Download The Impact of Costs and Returns on the Investment

REPORT
The Impact of Costs
and Returns on the
Investment Decisions
of Swiss Pension
Funds
i|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
EXECUTIVE SUMMARY
This report aims to increase transparency on the decision criteria that drive the
investments of Swiss pension fund managers and the interactions of return and
cost perspectives throughout the decision making process. The report highlights the importance of net returns in the assessment of investment opportunities.
The findings presented in this report are the result of a comprehensive survey
among large Swiss pension funds. Public, corporate, and industry-wide/multiemployer pension funds participated in the survey.
The report reveals that portfolio diversification is the main decision criteria
for Swiss pension fund managers when structuring their portfolios. The riskreturn-relation is seen as the most important measure to assess an asset’s
performance followed by its net returns. However, some fund managers also
look at gross returns and investment costs.
Most portfolios are rebalanced and restructured less than once a year as investment decisions are usually very long-term oriented, not only for illiquid
assets such as real estate and private equity investments but also for more liquid
asset classes such as bonds and stocks.
Surprisingly, the current negative interest rate environment still has limited
impact on the portfolio structure of most Swiss pensions. However, more
than 50% of fund managers claim to invest more in private equity and real estate
as a response to negative interest rates; while they withdraw their bond investments.
The average total expense ratio (TER) of the participating pension funds
is 0.6%, approximately 75% of which are portfolio management costs. Administrative costs and other costs only play a minor role. The survey shows that bonds
and stocks impose the lowest investment costs but their returns are also relatively low. Costs of some private market investments, in comparison, are significant but the even higher gross returns lead to net returns of around 6% in
2015 which are by a wide margin higher than net returns achieved by stock
or bonds portfolios in 2015. Consequently, correlations between portfolio net
returns and portfolio management costs are strongly positive.
Despite low net returns, the majority of pension fund managers still seem very
satisfied with the cost-return-ratios of bonds, stocks and real estate, but are a
bit more cautious regarding the assessment of private market (private equity,
private debt, private infrastructure) and hedge fund related investments.
The results of the survey are reason to suggest that pension funds do not
sufficiently distinguish between the different asset types when assessing
their investment options. High costs are not necessarily a bad sign. Some
asset classes require more investment sourcing efforts (e.g., screening, due diligence) prior to investments and also come with higher direct costs, thus, driving
EXECUTIVE SUMMARY
ii | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
up portfolio management costs. However, returns of these assets are often
significantly higher and more stable than returns of more conventional asset classes (e.g., bonds). Against this background, pension fund managers
should pay greater attention to net returns when taking their investment decisions. No investment decision should be based on isolated views on gross returns or investment costs.
Should pension funds stop focusing on the cost perspective of their investments? Not at all, cost awareness remains important to generate high net
returns. Yet, instead of comparing it on an aggregated portfolio level, pension
funds should assess cost efficiency on the level of an individual asset
class and not across different ones.
We hope you will enjoy reading our report and we hope to contribute to the
ongoing discussion on the future development of the Swiss pension fund system.
Prof. Dr. Stefan Morkoetter
Thomas Wetzer
EXECUTIVE SUMMARY
iii | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
TABLE OF CONTENTS
EXECUTIVE SUMMARY
i
1. INTRODUCTION
1
Focus of this report
1
About the survey
2
2. THE SWISS PENSION FUND LANDSCAPE
5
The Swiss pension scheme
5
Current challenges for Swiss pension funds
6
The role of costs and the difficulty of comparing costs
across asset classes
7
i.
Total expense ratio
7
ii.
