vagaries of the outside world.
This impression, however, has been challenged in recent years by the prolonged fall in stock markets and the dramatic effect this has had on Swiss pension scheme funding levels.
A report in June this year by the Association of Swiss Pension Funds (ASIP) estimated that some two in five plans (43%) were technically underfunded.
The Swiss government’s response has been to slash the generous guarantees that once characterised the country’s supplementary pensions pillar. At the same time, a number of Swiss insurers have followed suit by cutting their annuity conversion rates (see box).
As Graziano Lusenti of Lusenti Partners LLC, a Nyon-based independent consultant, notes: “There has been some improvement in investment performance over the last quarter, but probably just short of half of all schemes are still underfunded. The deficit may not be dramatic in size, but it does mean pension funds have to act.”
To this end, Swiss schemes are currently negotiating with their 26 local regulators (Swiss pension funding rules are set at the kanton level) on funding stabilisation programmes.
Nonetheless, whether it is the unfamiliarity of present investment circumstances or the heterogeneous aspect of the Swiss pensions market (a combination of insured plans, pension foundations and autonomous schemes), there seems to be little consensus as to how Swiss pension plans are reacting.
As Lusenti notes: “What I see at the moment is that most people are puzzled about what to do next. I’m hearing suggestions for a much wider range of asset allocation and investment strategies, ranging from the conservative to the very aggressive.”
Giaocchino Puglia, vice president asset management at Lombard Odier Darier Hentsch (LODH), a former consultant himself, says he has yet to detect a “radical” change of asset allocation.
“It is coming progressively though. Strategy is now less focused on equity and market impact has driven down allocations and stopped any rebalancing.”
The issue, of course, is where the money is going.
With cash not yielding significantly and bonds at historical lows, the old favourite of Swiss pension funds, real estate, has come roaring back into fashion. Swiss investors certainly have a pedigree in bricks and mortar. Go back 20 years and the assets of Swiss pension funds were composed almost exclusively of Swiss bonds and real estate, with the latter being reduced hard during the bull market years for liquidity reasons.
Says Hans Jörg von Euw, head of client department and executive vice president at Swissca Portfolio Management in Zurich: “There has been a surge of interest in property. Besides CHF bonds it is the only asset class that has shone over the last two or three years, not just in terms of performance but also in terms of attracting new money.”
Mike McShee, managing director at Nyon-based consultant Pendia Associates, adds: “Pension funds mainly invest in direct real estate and that’s not new, but this is an asset class that is being rediscovered because you can get around 4-6% in income generation and on top of that the price has tended to go up with demand in big Swiss cities. Direct real estate is also quite stable for the portfolio and pension funds have been taking money out of equity to go here.”
McShee believes that schemes are now trying to find the best balance in terms of allocation and liquidity, and he points out that that in the current market a 20-30% portfolio tranche in property might not be considered unreasonable.
The other hot topic of debate amongst Swiss pension funds is hedge funds.
One reason is that current funding levels are pushing funds to look for clearer absolute return opportunities, spurred on in part by the success of high profile funds like Nestlé whose forays into alternatives in the late 1990s have proved successful.
Patrick Fenal, chief executive officer at Unigestion Asset Management: “Those pension funds that didn’t make the earlier moves to alternatives when the pickings were good and they had the allocations to do so, are now revisiting the area.
“Swiss pension funds in particular are looking carefully at long-short, once equity markets move. The reasons are pretty simple, long-short is easier to use and easier to explain, with almost none of the capacity constraints of other strategies. Importantly there is also little leverage involved, which is what pension funds are looking for.”
Udo von Werne, vice president at Pictet Asset Management in Zurich, agrees that absolute return strategies are high on the agenda for many pension funds, but adds that few schemes are willing to dedicate more than 3-5% to alternatives, which begs the question as to how effective such toe-in-the-water strategies can be.
He argues that discrepancies in the perception of risk in Switzerland are not helping here: “Currently you could have 50% in equities and no-one would say anything even if you were running much more risk than say having 10% in equity and 10% in hedge funds.
