The recent falls in equity and bond markets - added to the losses from foreign exchange risks - have caused Swiss pension funds to shiver in recent months. But the decision taken by the Swiss National Bank (SNB) on 6 September to set a minimum exchange rate of CHF1.20 to the euro has come as a breath of fresh air for local pension schemes.

Even though consultants agree that Swiss pension funds have been less exposed to equity than some of their European counterparts, their currency risk expsoure has been more significant. The reason for this is the small size of the domestic Swiss market, which has pushed local investors into other developed equity markets, such as in Europe and the US.

Caisse de Prévoyance du Valais (CPVAL), for instance, has invested 8% of its portfolio in the US and another 8% in the euro-zone, taking a currency risk of 16%.

Meanwhile, data published by the pension fund association, ASIP, reveals that returns among Swiss pension funds shrank by 0.2% in the first half of this year, while some schemes reduced their exposure to foreign equities as a result of the recent market slump and the strengthening Swiss franc.

The most significant losses were made over the summer. Several consultants value the losses recorded by Swiss funds on the equity market at around 15% in July and August.
Clearly, the fact that funds failed to hedge their portfolios against currency risk has made its effects worse. The majority of funds decided not to implement a hedging strategy, arguing that it offers poor net benefit in relation to cost.

All these reasons explain why Swiss pension funds were looking forward to an announcement by the SNB. Claude Schafer, administration and communication manager at Caisse de Prévoyance de l'Etat de Fribourg, estimates that its pension plan's portfolio has bounced back by 15% thanks to the recently implemented measures, having lost up to 20% in August.

However, the SNB, which conceded that the massive overvaluation of the Swiss franc posed a serious threat to the Swiss economy and risked deflation, warns that even at a rate of CHF1.20 per euro, the local currency is still overvalued and should weaken further.

Schafer comes to the same conclusion and notes that the exchange rate was at CHF1.25 per euro in January this year, against CHF1.21 on average in September.
In addition, the decision to set a minimum exchange rate will only be viable over the short term. Such a measure could lead to long-term inflation risk, causing further difficulties for Swiss pension plans.

One of these difficulties will be directly linked to indexed pensions. "Pension schemes that have promised indexed pensions will see their costs rise as the inflation increases," Schafer says.

Inflation risk could also hit hard funds that have indexed their pension benefits against final salary, a scenario which would immediately lead to salary increases and a rise in benefits paid out by schemes.

Consequently, and in spite of the fact that the idea of setting up a minimum exchange rate between the Swiss franc and the euro has been welcomed by local pension funds, further measures might be necessary.

Despite this, Swiss pension funds might also want to adapt their investment strategy to mitigate the effects of a longer term strengthening of the franc. But, while the option of moving away from foreign equities seems limited due to the small size of the Swiss market, implementing currency hedging strategies is also unlikely to happen as pension funds are not willing to take on their costs.