The City of Zurich Pension Fund certainly belongs to the city as a wide range of local bodies use it as their pensions provider. In addition to city employees, other employers’ staffs can join whose work is of ‘special interest’ for the city, such as housing associations, explains the fund’s chief investment officer Armin Braun. The resulting embrace is wide, from the zoological gardens to church organisations, libraries, theatres, even the local social democratic party.
The scheme is sizeable, particularly for Switzerland. “At the end of last year we had precisely 23,000 members, of whom around 14,000 are pensioners,” says Braun.
While not the oldest fund in the country by any means, it has a history dating back to 1913. But its financial history has not always been what might be expected from a city of Zurich’s reputation. The issue was grasped in the decades after the war. “Around mid 1980s, the fund achieved full funding.” This was in contrast to other public sector pension funds in Switzerland, he adds. “In fact, this led in time to over funding, which enabled the fund to widen its investment horizons.”
The political element has, for a long time, played a major part in the fund’s life. Private Swiss plans have to be legally separated from the employer and are set up as foundations. “By contrast, public pension funds may be part of the administration and certainly need not be separate.” The pension fund is changing this relationship at the end of the year, when it becomes a public foundation. This was a long and complicated process, which only happened after a public vote approving the change with an 80% majority.
“The reason for this change is that up to now, the fund has two main boards, one looking after actuarial issues, run by the council of the city.” These are political boards, and so are unable to grapple easily with the fine detail of actuarial and financial principles that they need to, Braun points out. “A board called the Kassenkommission, comprising 24 members, is responsible for all the investments.” But what the fund has long needed is a board that can have regard to both the actuarial and investment sides when making overall benefit strategy.
“Anytime we tried to get the fund’s rules changed, we had to go a very long way around when approaching the Kommission and the political board. We had to involve the unions, with the final decision being made by the city’s parliament.” The process could take nine to 12 months – much too long, he adds.
“We feel the pension fund can be run much more efficiently once next year comes,” Braun says. “We now have to make our new rules and establish the new organisational framework.” The structure will follow the well established Swiss pension fund model, with a board of trustees, made up of 20 members, 10 members of the pension fund and 10 employers’ representatives, eight from the city and the other two from other employers. Two committees will be below this board, one for actuarial and administrative issues and the other for investment - its members will be essentially the same as those currently looking after the area.
Over the past six years, the ratio of pensioners has been growing as a proportion of members, Braun points out. “What we are seeing is that the capital allocated to funding payments to pensioners is growing faster than for the active membership.”
The fund calculates each member’s benefits as a percentage of the retirement savings capital using a conversion rate that is determined precisely on an actuarial basis. “For a long time the City of Zurich pension fund has used its own actuarial database, rather the alternative being the Federal statistical tables. Ours and theirs are the only tables to be currently used in pensions calculations in Switzerland,” he notes.
The fund’s own figures show that longevity has been increasing significantly for pensioners. “In each of our annual reports we make a public comparison between what we expect and what actually happens. This shows up systematic deviations. Over the last 10 years, our longevity figures based on the actuarial base of 1990 were under estimated and we have had to increase each year the capital put aside for our body of pensioners and active members, by a factor that in fact it is nearer to 0.5% currently.”
The fund changed its benefit structure from DB to DC in 1995 so the benefits at retirement age are now calculated as a percentage of the retirement savings capital, but the savings capital is guaranteed as is a minimal annual return, currently 4%. “From an international perspective, these plans are sometimes seen more as DB than DC, because of the guarantees.” It is akin to the cash balance plans in the US, he agrees.
The overall target is to provide benefits of 60% of final insured salary, assuming full service and an average individual career progression on the salary front. “Every member is credited each month with their retirement savings credits, composed of employers’ and employees contributions, and the sum of all these retirement credits is the savings capital that determines the ultimate payout at retirement date. We use the same interest rate throughout for both the mandatory and non mandatory pension limits.”
The sum which is transferred for the pensioner is converted into pension at a fixed ‘cost neutral’ actuarial rate set out in the fund’s statutes agreed by the city’s council.
Technical reserves are built up at this 0.5% pa rate to adjust for changes and this is periodically transferred to the individual member’s capital amount to adjust, when conversion rates are lowered according to new actuarial tables. “The calculation is to make sure the member receives the same constant benefit. We are different to many other pension funds in going into these actuarial aspects in such a precise and detailed way.”
Since 2002, the system is also based around an annual inflation rate of 2% and a real interest rate on the retirement savings capital of 3% throughout. When inflation rate is 1.2% eg, the fund aims to credit the savings capital of its active members with 4.2%. But the interest rate may not be below of the minimal interest rate for mandatory pension limits, currently 4%.“So when we look at the long term average return targets for our assets overall, we come to a number of 5.5% pa on retirement savings capitals of active members, taking into account the inflation adjustment of 2%, longevity of 0.5% and the real return of 3%,” says Braun. On the other hand, average returns on funding capital of pensioners amount to 6.5%, composed of 4% technical interest rate, 2% inflation adjustment and longevity of 0.5%. The resulting fund’s overall return target amounts to 6.1% pa.
The investment process had to be revised at the beginning of this year to meet these strict criteria. At the end of last year, the fund value was over SFr11bn (E7.5bn), but has declined since then with market falls.
“Our philosophy on the investment side has been influenced by our actuarial approach,” Braun says. “For one thing, we do not feel we can make forecasts about markets, sectors and individual securities. We try to reach our investment targets by asset allocation and diversification of total assets in a broad range of asset classes, which include non-traditional investments such as private equity, hedge funds and commodities.” About 75% of assets are invested on a passive basis. “Everything, both active and passive, is externally managed, including fixed income, in accordance with our philosophy.”
