One of Eric Breval’s first decisions when he started as managing director of the Swiss Federal Social Security Fund (AHV/AVS) in December 2003 was to move his investment management unit out of the headquarters of the Swiss Social Security Administration and into a new building in downtown Geneva.
The fact was not just that Breval was unable to secure extra office space in the administration building to accommodate the expanded team he was planning, there was something about the long, echoing linoleum clad corridors of the building - which resembles somewhat the 1930s IG-Farben-Haus in Frankfurt - that was perhaps not conducive to the culture of a modern investment management team running more than CHF20bn (€12bn).
But despite the fact that it is now - physically at least - a satellite operation, the fund is still a key component part of the Social Security Administration. This institution was established in 1948 to operate Switzerland’s social security system and pay-as-you-go pensions. The AHV/AVS fund provides a buffer to secure the benefits promised to the Swiss working population.
In recent years the fund has evolved into a sophisticated, internationally diverse investor. The fund managed some CHF28.8bn as of 30 June this year and the investment team has grown from five heads to 20 since Breval joined in 2003. And last winter it completed its annual strategic asset allocation review, which recommended several new areas for investment, such as commodities and emerging market equities.
“We review our strategic asset allocation annually, and in 2006 reviewed also the detailed asset allocation within equities,” says Breval. “We thought there was no reason that we should not be invested in emerging market equities and therefore decided to allocate a portion into emerging markets [7%]. We also created a space for Japanese small caps.”
Breval, who started in finance working on Japanese equities, says his experience with Japan has been “ups and downs but mostly downs”. However, he takes a long-term position: “My view is that we’re not invested because the market is low and going up, but because we believe it can contribute something positive to our asset allocation in terms of returns, risk and therefore in terms of diversification.”
The fund has been in emerging market bonds for four years, achieving results that Breval commends highly, and went into high yield fixed income about the same time.
When it came to manager searches, Breval says the fund received a good response to its recent RFP exercise in US corporate bonds, but that the response to its emerging market equities tenders was a “mixed bag”. AHV/AVS was searching for managers to run regional emerging markets equities mandates through funds. “Try to find an Africa ex-South Africa fund,” says Breval, “There aren’t many of those around.”
Commodities was another new area for AHV/AVS this year. But instead of going long on the GSCI - the tried and tested route for many a commodities investor - the fund decided to adopt five benchmarks, largely for diversification reasons rather than the actual underlying properties of the indices. Accordingly, five allocations of 1% of assets apiece have been made to managers with the CRB, DJ AIG, GSCI and two other specific benchmarks.
As an entity of the first pillar, AHV/AVS is exempt from the BVG law governing occupational pensions. Instead it is governed by a 17-strong board of directors and an eight-member committee whose purpose is to approve investment decisions. Decisions within existing asset classes, like the one to invest in Japanese small caps, are approved by the committee. On the other hand, decisions to move into a totally new asset class have to be approved by the full board. Breval is present at all of the meetings but not as a member.
Governance for Breval means more than effective decision making within the board of directors and the investment committee. For him, building up his team to 20 heads also means implementing the highest standards of internal governance.
“There have been some smelly affairs here in Switzerland, like, among others, the Swissfirst issue. If a smallish pension fund somewhere in Switzerland messes up a bit that’s great for the media and someone will lose his job, maybe,” Breval remarks. “But if the AHV/ AVS messes up that is a European wide scandal and would have major ramifications.”
Internally, this means a range of checks and balances and a compliance officer. Watson Wyatt performs an external controlling function at the level of the board and UBS is custodian bank. “This does not ensure that nothing could ever go wrong but it does maintain a high level of security,”
The fund does run money internally - namely in Swiss bonds, dollar and euro sovereign bonds, currency hedging, and a number of other futures-driven overlay mandates. Like other Swiss pension funds, long-term loans to cantons and municipalities are a part of the asset mix. And they are one that Breval says are fully justified in economic terms. There is no political pressure to provide credit to these bodies, he assures. AHV/AVS maintains ratings of every Swiss canton and municipality.
Finding the right people in Geneva at the moment is not an easy undertaking, given the competition in the financial services market for talented professionals. And being a public sector institution means that AHV/AVS has to compete with the salaries offered by the city’s private banks. “What I offer is a unique opportunity to learn and get things done,” says Breval. “I trust my colleagues and give them a lot of responsibility. In this way, they accomplish things that they would never be able to if they worked for a bank or a normal pension fund.”
The working environment that he has created, Breval believes, is also a pleasant one: “That’s worth a lot to me and I know to a lot of other people.”
Furthermore, the fund is a social institution, which Breval also believes leads to a unique level of job satisfaction: “We are running the money of 7.5m Swiss people. Every single person who works or used to work in Switzerland is our client, so the Swiss population feels that these are their
Breval continues: “In the financial community [the issue is] relative performance. Here you are trying to help the Swiss population indirectly to have a decent pension when they retire. There’s a certain meaning to your job that you wouldn’t find elsewhere and that is satisfying.”
One path that AHV/AVS has not travelled is the path towards alternatives. Breval’s plate has also been full so far in his tenure, initially with the reorganisation and expansion of his team, and lately with the implementation of other new investment classes. But still, says Breval, “every Tom, Dick and Harry comes around to talk to us about hedge funds”.
He elaborates further: “Have we looked at hedge funds? Yes. Have we officially discussed them within the board committee or even the board? No, we have not. That is simply because I have not brought it up. Will we in the future? Possibly. We will certainly analyse the issue here in the management office before going to the board.”
Private equity is likely to be off the agenda for the time being, especially in the current economic climate. “We need a long time horizon for private equity and our asset liability match is such today that if the federal social security forecasts are correct, and if the laws do not change within the next eight years, we will one day end up without any money in the till.”
This problem is a somewhat intractable one, albeit one that was temporarily postponed this year with the transfer of some CHF7bn from the federal government, representing the proceeds of the Swiss National Bank’s 2002 sale of 1,300 tonnes of gold from its reserves.
Switzerland being what it is, two thirds of the CHF20bn sale proceeds was already earmarked by law for the cantons with the remaining third allocated to the federation.
A referendum in September 2006 led to the transfer of the federation’s share to the AHV/AVS fund. The proceeds arrived at AHV/AVS in the 10 tranches of CHF700m from March to May this year.
But this is only a temporary solution. “We are bleeding money every single day of the year,” says Breval. “This year we expect a net outflow of CHF1.5bn and CHF3-4bn a year by 2015. We have disability losses of CHF1.5-2bn a year for the next 10 years, so that is pretty stable. What is getting much worse is social security itself.”
If Switzerland’s politicians are to avert the unpalatable prospect of running the fund down to nothing, they must consider a number of equally unpleasant alternatives - such as increasing social security contributions, cutting benefits or raising the retirement age.
“Which politician wants to stick his neck out and suffer the consequences, even if he knows it is the right thing to do?” asks Breval.
The managing director of the AHV/AVS fund is a tri-national with US, Swiss and Italian citizenship. He started his career as an analyst at an M&A firm in Houston, Texas, and from there moved in 1989 to Switzerland to join BCV Group in Lausanne. His first position was as a fund manager and he was finally CIO of Gerifonds, the mutual fund management company affiliated with the bank. He was simultaneously a member of the board of Gerifonds. Since December 2003 he has been managing director of the Swiss Federal Social Security Fund in Geneva. Breval holds an MBA from Duke University and is both a CFA and a CAIA charterholder.