One of the most developed markets in Europe, the Swiss pension fund industry is now entering a new phase of maturity. Disappointing investment returns and shrinking reserves are pushing institutional investors to rethink their strategies to find new investment solutions to face the future. Overall, investors are not satisfied with the work of money managers and money managers are finding it more difficult than ever to keep their positions in the market.
Swiss pension funds were used to having comfortable reserves positions that allowed them to have aggressive asset allocations in place. But now the situation has changed and some are starting to panic.
Asset managers and, especially, insurance companies, are seeing how the pensions business, once extremely profitable, is now having a negative impact on their organisations, and have asked the government to take measures in order to find a solution to the situation. Earlier in July, the federal government announced its decision to lower the minimum guaranteed rate for occupational pensions from 4% to 3% from the beginning of October in a move that some have described as a way to satisfy the lobbying from insurers, (see page 26).
“The situation of shrinking reserves became very obvious at the end of last year,” says Laurent Bachmann, executive vice president at Lombard Odier in Geneva. Lombard Odier merged in July with Darier Hentsch (LODH), to form Lombard Odier Darier Hentsch with assets of SFr140bn (E96bn), half of them coming from private banking. “The average performance of Swiss pension funds at the end of 2001 was around -7% and because they have to meet the 4% minimum guarantee requirement around 10% of their reserves vanished,” Bachmann says. Taking into account that these reserves had already been reduced at the end of the previous year, this means most pension funds have very little left.
This situation is affecting the market as a whole, forcing reviews of investment strategies and increasing risk awareness and cost consciousness. Investors are looking for effective low-cost products and it seems that passive management is now more attractive than ever.
Some of the big Swiss players have been able to develop large indexed capabilities, and foreign providers are gaining ground.
“The trend towards indexation started years ago, but now we are seeing how these products are becoming more and more popular in this market maybe driven by the frustration among investors regarding the poor performance of active managers,” says Michele Porro, managing director and head of the institutional clients department, at Credit Suisse Asset Management (CSAM) in Zurich. “Also, as we have seen in the past, people try to save some money during difficult times, and indexation fees are lower than those of active management,” he says. CSAM’s passive management business currently accounts for around SFr35bn, and the company has been able to get a large share of the Swiss institutional money invested in indexed structures. “During the last couple of years we have seen many active mandates going passive and in the past few months we have also witnessed some balanced mandates following the same route.” Other Swiss firms like UBS or Pictet have also benefited from this trend, and even though the Swiss players still dominate this area of the market, foreigners are seeing their businesses grow too.
“It’s true that the local players have a very strong presence in this market, but we have seen our market share increase considerably,” says Alex Orus, managing director at State Street Global Advisors (SSgA) in Zurich. “People know that in this business you need global platforms and the latest technology, which some of the Swiss big players have, but they are also looking for specialist in this area like ourselves.” He adds: “The last year has been very positive for us in terms of business growth as Swiss investors are demanding more and more indexed products, not only for the equity side but also on the fixed income part for the fixed income side of their portfolios.” And the new money is not only coming from pension funds but also from financial organisations unable to handle some investment strategies themselves, have decided to hire the services of other providers. Orus adds: “Some companies have realised that they just can’t offer every single investment solution to their clients and they rather outsource specialist products than seeing their customers going to talk to someone else. This type of outsourcing will become very important in the future and will definitely strengthen our position in this market.”
And it is true that foreign presence in the Swiss institutional market is growing, but it’s still quite limited taking into account the size of the market. The very specific characteristics of the Swiss market and the great sophistication of the country’s financial organisations has made life difficult for international houses trying to establish themselves here. Very few have got it right, and many haven’t been patient enough for the market to accept them. Everything indicates that things will not change much in the near future.
“If you want to be successful here you need to have a very strong local presence and behave as the market wants and not as you think is best for your business,” says Graziano Lusenti, who previously worked for Robeco in Geneva and has recently established himself as an independent adviser for pension funds. “Local players are very sophisticated and they can offer clients very specialised products and they know how the Swiss market works. This is something that people do not always see and try to enter this market thinking they are better or more innovative than domestic houses.” He also points out the need for international houses to be prepared to wait and be patient. “This means you can’t change strategy every year, you can’t change your organisation’s structure all the time and you can’t change your staff every quarter. Swiss investors like to know who are they dealing with and moving people around is very confusing for them. Sometimes they are reluctant to enter a relationship with foreign houses because the fear they won’t be talking to the same people in a few months’ time. All these issues are crucial in the market and essential if you want to be successful here.”
Lusenti’s plans as an independent adviser will also focus on the distribution of investment products on behalf of foreign managers who “should enjoy the benefits or having a sales outlet here without having to open an office in the country”.
Another issue that is limiting foreign presence is the structure of the pension fund market itself. With around 3,000 pension funds, most of the market is covered by small and medium size schemes, which won’t buy hedge funds, emerging market equities or even European small caps. “Also, and even though there is a obvious move towards specialist products, balanced strategies are still very important here, and managing those is not an easy task for foreigners,” says Lusenti.
However, the larger funds, those who are more likely to hire an international house, are more and more looking outside in search of providers who can satisfy their more specialised investment needs, although Swiss players have also a lot to offer in this arena.
In search for extra returns, more pension funds in Switzerland are looking at alternative asset classes and even though the total exposure to alternatives is still low in most portfolios their presence is steadily growing.
“We have seen a number of funds moving into hedge funds and their presence is progressively increasing in the market,” says Bachmann of LODH. “They have been pushed into this asset class because of the market situation and the need for returns that can boost their total portfolio performance.”
