Opportunity for "de-risking" at Swiss pension funds

The accounting rules revised in 2013 in accordance with IAS 19 (International Accounting Standards) for the valuation of pension plans require the full disclosure of under- and overfunding in the company books. This should result in a high level of transparency, especially for listed companies. However, the improved transparency also has its downsides, because - as two Swiss studies have shown - it is associated with high balance sheet volatility.

As Peter Zanella and Richard Köppel, pension fund experts at Towers Watson Switzerland (see also "New studies on the funding ratio for Swiss companies" at the end of the text), there is a great deal of risk potential within corporate accounts. The 2015 Pension Risk Study by Watson Towers underlines that "companies are experiencing high year-on-year balance sheet volatility. " Many Swiss companies would need to take the opportunity to look at ways to understand and control the funding risks associated with pension schemes.

Declining results

Since the introduction of negative interest rates by the SNB, the economic situation of Swiss pension funds has become particularly difficult. "To reduce volatility, the implementation of lower-risk investment strategies could also be considered," Richard Köppel continues, "however, there is no standard procedure for this, as the starting position varies from company to company," the expert explains.

According to a recent study by the Lucerne University of Applied Sciences and Arts (hslu), when asked about their most important investment objective, Swiss pension funds mostly prefer direct investments in real estate. Many Swiss institutions are implementing longer-term strategies, show the hslu study results, which were already published in March 2015.

Pension funds invest in buildings and land so that they can achieve a defined return, preserve their capital and protect themselves against inflation. In Switzerland, the investors surveyed achieved average returns of between 5 and 6 percent in 2012 and 2013, with an increasingly downward trend.

Nevertheless, Michael Trübestein, lecturer and project manager at the Lucerne University of Applied Sciences and Arts, points out the following with regard to pension strategies

Swiss pension funds are oriented towards direct investments for real estate.

The Swiss real estate market is levelling out and opportunities are becoming harder to find: "One fallback option would be for institutions to investigate foreign markets for suitable - indirect - investment opportunities. However, Swiss investors are also competing with national and international investors there, and good properties are limited in number," says Trübestein.

In any case, compared to the previous year, the pension obligations of the so-called SLI companies increased by around CHF 36 billion (+19.8 %) and by CHF 30 billion (+18.0 %) for the SMI companies in terms of plan assets. However, the average funding ratio decreased by five percent for the SMI companies and by four percent for the SLI companies, mainly due to the low discount rate.

According to Towers Watson, 84 percent and 80 percent, respectively, of SLIs' pension liabilities in 2014 were covered by corresponding separately segregated plan assets.

Nevertheless, given the further decline in interest rates and the increasing difficulty of finding traditional investment vehicles that generate adequate returns in the short and medium term, the focus on pension liabilities is evident.

Possible effects

Not only economic but also legal intransparencies thwart the plans of Swiss pension funds. However, most Swiss people study the coverage ratio reported by the Swiss pension fund, which is based on Swiss GAAP principles. There is now movement among these in the domestic market:

However, the pension liabilities (and their volatility) according to the accounting standards could lead or even force employers to better control the underlying risks of the plan by directly influencing the way the occupational pension is implemented or the level of benefits offered. This is testified by the research report "Impact of IAS 19 on occupational pensions" (No. 02/15) from the Federal Social Insurance Office FSIO.

As a result of the falling interest rate, the employer could exert more pressure on the pension fund, which is under the management of the board of trustees composed equally of employee and employer representatives. In its study, the hslu research team asked investors about criteria that are important for the selection of an external management for the administration of their investment portfolio:

"Pension funds, foundations and life insurers are paying close attention to the experience and reputation as well as the costs of the service provider, while contractual aspects such as the term of the contract or the equity participation of the management play a less important role," says the hslu study published in March 2015.

According to Michael Trübestein: "On the one hand, this behaviour means that new management providers have to break through 'high entry barriers' in each case. On the other hand, it shows that market participants have a lot of trust in their partners in the real estate sector." A fundamental difference in the requirements for external management for direct or for indirect real estate investments could not be identified.

So how might larger pension funds behave if they are forced to watch their bond yields fall passively, so to speak?

Experts like Michael Trübestein differentiate: "In addition to currency losses, there are always political risks. Nevertheless, institutional investors consider a high degree of diversification to be very important, but only partially reflect this in their portfolios. A stronger internationalization would therefore be quite purposeful from the point of view of portfolio optimization and hedging." Pension experts believe that it would be rather suboptimal if, due to the SNB passing on negative interest rates, many investors were to suddenly find themselves in a situation where they were unable to invest.

In addition to currency losses, there are always political risks.

Swiss funds deposit pension capital in their own safe deposit boxes for long periods of time. The pension industry urgently needs to find solutions on how to properly exploit the transparency of foreign markets and optimise investments for sound investment.