A company pension fund might not be the first place you would think of applying for a mortgage.
According to Matthias Weber, a partner at Zurich consultancy ifund services, the issuance of mortgages by investors is likely to deepen as Swiss pension funds continue on their quest to find good alternative assets.
Weber has just helped to complete a survey of 200 Swiss pension funds’ investment priorities and reckons that the hunt for alternatives is at the top of the list. He expects major Swiss investors to grapple with this in 2013 as they look to reduce bond holdings. Yields of Swiss government bonds dated five years or less have hovered around zero in 2012, placing great strain on their return potential and necessitating a search for new ideas, in Weber’s view.
The typical major Swiss pension funds hold a rather chunky 30 to 50 per cent of their assets in domestic bonds. Government issues are a significant proportion of this, says Weber, as domestic corporate debt offers only a “limited” market.
Alternative ideas
Weber simply does not think that conventional asset classes can soak up all the money that Swiss pension investors will take out of domestic bonds in the next few years. As many pension investors are also looking to de-risk due to the closure of defined benefit schemes, alternatives generating dependable return streams will be the name of the game.
Weber identifies commodities and insurance-linked investments as two asset classes in the alternatives space attracting the attention of major Swiss pension investors.
The survey of Swiss pension funds by ifund services found that 61 per cent already hold commodity investments. The company also knows of seven pension funds looking to take on new external commodities managers in the next year. Commodities allocations rarely exceed 2 per cent of overall portfolios though, according to Weber, with investors wanting to keep their overall performance detached from the well-known volatility of commodity prices.
An even greater number pension funds are said by Weber to have an interest in appointing new insurance-linked investment managers. Some 21 per cent of Swiss funds responding to the survey already hold the relatively new asset class.
Catastrophe bonds in particular are interesting Swiss investors, Weber says.
More than a decade after their introduction he says they have performed well – with returns usually between 4 to 6 per cent – proved to be fairly liquid with low fees. “The market is tiny though, at around $15 billion, so you can only really allocate 2 to 3 per cent to catastrophe bonds” he says.
Hedge fund-style alpha and mortgages
Hedge funds might appear natural bedfellows of Swiss funds looking to diversify and find low-risk, steady returns. Weber explains that Swiss institutional investors were extremely enthusiastic about hedge funds from the late 90s, but there has been widespread disappointment since. Now, many of them feel hedge funds have been “expensive and have not performed well in the past few years”, says Weber, with the Swiss media frequently honing in on concern at hedge fund fees. The ifund services survey found that eight Swiss institutional investors are looking to drop their hedge fund managers in 2013.
Well-managed unconstrained bond funds and alternative UCITS are of interest to Swiss institutional investors looking for hedge fund-style alpha, says Weber (pictured left).
Another developing alternative asset class for the largest Swiss institutional investors is the issuance of credit to replace reduced bank lending in Europe.
Weber says that “some pension funds have begun issuing mortgages to their employees, and there is a feeling that direct lending can bring in good returns at low costs”.
The $15-billion Swiss Railways’ SBB Pension Fund last year acquired $686 million in mortgages while the $10.9-billion Basel City pension fund and $8.3-billion Aargauische Pensionskasse also offer mortgages.
On the whole, Weber reckons that Swiss institutional investors will look for holdings in alternative asset classes of around 8 to 10 per cent of their total portfolios.
Ultimately, with limited interest in existing alternatives and other asset classes just arriving on the scene, a lack of acceptable alternatives might lumber Swiss pension funds with the government bond holdings that many are looking to reduce.
Sticking to the well-trodden path of caution on alternatives and faith in large bond holdings might result in many funds needing to reduce liabilities with benefit cuts, Weber warns.
The established options
Given the scarce supply of alternatives, Weber expects real estate and less traditional bond holdings to prosper even more from a sustained move away from domestic bonds.
Global corporate bonds, high yield and emerging market debt as well as real estate investments offer established alternatives that Weber expects Swiss investors to utilise.
Weber cautions though that “a lot of pension funds might hesitate to swap the safety of Swiss government bonds to emerging markets or senior loans when they don’t know the issuers or the risk.”
The Swiss real estate sector is more of a trusted destination for pension capital, however. The sector has been a beacon of solid performance while its European counterparts have crashed recently.
Any fears that Swiss real estate is overvalued by this resilience are wide of the mark, reckons Weber.
He argues that property price increases have been more modest in Switzerland than elsewhere over the past two decades, offering 3 or 4 per cent net returns on average.
Taking the passive route
The ifund services survey found that around 50 per cent of assets at the Swiss funds responding are managed in passive external mandates. Some 56 per cent of assets in developed market equities are passively managed according to the survey, making this the most passive asset class.
A range of Swiss pension funds want to further increase their use of passive managers, according to Weber, but does not know a single pension investor looking to increase active management.
He thinks that reducing risk relative to benchmarks is the overriding reason why cautious Swiss pension funds have come to embrace passive investing, explaining that most pension fund boards in Switzerland are very conservative and “there is no reason to select active funds if you are not convinced”.
“Many funds feel that the search costs and monitoring of active managers – occasionally revealing big mistakes – are excessive”, says Weber.