“Another problem with hedge funds still is that there is an increased responsibility for trustees because hedge funds are not always transparent and can be expensive. For good or bad, when pension funds compare the risk and return opportunities with hedge funds a lot of the time they decide not to do it.”
Nonetheless, the interest in hedge funds is prompting mainstream asset managers to look at what kind of product they can provide on the alternatives side. Von Werne says Pictet is looking at the hedge fund market to see where it has own alpha possibilities in-house: “I expect that we will launch a market-neutral fixed income fund and that we will do the same for long-short on the emerging markets side.”
While real estate and hedge fund investment may be the discussion topics of the hour in Switzerland, exposure to equities and bonds has nevertheless remained relatively stable.
Michel Thetaz, director at Independent Asset Management (IAM) in Geneva, argues that this is not a time for panic amongst pension funds: “The clients we talk to are increasing their contribution rates and reducing benefits, but they are not taking drastic action on the investment side. They are certainly not walking away from equities.” The consensus is that average equity levels for Swiss pension funds had been sat between 30–35%, with market impact now driving them just below 30%.
Thetaz adds: “Faith in equities has been shaken, but not to the degree that pension funds would focus only on bonds.”
Underlying the equity market lull, however, most investment managers agree that the diversification shift from Swiss to global shares continues.
While many funds still hold a core domestic equity quota, Marco Lanci, head of institutional asset management Switzerland at Geneva-based, BNP Paribas Asset Management, says that at the margins they are seeking greater exposure to asset classes such as small caps and emerging markets.
“Many pension funds have seen the logic in increasing passive mandates for the core assets and looking for alpha in niche products.
“Another area where we are seeing interest from clients is in currency overlay. There are a few mandates in the market at the moment, but it is increasing, both for active and passive overlay strategies.”
On the fixed income side of things, fear that the bond market might be hurt by rising interest rates has also seen funds start to cover themselves, both through a flight to quality issuance, but also alternative ‘safety-first’ products, especially while returns on government bonds are so low.
Convertibles, high yield, emerging market debt and structured bond products like asset-backed securities are all being sourced in an attempt to secure regular income streams.
Kurt Fisch, a partner at convertible bond specialist, Fisch Asset Management says the three year bear market has posed a fundamental question to Swiss schemes: “A lot of pension funds are now asking: what can we do to add value in this different market environment?
“There has been a climate change in terms of risk management and we believe that with convertibles it is possible to have a good risk/return profile without risk appetite. In fact Swiss pension plans cannot take risk because they have no free space. We think the convertible bond is a perfect instrument in this case. The option with the bond means that you can get a higher upside but less downside participation.”
Lanci at BNP Paribas says clients are looking to increase exposure in high yield, corporate bonds, emerging markets, and also some inflation-linked bonds hedged back to the Swiss Franc.
He adds: “Typical bond selection is usually around the single A level, but corporate bond allocations are down to BBB, and high yield could be B or BB.
“The overall spectrum of bonds at the moment is more focused around the BBB area, meaning that investors are moving more to high yield, although not junk bonds.
“They are certainly not looking for duration mandates, but more credit premium and market anticipation opportunities.”
With Swiss investors diversifying equity exposure and on the prowl for liquidity, yield curve and credit spread potential that they can’t find on the Swiss bond market, the implication would seem to be a drive towards specialisation in their overall management selection. Not quite so. If anything, the dissatisfaction with managers in recent years appears to run across the board from specialist to balanced houses.
Puglia at LODH, comments: “We are seeing two opposite trends happening at the same time. Those funds that had shifted to specialist mandates are now returning to balanced managers in the belief that an external manager might better make tactical investment moves than the fund can internally.
“At the same time, some investors with balanced mandates are disappointed because the managers they hired have not reduced equity exposure as much as they could have. These funds are now considering switching to specialist mandates with passive asset allocation.
“Performance comparison statistics tend to show that almost all balanced houses have underperformed the standard Swiss pension fund industry benchmarks in recent times.”