“At present, we are passive for European equities, but we are discussing placing active mandates for small European caps. In US equities, large caps are on an indexed basis, while small and mid caps are active. On the Swiss side 60% are on a passive basis, but the balance is actively managed.” A number of actively managed mandates cover Japan, Pacific Basin and emerging markets equities, altogether, the fund has 25 specialiced mandates for investments in securities in place, usually with only one mandate per class. Real estate and other non traditional assets are invested in 43 fund investments.
“We like passive accounts because fees are lower. But we are concerned that passive managers can lose money by dint of transaction costs and need to exercise skill.”
With bonds there is always the need for judgement when replacing redemptions. “You can buy and hold equities, but you can’t buy and hold bonds!” In fact, up to mid 2001, the fund had actively managed Swiss and foreign bond mandates, but changed as the Swiss portfolio always tended to be below the benchmark, and the foreign bonds were only sligthly over the benchmarks. “But with the stamp taxes that came in last year, we terminated these mandates.”
Last year’s returns worked out at a negative 5.4% overall, following a number of very good years, when the fund was able to reduce contributions by 60%, for three consecutive years. The fund has a number of reserves built in, such as technical reserves for inflation and longevity and higher interest rates, plus a fluctuation reserves to cover asset value movements. “We have spent our free reserves, due to the losses on assets and the costs of implementing the new actuarial tables.” The mid year figures show assets at 129% of liabilities, compared with 138% at the end of 2001. “We are still somewhat overfunded, but we need to have our valuation reserves, which were built up on the strong returns of the last decade.”
With the investment strategy changed for this year, the fixed income target is now 37.5%, of which 25% will be in Swiss Francs denominations. Around one fourth of this allocation is a loan to the city of Zurich, with a 4% interest rate and equal annual redemptions until 2023. “We would refuse all attempts on their part to pay this back earlier,” quips Braun. A further portion is placed with mortgage companies and used to grant mortgages to scheme members.
Foreign currency fixed interest has a target allocation of 12.5%, but this is now fully hedged, for Yen, US dollar and pound sterling exposures. “As far as the euro is concerned we don’t hedge, as we believe the changes in terms of annual volatility between the two currencies will not be very sharp.” Around 10% is in real estate, but only indirectly, such as US REITS, foundations, and quoted real estate companies. “It is possible we will join with a number of pension funds in a new foundation that would engage in direct real estate investment.”
Equities make up 45% of target allocation. “40% of the portfolio will be in listed equities, and 5% private equity.” Of the core 40%, around a third, 32% is allocated to non domestic and 8% to Swiss. One reason for private equity is to invest broadly in the world economy, since a big proportion of this economy is not listed.
Under the new strategy, hedge fund allocation was increased to 5% from 2.5%, at the end of last year and commodities account to 2.5%. For dollar, sterling and yen investments in the hedge funds and real estate, the portfolio is fully hedged, but only 50% so for the listed equities and commodities, he says.
Commodities are to provide a return in excess of that from bonds, but his expectations are for an outperformance of not much higher than a 1% risk premium. Commodities have extreme volatility year to year – they were either the best or the worst asset class in any particular year, Braun points out. “The main reason is the likely negative correlation with stock prices. Last year this did not hold true because stocks fell on the prevalent views of the poor outlook for the economy, which was also bad for commodities.” The fund is attracted by the diversification aspects, but will not invest in more than the 2.5% committed. “We were lucky in that we started in 1999, which was a very good year for commodities, which rose over 50%, in fact we started off with 2% allocation, found we reached our target of 2.5% due to price rises, and had to divest twice to keep within our limits.” Last year returns dropped 30%.
The commodities strategy is implemented via futures on the Goldman Sachs Commodity Index. “We have placed one mandate with a manager who invests passively in the index, but he tries actively by overall timing of the futures to overcome the rolling cost, but he does not make any bets on the different classes of commodities.”
The approach to hedge funds was likewise not looking for dramatic additional return, “We just wanted to improve risk return ratios by means of low correlations. Though the original decision was taken in 1998 to dedicate 2.5% of the portfolio to the area, the fund was not fully invested until the beginning of 2000, says Braun. “We work with a specialist hedge fund consultant and invest in five different strategies, which is designed to give us a return between bonds and stocks. A correlation of below 0.6 is what we are expecting and so far, we have been below this.” The mandates and funds of funds are specialised, he says. “We are currently in seven vehicles.” He describes the fund’s experience last year with hedge funds as “perfect”, being the best main asset category. “So far this year, still positive, if not so good as 2001.”
The hedge fund portfolio is very closely monitored, which requires transparency about the activity both at the individual fund level as well as at the fund of funds level. “Through these arrangements we are invested in over 90 hedge funds.” The new strategy is to invest 5% in these funds.
“Currently we are implementing the new strategy, including the overlay currency hedging programme, which is done purely to protect our positions, otherwise the risks would just be too high,” says Braun.
Taking risk completely out by having a pure bond portfolio is not something the fund can envisage, it would never yield the required results. “We could never reach our minimal returns.”
The fund uses a global custodian but not just for settlements and safekeeping, says Braun, but very much for reporting needs, on a consolidated basis, giving performance and risk figures on a weekly basis. This data is discussed every quarter by the investment committee working with the external investment consultant.
“While we cannot turn the ship very quickly, we do have all the capacity and information we need to focus on highly professional implementation and monitoring of our strategy.” A great deal is outsourced to consultants and the managers. The ship itself is run very tightly indeed – with just 3.8 people fulltime, says Braun, with an understandable degree of pride.

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