Switzerland: Efficient stability
Nina Röhrbein reviews current Swiss asset allocation trends
The Swiss have a reputation of being efficient, punctual and conservative. This is certainly true when it comes to asset allocation of their pension funds. This typically consists of 25-30% equities, 15-20% in mainly Swiss real estate, 5-10% alternatives and 5-10% liquidity, while the lion's share, 40-70%, is made up of fixed income, depending on the risk appetite and the coverage level of the pension fund.
Due to a generally positive performance on the back of falling interest rate cycles, the overall asset allocation by Swiss pension funds has remained stable over the last few years although fixed income portfolios may have gained a few percentage points in line with the markets' drop in equities. Investors did not strategically add to their bond portfolios.
"The biggest shift was the move from equities to real estate," says Christain Bodmer, head of investment consulting at Mercer Switzerland.
Between two thirds and three fourths of the average fixed income portfolio is allocated to Swiss francs but, of course, there are exceptions where pension funds have a much higher allocation to non-CHF denominated bonds, generally with a bias toward Europe and the US.
"Although the home bias in bonds has declined over the last few years, pension funds are happy about their home bias due to the turmoil in other bond markets," says Reto Wild, vice-president and investment consultant and controller at Complementa Investment-Controlling.
The Swiss Bond Index (SBI) has always been an aggregate benchmark, containing around 50% corporates, 40% government bonds and 10% securitised bonds, in other words, Pfandbriefe.
"The advantage of investing in the SBI is that it automatically includes a relatively high exposure to corporate bonds," says Wild. "Among foreign bonds, corporates only make up 20% but this number is rising."
The popularity of Swiss domestic bonds is down to their good reputation, whether it is utilities or Pfandbriefe, which hold only prime mortgages. However, the illiquidity of the Swiss bond market, substantial bid-ask spreads and higher transaction costs due to stamp duty, slightly dampen the spirit.
Nevertheless, they continue to play an important role in the strategy of a pension fund because they bring stability to the risk-return profile. Cashflows must be generated regularly and the least risky way of achieving this is through Swiss, or hedged, foreign bonds, and Swiss real estate. This explains why the home bias has been stable over the last few years.
"Reducing the bias is a topic in equities and increasingly in real estate," says Aris Prepoudis, head of institutional clients and wholesale at Bank Sarasin in Basel. "Some investors are still hesitant to invest abroad because they believe they would run too much risk, especially bad experiences in international real estate."
Diversification is achieved through the inclusion of a variety of bonds from high yield to AAA-rated. While some pension funds are happy to diversify in their bond portfolio, others are reluctant to invest in anything rated less than A.
"High yield bonds are not common because pension funds assume they behave like equities with regard to risk and performance," says Hertzog, market director at Aon Hewitt Switzerland. "If investors wanted equity characteristics they would rather invest directly in equities."
But the sovereign debt crisis certainly led to higher scrutiny of Swiss fixed income portfolios and changes are under way. "Some smaller pension funds have abandoned foreign bonds altogether and only invest in Swiss government and corporate bonds and Pfandbriefe," says Stephanie Spozio, senior consultant at Ecofin Investment Consulting. "Larger pension funds that previously had a market capitalisation strategy have started a country picking approach, away from the traditional benchmarks, which allows them to exclude countries such as Italy, Spain or Greece and reduce the weighting of other industrialised countries with a high debt burden. And while previously, foreign corporate bonds were part of a satellite portfolio, today they are often included in the core."
"However, the new bond world they are investing in now is not too different from what they did before," says Kottmann. "Investors and consultants want to avoid difficult countries but do not know how because of open benchmark issues."
Overall, diversification in fixed income portfolios, which has moved beyond foreign corporate bonds now to include emerging market debt and high yield, is on the rise, accelerated, no doubt, through the European debt crisis.
Emerging market debt comes into play as part of the country picking approach, according to Spozio. Standalone emerging market debt - as well as high yield - portfolios are still rare. "These were typical satellite investments," she says. "High yield remains there but emerging market debt of certain sovereign issuers is now being included in the core portfolio."
"Pension funds are always looking for more diversification in fixed income and some of them have even started to look at bank loans," says Wild. "This can be at the expense of equities or other foreign bonds. Inflation-linked bonds are also in demand."
But some Swiss pension funds that incurred large losses through investing in unhedged foreign bonds are now too worried to move from domestic to foreign bonds. And if they hedge their foreign currency exposure, there is little difference between Swiss and foreign bonds.
Those pension funds with a strategic currency overlay in place - typically euro and dollar, but also for sterling and yen investments - believe currencies increase risks for which they will not be compensated and want to use the risk capital they gain from this hedge for other investments. Those who play currencies think they will be rewarded for taking the risk.
"Currency hedging was very important in 2010, a lot of Swiss pension funds hedged a good part of their foreign currency investments," says Ryter of ASIP. "Due to the high volatility of currencies - until August 2011 - it was a case of the higher the hedging rate, the better the performance."
At the end of September, the SBI generated 4.3% year-to-date, compared to the 0.6% that the BarCap European Aggregate in CHF without currency hedging returned and an unhedged global bond aggregate of 2.7%. The BarCap Global Aggregate hedged in CHF returned 4.2% over the same period.