Little surprise then that in the midst of this apparent zero-sum game, advisory work on ALM and asset allocation is keeping the consultants busy.
And while the advisory market is still dominated by the presence of Swiss outfits, PPC Metrics, Complementa and Ecofin, with Watson Wyatt making the running amongst the foreign players, the fact that pension funds are increasingly in need of guidance on actuarial work, administration, risk control and investment strategy has led to a boom in one-man-advisory-bands. A downsized domestic banking industry in Switzerland has ensured there are plenty of professionals out there willing to go it alone, although as one manager comments, they may not necessarily have the tools for the job.
“My fear is that they are all trying to do everything. There is a new generation of consultants out there who are mixing themselves into the relationship between client and asset manager and sometimes this hasn’t been so productive because they don’t have a consultant education and don’t always know the rules. It can feel like a situation when no-one is in charge of anything.”
To this end, many believe that the Swiss market is more open than ever to foreign consultants as the more sophisticated funds require broader manager databases and advisory networks, particularly in the French speaking part of the country.
Additionally, the multi-manager proposition is gaining a foothold as the boundaries between consultancy and implementation of asset management solutions blur somewhat.
Pendia Associates, is one firm that has moved into this area, branding itself a provider of consulting driven pension management solutions and offering Frank Russell’s multi-manager programme as an investment point of sale.
Andreas Schlatter, managing director at UBS Global Asset Management, the first investment house in Switzerland to put forward an institutional multi-manager concept in tandem with consultancy firm PPC Metrics, claims the firm has seen a ‘steady inflow’ of money, despite the state of the markets.
“The multi-manager concept makes administration of pension funds very easy with one point of entry.”
Schlatter argues that the consultancy tie-up negates any possible conflict of interests:
“The responsibility for choosing managers lies with UBS, but PPC Metrics gives an independent and neutral view on this. We believe this shows that we really have an unbiased open-architecture product.”
He notes that the multi-manager capability is typically marketed to Swiss pension funds seeking a diversified solution and lower administration cost. It is also marketed in the form of UBS AST funds (a non-profit making collective institution for pension funds).
Puglia at LODH, however, is less convinced of the merit of the multi–manager structure: “It’s a very fashionable thing and all financial institutions are developing some concepts in this area. My personal view is that although the concept sounds appealing, the fees for such constructs are often disproportionately high compared to the potential added value they can generate, and this is particularly true for institutional investors. However, if things are properly structured and arranged, the larger funds might get competitive investment offerings in this area in this area at a reasonable price.”
Despite the somewhat contradictory signals emanating from the Swiss market, which suggest potential for new players on the scene, Graziano Lusenti enjoins a reminder that Swiss institutions can be rather ‘conservative’ in moving away from managers with which they have had a long and often fruitful relationship in the past. “With the performance issues in the last three years there is an opportunity for new players or domestic houses to shine and pick up good market share. On the other hand though it’s not so easy. This is a stable market and you need a lot of strong arguments, a solid local presence and very close contact with pension funds.”
Puglia at LODH adds his belief that brand name and investor confidence is more important than ever in these tough times in Switzerland, predicting that the big Swiss names will go all out to consolidate market share, albeit leaving room for well-focused satellite managers.
Michel Thetaz at IAM believes that smaller asset managers may be able to court business from the country’s smaller pension plans on the back of changing regulation and reduced pension promises from the Swiss insurers that have traditionally had significant market share in this segment: “In the future the insurance regulator will join up with the supervisor for investment funds. This is good news for us because it opens up a sector of the market and we are already seeing greater subscription to investment funds by insurance companies.”
Similarly, Von Euw at Swissca believes that the increasing competition in Switzerland does not necessarily predicate size:
“We believe you have to be clearly focused on the products and services you offer and how to manage them professionally.
“If you look at some of the best known players in this market there has been a huge fluctuation in personnel and successful asset managers in the past have suffered considerably and people have shifted.
“Switzerland is a mature market with a large number of players, both domestic and non-domestic. You can no longer have a broad-brush approach.”