Difficulties when comparing costs
8
The Swiss pension fund system in comparison to other
countries
9
3. ASSET ALLOCATION OF SWISS PENSION FUNDS
11
4. INVESTMENT PARAMETERS OF SWISS PENSION
FUNDS ACROSS ASSET CLASSES
14
The impact of the negative interest rate environment on
investment decisions
18
5. THE RELATIONSHIP BETWEEN PERFORMANCE AND
COSTS
21
Why high direct costs are not necessarily a bad sign
22
CONCLUSION
29
CONTACT INFORMATION
30
REFERENCES
31
TABLE OF CONTENTS
iv | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
TABLE OF FIGURES
Figure 1: Distribution of survey participants
3
Figure 2: Current asset under management of participating pension funds
4
Figure 3: Number of employees in asset management teams of participating
pension funds
4
Figure 4: Illustration of 3 pillar-retirement plan Switzerland
6
Figure 5: Current asset allocation of participating pension funds (in %)
13
Figure 6: Investment decision criteria
15
Figure 7: Criteria that are most useful to assess asset performance
16
Figure 8: Frequency of (substantial) portfolio adjustments
17
Figure 9: Typical time horizon of investment decisions
18
Figure 10: Impact of negative interest rates on investment decisions
19
Figure 11: Impact of negative interest rates on pension funds’ portfolio
structures
20
Figure 12: Current cost split of pension funds
21
Figure 13: Relationship of assets under management with the total expense
ratio
22
Figure 14: Illustration of the levels of pre-investment sourcing efforts
23
Figure 15: Investment costs and gross and net returns by asset class
24
Figure 16: Relationship of net returns with portfolio management costs
25
Figure 17: Fund managers’ opinion on cost-return-ratios of individual asset
classes
26
Figure 18: Fund managers’ opinion on risk-return-ratios of individual asset
classes
TABLE OF FIGURES
27
1|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
1. INTRODUCTION
Focus of this report
Swiss pension fund managers currently face a tough challenge: they need to
generate consistent returns in a low interest rate environment in order to finance
high pension commitments incurred in the past and to build up capital for future
pensioners. Many pension funds find it hard to achieve these goals to the satisfaction of their stakeholders (employees, employers, governmental institutions,
etc.).
Like in most other industrialized countries, pension funds in Switzerland struggle
to achieve their expected returns in light of an aging population, scarce profitable
investment opportunities, and unfavorable interest rate trends. Interest rates are
on a historically low level and it is unclear when the markets will return to higher
yields. The situation in Switzerland has toughened even further since the introduction of penalty interests by the Swiss National Bank (SNB) in early 2015.
So far, the Swiss pension system has not yet been noticeably adjusted to these
demographic and macroeconomic changes. Conversion rates (Umwandlungssätze) are still based on a high interest rate environment and on a younger
workforce. Most recently, pension funds have started to respond to current developments by reducing their commitment to (future) pensioners by lowering the
technical interest rates (Technischer Zins). Most likely, these measures will not
be sufficient to circumvent a deficient cover (Unterdeckung). Pension funds will
also have to adjust their investment activities in light of
current changes.
Fund managers
Pension funds have to carefully analyze how their curstrive after low
rent portfolio structures can be optimized. In this concost levels
text, two important decision parameters are investment
costs and returns. Returns can undoubtedly help to
achieve outstanding results. While this might be a solution for some pension
fund portfolios, it will not be achievable for all. As a result, the reduction of costs
is often considered the core objective by fund managers. Pension fund managers that seek to minimize overall asset cost ratios will channel capital into asset
classes with low cost structures – but not necessarily high return structures.
Thus, an isolated consideration of asset costs often prevents more favorable investment results.
This study highAgainst this background, our report aims to link the cost lights the imand return perspectives in pension fund portfolios and by portance of a
doing so it emphasizes the importance of net returns of net-return-perindividual asset classes. The report argues that invest- spective
ments should only be made after assessing asset costs
relative to asset returns for each individual investment class; only net-of-costreturn perspectives will lead to optimal investment decisions. Costs, in turn,
should be benchmarked against individual asset classes. They should not be
INTRODUCTION
2|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
aggregated on the portfolio level as both cost and return structures are significantly different between asset classes. Pension funds should regularly reassess
cost-return-ratios and restructure their portfolios if necessary. This study investigates to what extent pension funds have started to take such measures and it
discusses the decision criteria that drive these measures.
The findings of the report are drawn from a representative survey among over
80 participants from public, corporate, and industry-wide/multi-employer pension funds in Switzerland. All findings presented in this report are drawn from
the results of the survey unless otherwise stated.
Based on the survey responses, the report compares costs and returns of individual asset classes and provides transparency on how pension funds assess
asset returns relative to their investment costs; particularly in light of negative
interest rates and lower conversation rates. After a brief introduction to the Swiss
pension fund landscape, the report gives an overview of the current average
asset allocation of Swiss pension funds and the decision factors driving their
investments. The report then presents average fund costs and returns and the
relationship between them. It also shows how funds invest their capital against
the background of cost- and return-perspectives.
