Pensions in Switzerland: Changes on the horizon
Swiss Pensionskassen are on track to record their third successive year of positive returns. This performance mirrors an average asset allocation that has been equally stable.
However, many industry figures are convinced that a ‘wind of change’ will sweep through the pension sector, with management boards beginning to design and implement risk-based strategies.
At a Glance
• The average asset allocation of Swiss Pensionkassen has been stable but changes are predicted.
• Strong performance in real estate is starting to show signs of a possible slowdown.
• There is hunger for insurance-linked bonds and alternatives, but regulation makes investment in this asset class tricky.
• After growth in passive strategies, some believe risk-driven strategies are the future.
“We are on the verge of very significant changes,” as Théodore Economou, out-going chief executive of the inter-governmental Geneva-based CERN pension fund, puts it. He believes that, in response to market challenges and a number of underlying forces shaping the institutional investment industry, funds are adopting systematic approaches to portfolio construction that manage risk, as well as return.
Economou has applied this approach at CERN and is now developing it further at the Lombard Odier pension fund, where he chairs the investment committee.
Others share his opinion.
Reto Hintermann, head of institutional mandates for Switzerland at Swiss & Global Asset Management, and responsible for the firm’s pension fund, says: “Investors want risk protection in the portfolio, and they are looking to implement it in a cost-efficient way.”
The pension fund Hintermann is responsible for has been run through an active risk-based strategy for a number of years. He believes that this approach will prove successful because of the real drawdown risk that portfolios carry and the slowly increasing yield environment.
Aris Prepoudis, head of institutional investors at Notenstein Private Bank, believes that “a new era” lies ahead of the Swiss pension industry. He says: “The main question will be, how can we explore risk premia in capital markets in an integrated, diversified and systematic manner?” As a result, he sees great potential for low-volatility, absolute return systematic asset allocation strategies.
Economou adds: “There is evidence that an increasing number of pension fund boards are doing very sophisticated work in refining portfolio construction and adopting risk-based strategies. There is a general awareness that portfolio construction can be improved, but there has been little pressure to actually make changes to portfolios because of the good performance of Swiss bonds and equities over the past years.”
Time will tell whether such strategies are commercially successful. Nevertheless, few dispute that unless Swiss funds rethink their current strategies to respond to challenges at home and abroad, their positive track record may come to an end.
Swiss funds returned 7.21% and 5.76% during 2012 and 2013 respectively, according to Credit Suisse’s Swiss Pension Fund index. As of September 2014, it records a 5.68% return.
“The question is, is that party now really coming to an end?” says Harald Reczek, head of the global client group, Switzerland, Austria & CEE, at Deutsche Asset & Wealth Management.
On average, over recent years, Pensionkassen have maintained a domestic bias in both fixed income and equities, and focused on a strongly-performing real estate sector.
According to Credit Suisse, over the past eight quarters to September 2014, the allocation to Swiss government bonds oscillated between 24.8% and 26.1%.
The allocation to domestic equities has ranged between 12.5% and 14.5%. Real estate holdings, largely consisting of domestic properties, have taken between 19.4% and 20.7% of portfolios.
Commentators agree that Swiss funds are willing to diversify, both geographically and across asset classes. But, due to various factors, including regulatory trends, the shift could be slower than many would hope and, as a result, returns may be under pressure.
The CHF665bn (€552bn) Swiss second pillar total is split between a low number of large pension funds and a ‘long tail’ of small ones. Domestic cultural differences are also cited as a relevant feature of the market, with funds in the larger German-speaking part generally perceived as being more risk-averse and fee-sensitive.
“Historical analysis tends to show that asset allocation changes are actually more driven by market fluctuations rather than by real, active asset allocation decisions,” notes Gioacchino Puglia, first vice-president for institutional business development at Piguet Galland.
During the post-crisis years, the Swiss institutional investment industry has gradually moved towards passive investment strategies.
“There has been a move towards balanced, multi-asset mandates, especially for small to mid-sized pension funds,” says Economou. This has reflected growing concerns by regulators about fees, after a number of cases of high fees matched to poor performances pre-2008. “The pendulum has swung completely the other way,” Economou continues, referring to the fact that funds now have to be fully transparent about their total expense ratio (TER).
These factors, coupled with a sustained bull-run in capital markets, explain why the average allocation of Swiss schemes has been rather conservative as well as home-biased. However, against the backdrop of falling yields across the continent, several possibilities for Swiss pension schemes are on the table.
It is difficult to see hedge funds regaining favour, after they lost momentum due to “disappointing returns, increased transparency requirements and fee pressure”, according to Puglia.
The real estate sector is where Swiss funds have found a stable source of yield, which compensated the falling yields on domestic fixed income. However, price inflation in real estate has been so great that the word ‘bubble’ has started to crop up.
Hintermann says: “The demand for real estate is still here, but we are starting to see negative news from the fundamental side. Price increases are not happening, and in very expensive sectors prices seem to be going down. Still, we are maintaining our weighting in real estate as the yield gap is impressive.”
Nevertheless, given the concentration of domestic assets in portfolios, the case for geographical diversification is strong, and there are signs of a growing appetite for foreign real estate.
Prepoudis believes that funds have no real alternatives to equities, which may prove to be “the only really liquid asset class”. On the other hand, Reczek believes the search for yield will force investors to consider unconstrained fixed income strategies. “We need to recognise that if we stick with European investment-grade fixed income, total expected returns for next year will be lower than in 2014,” he says. “The market is becoming tighter and tighter. Investors need to think about their fixed income allocations more than ever before.”
One asset class that many feel will gain popularity is insurance-linked securities. These are well known in Switzerland and are “strongly uncorrelated with public markets”, according to Reczek.
However, Pensionskassen looking for additional yield and inflation protection in alternatives have to deal with imminent regulatory changes. Asset classes such as loans will be reclassified from fixed income to alternatives from 2015, while the maximum allocation to alternatives will stay at 15%. Funds can break the asset allocation limit provided that they explain the reasons for doing so – but that makes boards liable for any losses.
“Pension schemes are going through a challenging process of deciding how they are going to deal with the new classification of alternative investments,” Prepoudis concludes. “They are caught between a rock and a hard place, because they would like to go more into alternatives, but they are concerned that they will break through the regulatory limit.”
He believes that the more sophisticated pension schemes that have the expertise and the capability might take that risk, but smaller funds would rather not walk down that roa