Swiss Investment Foundations (Anlagestiftungen) are tax-exempt collective investment vehicles especially and exclusively designed for Swiss pensions. While their performance over the past year has been disappointing – in line with most Swiss investment vehicles – they are highly attractive structures for pension funds.
Governance friendly, tax efficient and relatively inexpensive, these investment foundations are particularly attractive for small and medium sized pension funds which do not have sufficient size of assets to achieve an efficient diversification through direct investments in all asset classes.
As well as being used directly by pension funds to structure their assets, investment foundations are also frequently used by asset managers to ensure a broad portfolio diversification for traditional mandates.
Investment foundations operate like mutual funds but within a lighter regulatory framework. Instead of being subject, like a Swiss mutual fund, to the controls of the Swiss Banks Federal commission, they are usually controlled by the Social Security Federal Office (BSV/OFAS) and can also be submitted to the regional (cantonal) pension fund authorities.
Their simple structure fosters low administration fees, and being exclusively designated to tax-exempt pension funds - with no retail sales – keeps management charges competitive. Management fees typically range from 0.2% to 0.3% for bonds and 0.5% to 0.8% for equities. Comparable mutual funds generally charge over 1%. Indeed, the relatively low administrative requirements have encouraged some large corporates to create their own internal (non-public) investment foundations and pool the assets of all their Swiss pension funds.
The disadvantage of the investment foundation structure is that due to the light legal framework and the limited requirements for their creation, practically anyone can set one up. This can rapidly lead to quality related problems. To avoid such difficulties, a group of large investment foundations, most of them sponsored by commercial banks, insurance companies and reputable Swiss private banks, have defined quality standards and created a conference of investment foundations which meet these quality requirements. The conference is known as KGAST (Konferenz des Geschäftsführer von AnlageSTiftungen) and it aims to provide investors with additional security and reliability while allowing them to continue to benefit from the inherently efficient cost structure.
There are currently nine Investment Foundation members of KGAST with assets under management totalling almost SFR50bn (E31bn). Some of these foundations have track records of over 30 years – far longer than most mutual funds.
The long-term performance of these investment foundations has been excellent, especially when compared to traditional mutual funds, with performance clearly above average for most segments and over all investment periods. Compared to benchmark, long-term results are also convincing with average performance in line or better than index.
Due to specific market conditions, last year’s results were disappointing for most asset classes. A strong recovery of cyclical and small and mid cap stocks in the Swiss market affected most active managers, who were typically overweight in the large cap growth segment that had been outperforming over the last five years. While the results for 1999 were disappointing – as they were for most mutual funds – longer-term performance remains ahead of market index.
The contrary situation occurred in the global equities markets, where Japanese equities allocation was rapidly increased after a good beginning of year. This, combined with the over exposure in high growth sectors like telecoms and technology, contributed to generate significant outperformance for Swiss investment managers. The average outperformance of investment foundations in that segment for 1999 was 3.5%.
The local bond market is a very important asset class, considering it represents more than 50% of the total investments of a traditional Swiss pension fund. Here the results produced by active managers were also disappointing. This is typical of a turnaround situation, where interest rates picked up after numerous consecutive years of decrease. The long-term results still remain positive compared to the market.
Although the results were not brilliant in all asset classes, Swiss balanced funds achieved excellent performance as a result of a combination of overweighting in the foreign equities market and excellent relative returns from that asset class. The average performance in Swiss franc terms for a fund with equity exposure between 30% and 40% (at the higher end of a typical Swiss pension fund’s risk profile) was approximately 9.5%.
The cash flow analysis of the KGAST investment foundations is also a very interesting market indicator as it shows the asset allocation trends from Swiss institutional investors. The analysis of flows for 1999 shows very interesting and unexpected results as the asset classes with higher net inflows were Swiss bonds and SFR bonds of foreign issuers.
While there clearly is some rebalancing impact explaining such results, this is surprising, especially in a period where interest rates are at their lowest level, and in light of the forthcoming relaxing in Swiss asset allocation restrictions.
Such a tactical move was also unexpected given that Swiss franc denominated bonds are currently clearly not favoured by most investment professionals. It may, however, reflect a certain willingness by pension funds to return to more conservative strategies after the high surpluses generated in the recent years.
Gioacchino Puglia is an investment consultant for Watson Wyatt AG, Zurich