About the survey
36 public, 26 corporate, and 19 industry-wide/multi-employer pension funds participated in the survey; 81 pension funds in total. The survey was conducted in April and
May 2016. Generally, we observed a very high willingness
among pension funds to participate in our survey. Please
note, however, that not all the survey participants completed the full survey. Hence, for some of the survey questions, we did not collect responses from all participants.
More than 80
pension funds
participated in
the survey
The survey consisted of 14 questions and questionnaires were sent out in German by email either to general managers, directors/presidents, or members of
the asset management teams of pension funds. 33 responses (41%) came from
members of the asset management teams, 29 responses (36%) came from
managing directors or CEOs, 5 responses (6%) came from presidents of the
board, and 3 responses (4%) came from other pension fund employees (e.g.,
Finance & Controlling, Administration) (Figure 1). 11 participants (14%) did not
disclose their positions. Answers were evaluated anonymously. For reasons of
comparison, we asked the survey participants to base their answers based on
their most recent financial figures. In most cases, these were end-of-2015 figures.
At this point, we would like to thank all participants for taking the time to answer
our questions.
INTRODUCTION
3|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
Managing director/
CEO
4%
President of the board
36%
Asset management
(incl. team heads,
managers)
41%
6%
Other
(Finance&Controlling,
Administration, etc.)
Figure 1: Distribution of survey participants
The focus group of the survey were larger pension funds as most of the smaller
funds maintain no or only very small investment teams. Smaller funds tend to
outsource their investment decisions to external service providers (e.g., banks).
Consequently, almost 80% of the funds that participated in the survey manage
at least CHF 1 billion (Figure 2). The number of Swiss pension funds has decreased recently but there are still more
than 2,000 funds registered in Switzerland. However, the Mainly larger
large majority of these funds have less than 1,000 people pension funds
covered by their pension scheme 1. According to a recent participated in
survey, the smallest pension fund among the top 100 the survey
Swiss pension funds manages CHF 1.1 billion worth of assets 2. We therefore assume that approximately 60% of the
top 100 Swiss pension funds participated in our survey.
Figure 2 discloses the distribution of asset under management among the participating funds.
1 Credit Suisse – Schweizer Pensionskassen (Perspektiven in der Demografie und im Anlagemanagement (2014)
2 Investmentoffice.com – Pension Funds Guide Switzerland (2015)
INTRODUCTION
4|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
CHF >5,000 mn
31%
CHF 1,000-5,000 mn
48%
CHF 500-1,000 mn
14%
CHF 100-500 mn
6%
CHF 0-100 mn
1%
0%
10%
20%
30%
40%
50%
60%
Figure 2: Current asset under management of participating pension funds
41% of the participating pension funds have 2-5 employees in their investment
teams, 29% have only 1 investment employee, while 19% employ 6-10 and 11%
more than 10 employees, respectively.
11%
29%
19%
1 employee
2-5 employees
6-10 employees
>10 employees
41%
Figure 3: Number of employees in asset management teams of participating pension
funds
INTRODUCTION
5|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
2. THE SWISS PENSION FUND LANDSCAPE
The Swiss pension scheme 3
The Swiss pension fund system is part of the so-called ‘2. Säule‘ of the Swiss
retirement plan. The ‘2. Säule‘ covers all pension fund payments related to a
person’s professional life. The pension fund scheme helps employees (i) to save
money for retirement and (ii) to hedge against invalidity and death. The ambition
level is that retirees should be able to continue the life they are used to in an
appropriate manner even in retirement age. Together with the ‘1. Säule‘ (protection of basic needs) and ‘3. Säule‘ (additional private contributions), retirees
should have access to approximately 60% of their last wage. Payments into the
pension scheme are mandatory for all employees in Switzerland which are paid
more than CHF 21,150 (as of January 1, 2016). The amount employees have
to pay depends on age and gender and it cannot fall below a certain minimum
rate defined by the legislator. Employers are obliged to pay at least the same
amount as their employees. Occupational welfare for life and death starts on
January 1 once the 17th year of the employee’s life has been completed and is
expanded to retirement savings on January 1 once the 24th year of the employee’s life has been completed. Payments into the pension scheme end with
the start of retirement, which is 65 years for men and 64 years for women currently.
