Although it has been present in Switzerland since the mid-1980s, indexing really took off over the past five years. Despite the lack of reliable statistics on the amount under indexed management, there is strong evidence that indexing has been increasing in Switzerland particularly on the institutional side. Here are some facts which support this idea:
p Several large pension funds have core portfolios, which are indexed; occasionally together with actively managed satellite holdings.
p The Investmentstiftung für Personalvorsorge (IST) created a successful world equity indexed fund (Globe Index) which for tax reasons is open only to Swiss pension funds. Launched in August 1993, with an initial amount under management of about Sfr120m (E75.2m), it has grown substantially to more than Sfr1bn today. Of course, some of this growth is linked to market performance as the relevant benchmark, the MSCI World Standard excluding Switzerland index, appreciated by 103.46% since the fund inception. Nevertheless, a major fraction of the growth in assets has been linked to net inflows.
The case of the IST foundation is interesting as its success is a clear indication of the interest small pension funds have in indexing. This investment vehicle, with its small minimum investment amount, was specifically designed for this market segment. In addition, in June 1996, the Globe Index fund was divided into three segments allowing institutional investors to buy indexed portfolios for North America, Europe excluding Switzerland, and the Pacific Basin. Pension funds still can buy directly a world excluding Switzerland indexed portfolio through a basket of shares of the three segments.
p The Swiss social security started in 1997 to invest a fraction of its assets in both equities and bonds. As far as stocks are concerned, some Sfr1.75bn is already invested in indexed Swiss equity portfolios with the Swiss Market Index (SMI) as the relevant benchmark.
p Over time, several indexed funds, mostly equities, have been launched for private clients. Indexed portfolios for Swiss, European, and US stocks can easily be bought by individuals from Swiss indexers. Overall their success appears moderate for the present time.
These examples are interesting because they show that indexing is making inroads in Switzerland with all categories of investors: large or small, private or public pension funds, private clients. The story of the development of indexing in Switzerland is not unique. It follows the model which originated in the US, then moved in Europe, starting in the UK and the Netherlands.
Institutional clients have varied motivations for embracing indexing. For large pension funds, there is often the realisation that a large number of active managers for the same asset class may not be in the best interest of the fund. Indeed the active bets of these managers often offset each other to a large extent. An architecture featuring passive core holdings with actively managed portfolios makes more sense. These core holdings can, of course, become prime targets for indexing. Among passive management clients, one can find those who have been disappointed in the past by the poor performances of active managers. Others are attracted by either the low cost of indexing management and/or the easier task of finding a competent indexer with respect to identifying a skilled active portfolio for the same asset category.
In terms of indexing companies, the situation has evolved quickly over the past few years as the big international indexers have moved rapidly into Switzerland, thus putting enormous pressure on local passive management fees. Among the local providers, the ones likely to have a hard time staying in the business are those that:
p do not have a dedicated indexing team;
p do not have enough money under management to justify the high fixed cost implied by indexing;
p cannot provide some niche services in indexing;
p cannot link indexing as a byproduct of custody;
p cannot provide enhanced techniques. Of course, these conditions may not all be met, but the first two are important because of the extent, the professionalism and the sharpness of the competition.
In a sense the future should be easy to predict. One has just to look at the situation of other countries that are more advanced in the expansion of indexing. Extrapolating these other historical and geographical examples, it seems likely that indexing will continue to grow in Switzerland. Assets passively managed should reach levels within a few years similar to those achieved, for example, in the Netherlands. Enhanced indexing, although already present in Switzerland, is also expected to expand as it represents a potentially viable strategy for local indexing companies facing the stiff international competition of plain vanilla indexing.
The only delay to this projected future could be caused by a period of several years of relatively poor performance by the market with respect to active portfolio managers. Market forces could bring this about if small growth companies come back in favour. Should this occur, the relative attraction of indexing may temporarily weaken.
Gérard Huber is head of quantitative research and management at Pictet Asset Management in Geneva