Swiss learn to love alternatives
For most Swiss pension funds, investing in alternative assets is a tale of two halves. “Compared with pension funds in other countries, the Swiss market is more mature on the hedge fund side, and less mature for private equity investing,” says Rolf Kessler, vice president, LGT Capital Partners.
For instance, around 18% of the Nestlé pension fund’s portfolio is in hedge funds, and other big investors include both the Canton and the City of Zurich.
Overall, however, according to the Credit Suisse Pension Funds Index, Swiss pension funds have an average of only 1.8% of their portfolios invested in alternative investments.
“In the past, Swiss pension funds liked private equity better than they did hedge funds,” says Kessler. “But the bad experiences of 1999 and 2000 onwards meant that they didn’t want to know about it.”
n contrast, hedge funds then became more popular and proved their diversification benefits, especially in the equity down years.
However, Kessler now sees the tide turning once again.
“In the last two ye ars, private equity has done very well, but there has been some disappointment about hedge fund returns,” he says.
Bernard de Halleux, head of institutional sales, Switzerland, Dexia Asset Management, says: “Though the Swiss pension fund market is one of the biggest in Europe in terms of size (roughly €300bn at the end of 2005) and one of the oldest (the law on the second pillar was passed in 1985), interest in alternative investments depends on the specific sub-asset classes.
“Private equity for instance is a pretty narrow asset class and just a very few large Swiss pension funds invest in it, with only a small percentage of their portfolios. The same applies to commodities, which are only generally used for managed portfolios by some of the large private banks.”
But although hedge funds are much more popular, he says that no Swiss pension fund will invest in a single hedge fund strategy.
“Instead, they go for respected and well-diversified multi-strategy funds of hedge funds,” he says.
“In my opinion, they favour those offering low volatility (between 2 and 4) with a target return of 6-8% annually. They also pay a lot of attention to the consistency of the investment process, the due diligence process of the managers screened and the risk management.”
“In terms of alternatives overall, Swiss pension funds tend to invest in all three main asset classes - private equity, hedge funds and commodities - or in none at all,” says Georg Stillhart, head of pension solutions for Switzerland at Credit Suisse. “If they do invest, they invest between five and 10% of their portfolio in alternatives.”
He says that a year ago, when equity markets were strong, people expressed an interest in alternatives, but as far as he is aware, little business materialised.
“Now, pension funds increasingly want to discuss them,” he says. “This is partly because of the negative development of the stock markets combined with a rise in interest rates, resulting in losses on bonds.”
He continues: “They see the volatility of their traditional investments and want to diversify. In addition, some pension funds are looking at traditional assets like bonds, but not just in a long-only way.”
But he says that pension funds are increasingly realistic about performance, and do not expect the type of returns which they saw in the 1990s. But what they want to achieve is further diversification of their portfolio.
Dr Stefan Hepp, founder and chief executive of Strategic Capital Management, says: “When I started SCM 10 years ago, alternatives made up only between 2 and 4% of the portfolios of those Swiss pension funds which invested in them. But today, it is typical to find funds with 2% in private equity, 2% in hedge funds and 2% in commodities. It can even be 4 + 4 + 2, ie, a total of 10%. And if investors have 10% of their money in alternatives, they want to understand it better than if they only have 2%.”
epp says that, as in other countries, the downturn in equities has brought funding ratios into the limelight.
“In some case, liabilities are bigger than assets, prompting the question of how to rebuild the funding ratio,” he says.
“Because of this, people are looking at the diversification properties of private equity, and its lack of correlation with other market cycles. One specific feature of private equity is that it is valued on business results, such as earnings before interest, tax, depreciation and amortisation (EBITDA) rather than stock market sentiment. Some pension funds have found their private equity programmes have helped to stabilise returns when other assets nosedive into negative territory.”
Hepp says that new investors, or those who have restarted after abandoning it, typically start with a lower allocation - say 2% of their portfolio - then add to it gradually with a trend to aim for a 5% private equity allocation over a few years.
“Investors do demand high returns from private equity, as it is expensive,” he says. “They don’t pay 1.5-2% on subscription amounts for bond or equity funds but are willing to do so as long as private equity continues to deliver a long term outperformance of 4-6% over listed equities.”
But he says that in Switzerland, there is not much of a focus on domestic private equity managers, as the small size of the market limits the supply of established managers, and therefore requires an international outlook for the asset class from the outset.
Kessler says Swiss pension funds use private equity as a return enhancer for equity exposure, while hedge funds are used more for lowering risk and for diversification.
As regards private equity, he says the preference is for buyouts rather than venture.
“Venture is more volatile, with a deeper J-curve, and higher risks, while at the same time getting access to the best venture funds is a real issue, as their managers have not accepted new investors for some time,” he says.
ith hedge funds, he says funds of funds are still by far the preferred route.
“Clients often start with a diversified core fund of funds,” he says. “These are broadly diversified in terms of strategies. The main purpose is to get absolute returns every year.
“After a year or two, some clients start to pick single style or theme funds. They could also add some direct funds, but only a few have the necessary resources and abilities,” he adds.
Regarding commodities, Stillhart says they are starting to be used more widely: “Clients say they want something that performs well in decreasing and sideways markets.”
And he points to the increasing commodity theme in the hedge fund industry.
“People don’t want to dive into the deep end with commodities, but using a commodities hedge fund gets round the problem,” he says.
As for the future, the consensus is that alternatives will become more popular in Switzerland.
“I expect to see more interest in the coming years,” says Kessler. “If Europe follows the US University Endowments with an average of 8.7% in hedge funds (even 16.6% on a dollar weighted average), there is a long way to go. In Switzerland, some consultants are advising a higher percentage in hedge funds, with 10% as a realistic target.”
“In my opinion, the Swiss regulators have an enormous influence on investing in alternatives,” says de Halleux. “I think that this will be a key element which will certainly have a positive effect on future inflows of money into the sector. As an example, I think that the market is asking for more transparency.”