This view is shared in the market with some of the domestic players working hard to dominate this area. This is the case of Unigestion, for instance, whose alternative investment team is one of the most aggressive in the country and really believes in the opportunities that the near future will bring. “At present, a lot of pension funds are reviewing their asset allocation strategies and alternatives will be one of the topics they are considering,” says Patrick Fenal, CEO at Unigestion in Geneva. “Hedge funds are a hot issue and what we are proposing in equity is a highly active investment strategy in long-short term hedge funds as a way for bringing alpha to institutional portfolios.” Unigestion manages SFr2bn in hedge funds for institutions. He adds: “Consultants are very interested in alternatives and it’s their job, and ours, to get the message across and help investors understand how these products can enhance their investment portfolios.”
In Zurich, head of consulting and sales at Zürcher Kantonalbank Stefan Angele comments: “The trend towards investing in alternatives is growing from a very low level, and it is not always due to investors sophistication but to desperation about not being able to meet the returns they need. Pension funds cannot just move away from equities into bonds because this way is not possible to meet their targets and they need to do something about it.” Zürcher Kantonalbank currently manages around SFr12bn for Swiss institutions. “Most of our clients are still increasing their exposure to equities and their international diversification, and looking at hedge funds is just another way of setting up a more dynamic investment strategy.”
Diversification in real estate is also becoming crucial for some Swiss funds which traditionally have invested large proportion of total assets in direct property holdings. “
Real estate has to be considered as an alternative investment and is a very important issue at present,” Angele says. “Traditionally, this has not been a very liquid class and investors are finding solutions to this liquidity problem by selling off their property holdings and moving to indirect real estate investments through investment funds.” Although this indirect approach to real estate is, so far, mainly focused on Swiss property, the general view in the market is that the interest in investing in international, mainly European, real estate is there and will increase in the future since regulation does allow it and managers are launching new products with these characteristics. If this is happening on the real estate side, diversification has also arrived to the fixed income part of the portfolios.
“What we have been seeing in the market is that fixed income, as an asset class, is enjoying more popularity,” says Udo von Werne, responsible for marketing at Pictet Asset Management in Geneva. “People are now thinking more in terms of products as they do on the equity side and areas like corporate bonds, high yield or even emerging markets debt are now being seriously considered.” Pictet handles assets of SFr50bn for institutions, of which SFr7bn are passively managed.
So, for those managers offering diversification on the bonds side, this seems to be a good moment to gain clients. This is the case of Fisch Asset Management, a Zurich-based company which specialises in convertible bonds and currently manages SFr1.2bn. “Not long ago we could go to a pension fund to talk about convertible bonds and they wouldn’t even listen to us, only because risk control was not top of their agendas,” says Kurt Fisch, managing partner at Fisch Asset Management. “In today’s new environment everything is different and risk is a very important issue and taking into account that our assets under management doubled during a year, it is obvious to say that pension funds are really looking into these products.” This interest has attracted foreign houses offering similar products into Switzerland and competition is starting to grow. “I think this is a very important development because it keeps the discussions about convertible bonds among investors and they are getting to know these products better.”
And if the market behaviour is pushing some different investment strategies forward, it is also slowing down the growth of other approaches which, not so long ago, were achieving quite a substantial importance in the market. This is the case, for instance, with socially responsible investments (SRI) which had attracted interest among investors, and although it is still there, it seems the whole debate has been put aside for a while.
“SRI is more than a trend that comes and goes,” says Lusenti. “It is here to stay and has acquired quite a lot of relevance in Switzerland because pension funds are managed by boards of trustees where employees’ representatives occupy half the seats.” He adds: “However, it could well be that poor performance has forced SRI out of investors’ priorities for the time being.” He continues: “The real test for SRI products, especially in the equity field would be if they can outperform over a number of years.” Lusenti also mentions corporate governance as another topic high on pension funds’ agendas. “So far very few companies are offering convincing solutions to them. There is a market to grasp easily here.”
With disappointing returns at the end of 2002, the industry has not yet started to recover from last year’s performance. However, managers are optimistic about the near future and expect it to be a busy period where investors will finalise the revision of their strategies and start manager searches for new mandates or for replacing those who haven’t met their expectations.
Both financial institutions and pension funds will need some time to recover from recent losses and prove that the pension fund industry, which has been seen as a model across Europe, is built on solid pillars and able to continue growing. Those wanting to profit from it will have to learn the rules of the Swiss market and, first of all, to really demonstrate they are better than the local professionals. “Switzerland is a mature pension funds market and no longer a ‘strongly-growing’ one,” says Lusenti. “Anyone wanting to do business here has to understand this. “On the other hand, the potential to get new business is still huge. First, you have all the asset classes which are getting more and more popular among pensions funds like hedge funds, small and midcaps, international real estate, mortgages and so on. Second, there is a lot of potential with the small and medium sized insured funds. Surprisingly, alomost all foreign managers focus exclusively on the very large funds rather than trying to get business from the ‘not-so-big guys’ where the relationships are usually more stable and the competitions less,” he says.
The decision recently taken by Swiss authorities to reduce the technical guarantee rate has created a storm against insurance companies which will not doubt contribute to transform the market. “These changes represent real opportunies for newcomers, since this segment of the market will certainly become more dynamic in the future,” he says. This is an area where new players have a lot to say because the established leaders are in trouble at present and even thinking of getting out of the business. But so far I haven’t seen any serious interest from international houses to position themselves as a trustworthy, long-term provider of financial services in this market segment.”