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Investment for Swiss pension funds: Have the rules of the game changed ?

360°Benefits I News

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By Michael Valentine and Jérôme Franconville | May 10, 2021

How to adapt swiss pension fund portfolio to succeed in 2021?
  1. 01

    Challenging times

    After an incredibly turbulent 2020, long-term institutional investors are left wondering what the shifts we have all seen in the way we work and enjoy our social life mean for investments rules.

    In our 360° Benefits Academy – Investment Webinar earlier this year we addressed the following pressing question faced by our clients (notably Swiss pension schemes): How to adapt swiss pension fund portfolio to succeed in 2021?

    The quick, initial answer to the question about “the rules of the game” is that the same basic rules still apply today which is to maintaining a liability-oriented focus on delivering adequate long-term, robust investment returns. But, with the change in pace and complexity of market developments, for example with “ESG” factors proving that they are relevant to financial outcomes, it is necessary to re-think how we deliver such returns.

    Whether or not COVID-19 was directly responsible, market developments over recent months have accentuated the problem zones in existing, traditional asset classes and investment approaches e.g. market-capitalisation-weighted indices.

    Typical Swiss pension scheme portfolios, with 38% in cash and bonds, 30% in equities and 32% in property and alternatives* reflect the amazingly benign historical conditions of recent decades (demographic shifts, technological progress, new actor emerging as a global power). The result is high concentrations of risk and low return expectations.

  2. 02

    What actions can be taken?

    Below we take a simplified view of the “liability-oriented” and “return-seeking” parts of the portfolio, which we proxy with bonds and equities, respectively:

    Traditional bond investments, making up nearly 40% of total assets, are expected to deliver little or no return, are exposed to inflation risk (rising interest rates), and also carry substantial credit risk. We recommend considering incorporating the following components:

    • Secure Income Assets (SIAs): these are (very) long-term, contractually secured, real income streams and include real estate debt, infrastructure, mortgages, property;
    • Alternative Credit: by looking beyond the mainstream, listed credit markets, there is an increase in available assets and therefore return and diversification potential e.g. direct lending, non-agency securitized debt, corporate EMD, specialty finance;
    • Green Bonds: bonds specifically designed to fund projects with positive environmental benefits; and
    • Being as diversified as possible across issuer, industry, geography.

    Traditional equity investments, comprising approximately 30% of total pension scheme assets, are volatile and highly concentrated in a few mega-cap, tech. companies and sectors. These issues can be mitigated by a combination of the following:

    • “Capped” indices, whereby the maximum exposure to a single stock is limited to, say 5% (also potentially applicable to bond exposures);
    • “Better equities”, which combine concentrated portfolios, each with only 10 – 15 of the highest conviction stocks, with distinct styles to form a diversified combined portfolio with significant alpha potential; and
    • Private markets which benefit from the illiquidity and complexity risk premia
  3. 03

    Final remarks

    At total portfolio level , a greater granularity in the asset class definitions used for strategic allocations, often leads to too passive an approach, with investors getting “stuck” in temporary market hotspots. Therefore loosening the definition of individual asset classes makes excellent sense e.g. alternative credit instead of separate and distinct secured loans, high yield, emerging debt, … As a result, the number of building blocks required can be reduced as can the governance budget of the portfolio.

    Lastly, and arguably most importantly, it is vital for a clear set of responsible investment beliefs to be applied to all investment decisions. This could mean taking no action, or it might lead to a thorough decarbonization plan affecting the entire portfolio. The point is, at a time of great momentum in ESG and impact investment among institutional portfolios, not to think seriously about climate risk and other ESG factors is simply no longer an option. These are historic, but entirely justified developments that are further bolstered by increasing levels of political backing, notably regarding the matter of global warming.

    The ESG train is gathering momentum and requires to be factored in for any future investment decisions as this could become a real risk and return differentiator. A minimum approach of understanding and review is recommended.

    * Source: Willis Towers Watson Database based on 2019 year-end accounts for 116 Swiss pension funds

Authors


Head Investment Services (Schweiz)

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