Pensions In Switzerland: Caught in an impasse
Swiss pension funds are still coming to terms with negative bond yields and uncertainty over the strength of the Swiss franc. Daniel Ben-Ami examines the considerable challenges they face
At a glance
• Swiss pension funds are caught in an impasse.
• It has become apparent that negative yields will pose a challenge for the foreseeable future.
• There is also the possibility of another realignment involving the Swiss franc.
• Under such circumstances any significant shifts in allocation pose challenges.
After the shocks of the past 18 months it is unsurprising that Swiss pension funds are confining themselves to tweaking their asset allocations. With such economic uncertainty it would take a brave manager to make any dramatic shifts.
The revaluation of the Swiss franc against the euro in January 2015 is still fresh in managers’ minds. It meant that pension funds, with their liabilities in francs, found that their overseas assets and their associated income streams were suddenly worth substantially less.
It is perhaps forgotten by outsiders that in December 2014 the Swiss National Bank (SNB) dropped official interest rates into negative territory. Rates were further lowered as the currency peg was severed.
Unfortunately for Swiss pensions funds these events have not receded into history. With the euro-zone lapsing into deflation, the European Central Bank (ECB) lowered its rates in March. Although the SNB did not respond with further easing it might be forced to do so in the future. Switzerland may maintain a tradition of diplomatic independence, but in economic terms it is vulnerable to global shifts.
“We are scared the SNB could move interest rates even lower,” says Fiona Frick, the chief executive officer of Unigestion. “It is sacrificing the savings of the people.”
So what at first looked like a temporary move – the shift to negative official interest rates – looks set to last for several years. The fundamental question is whether Switzerland is facing the prospect of a deflationary spiral.
In parallel with the pressure on interest rates is the prospect of another currency realignment. Although the exchange rate with the euro was stable at the time of writing, there is a possibility of a future shift.
It is not hard to see what challenges this poses for pension funds. Take the decision about how much to invest abroad. On the one hand, there is a substantial incentive to invest abroad since Swiss domestic assets are regarded as expensive (see Returns, but at what cost?). Stefan Beiner, the head of asset management at Publica – the Swiss Federal Pension Fund – expresses a common view when he says “we think the prices in many asset classes are quite rich”.
“It looks like larger pension funds have done better than small and medium-sized ones”
On the other hand, if Swiss institutions invest more overseas they face the prospect of an adverse currency shift. That could hit returns on assets that might otherwise look attractive. “To diversify out of Swiss francs is a risky proposition today,” says Frick. “The Swiss franc is playing the role of a safe currency so there is a risk that it will appreciate again.” At present, the SNB has reportedly adopted a new informal cap of CHF1.1 to the euro, but there is no guarantee it will hold.
The result, therefore, is often stasis. The forces pushing in each direction more-or-less cancel each other out.
“The prices in many asset classes are quite rich”
Nor is the decision about how much to invest abroad the only one that faces such a difficult choice. Many asset allocation decisions raise similar challenges. Under such circumstances it is probably apt that Frick describes the situation as “mission impossible”.
One of the few simple choices, with rates so low, is to reduce cash holdings, as pension funds are having to pay for bank deposits. Liquidity holdings fell from an average of 6.51% in the final quarter of 2014 to 4.74% in the final quarter of 2015, according to Credit Suisse.
Although 2015 performance, with an annual average return of 0.95%, was poor there have been worse years recently. Returns were slightly negative in 2011, while they contracted by 13.25% in 2008.
Of course, averages obscure variations. In Switzerland, it helps to be a larger institution in the current environment. “It looks like larger pension funds have done better than small and medium-sized ones,” says Regina Anhorn, a senior project manager at the ZHAW University.
Professor Peter Meier, the head of the Centre for Asset Management at ZHAW, says that larger pension funds can take advantage of their more sophisticated capabilities. These include the ability to harness alternative investments as well as better currency management.
Although some pension funds are clearly in a stronger position than others, overall, there is little room for manoeuvre. To meet regulatory obligations in the current economic environment is a formidable task.
Publica’s Beiner says pensions funds have three choices. Asset allocation is one but it can only take them so far. Another is to decrease future payouts but this is unpopular with current employees, as those already retired enjoy guaranteed pensions. The final possibility is to increase contributions but that, again, is unpopular, since it means forsaking current income.
Under such circumstances it is not surprising that Beiner has had informal meetings with counterparts in the Netherlands and the Nordic countries. Although there are differences between their pension systems, they all face the challenge of trying to achieve reasonable returns in a low-growth environment.
Ultimately, the solutions are economic and political. There is only so much that pension funds, consultants or asset managers can do.
On the political front, the pensions reform package, the Altersvorsorge 2020, is making slow progress. Switzerland’s requirement for a referendum confirming any decisions that have a constitutional impact complicates matters.
But it should not be forgotten that economics also pays an important role. If Switzerland can escape from its deflationary environment it should be easier to achieve better returns.
Even an economic upturn elsewhere could help. For example, if the US enjoyed an upturn, that should lessen the pressure on the Swiss franc to play the role of safe haven currency. That would lessen one of the sources of uncertainty facing Swiss investors.
With pension funds facing such a difficult environment there is a tendency for those involved to downplay the scale of the challenge.
“A lot of people still want to engage in Schönreden – to make things sound better than they are,” says Peter Zanella, the head of benefits and retirement solutions at Willis Towers Watson in Zurich. “But I think we have to face reality.”