SWITZERLAND - Swiss pension funds have largely failed to consider long-duration risk in their bond portfolios, according to St Gallen University professor Heinrich von Wyss.
Speaking at the second annual CFA Swiss Pensions Conference in Zurich today, von Wyss warned that long duration in bond portfolios would lead to "painful losses" when interest rates increased in future.
He also predicted that the increases would be worse than the interest rate cuts of recent years.
"I don't see Swiss Pensionskassen really realising that their bond portfolios actually carry a major risk once interest rates go up again," he said.
The professor acknowledged that some pension funds had already been cutting back on duration, but he said the extent of the cuts had so far been too little.
"At the moment, you do not have to waive a lot of yield when reducing the duration, and, currently, there is actually a lot of potential for going into money market instruments instead," he said.
Von Wyss said it made "no sense" to hold a 10-year Swiss government bond in a portfolio with close to a 0% return.
But Stefan Mächler, head of asset management at insurer Schweizerische Mobiliar, disagreed, arguing that holding Swiss government bonds still made sense due to the default risk of other bonds.
He said Mobiliar was investing in high-yield bonds and corporates ex financials, but was "very cautious" to be paid for the extra risk taken.
Mächler warned pension funds against making forays into new investment areas without having the necessary in-house expertise to understand the risks involved - "otherwise, you have to completely rely on the manager".
Professor von Wyss agreed that, in recent years, Pensionskassen with in-house expertise had fared better than those using only "their feelings" for asset allocation decisions, or had been "too creative".
He said pension funds would be forced to shift their portfolios towards corporate bonds and the "high-yield segment".
"It will not be enough to just replace one Treasury bond index with a corporate one, as these mostly comprise only large companies," he said.
He also advised pension funds to put money into emerging market bonds where currency risk was not too high.
Two years ago, Mobiliar moved into emerging market bonds and equities, but Mächler warned that pension funds always had to check "who profits from the boom in those markets", adding that some "Western countries were actually quite well positioned for that".
Asked whether a much longer duration might make sense in light of liability matching, von Wyss told IPE that there were no interesting products with that duration available in Switzerland.
As for inflation-linkers, he said there were "hardly any products available in Switzerland", and that, with foreign ones, Swiss investors ran a "very, very high" currency risk.