In theory, there are two types of pension fund schemes in Switzerland: a benefit
plan (Leistungsprimat) and a contribution plan (Beitragsprimat). The benefit plan
defines retirement benefits based on the wage which has been covered by the
employee’s pension plan. Usually there is a fixed payment (a percentage of the
wage) and a surplus depending on the pension fund’s investment return. If an
employee is insured under the contribution plan, he/she will be paid depending
on the savings balance which has been accumulated during the time of employment. Most Swiss pension funds have started to follow a hybrid model combining the benefit plan and the contribution plan: retirees are usually paid based on
a conversion rate (Umwandlungssatz) which is computed based on a minimum
technical interest rate (Technischer Zinssatz) of currently 2-3% and the employee’s life expectation. An employee with a savings balance of CHF 100,000
and a conversion rate of 5% is paid at least CHF 5,000 annually. The official
conversion rate is 6.8% currently and it is capped at CHF 84,600. Pension funds
can, however, choose to pay out higher pensions. The conversion rate of this
additional pension (Überobligatorium) is currently at 5.7%, on average. Larger
pension funds tend to apply lower conversion rates than their smaller counterparts. Pensioners can request a (restricted) lump sum of their pension payments
rather than regular payments. These ad-hoc payments are subject to certain
preconditions and can only be paid out every five years.
3 The information in this chapter is obtained from the Swiss ‘Bundesamt für Sozialversicherungen (BSV)’.
THE SWISS PENSION FUND SCHEME
6|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
Figure 4: Illustration of 3 pillar-retirement plan Switzerland
Current challenges for Swiss pension funds
In January 2015, the Swiss National Bank (SNB) lowered the interest rate for
bank deposits below 0%. The average 3-months LIBOR CHF rate from January
2015 to May 2016 has been -0.76% which is within self-defined SNB target interest range of -0.25 to -1.25%. The aim of this policy is to counter the appreciation of the CHF 4. Negative interest rates are supposed to help maintain a
EUR/CHF rate of at least 1.2.
A low interest rate environment in combination with a
strong demographic change (low birth rates and an aging The macroecopopulation) have direct and harsh consequences for nomic situation
Swiss pension funds: it is becoming harder for the funds and demoto achieve the investment returns required for the com- graphic changes
mitted pensions to their retirees. However, we should challenge penalso keep in mind that the situation might not be as cheer- sion funds
less as it first appears: real rates of interests have not
decreased as much as portfolio returns might suggest. The reason for this are
current inflation rates which are lower than in previous years 5.
Nevertheless, investment returns of pension funds that are below the current
minimum interest rate will ultimately lead to a deficient cover (Unterdeckung).
4 Schweizerische Nationalbank (SNB)
5 See Swisscanto Vorsorge AG – Schweizer Pensionskassenstudie (2016)
THE SWISS PENSION FUND SCHEME
7|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
The aging Swiss population combined with lower birth rates lead to longer retirement periods but lower payments into the pension scheme on the side of
employees.
There are no signs that the situation will change in the short- to mid-term. Several countermeasures are therefore being discussed to overcome the challenges including later pension start dates, higher payments into the pension
scheme, and a reduction of conversion rates. Some pension funds are already
taking actions. They adjust parameters that define future pensions and they
lower minimum technical interest rates. In addition, they can react by restructuring their investment portfolios and by reassessing the cost-return-ratios of the
asset classes they invest in. This study investigates to what extent pension
funds have (already) started to take such measures and the criteria that drive
these decisions.
The role of costs and the difficulty of comparing costs across asset classes
i. Total expense ratio
Art. 48a BVV2 specifies that pension funds need to display their costs in their
annual reports and they thereby need to differentiate between three cost categories: portfolio management costs (Vermögensverwaltungskosten), administrative costs (Administrative Verwaltungskosten), and marketing and advertising
costs (Marketing- und Werbekosten). Portfolio management costs are usually
an aggregate of the management costs of individual asset classes/investments,
while administrative and advertising costs are a lump sum of the total costs incurred by the pension fund over a given year. Total costs are commonly assessed based on the total expense ratio (TER). The TER ensures a transparent
cost structure in line with international standards. In Switzerland, the TER-definition is defined according to the guidelines of the Swiss Funds & Asset Management Association (SFAMA) 6. The guidelines are binding for all collective investment schemes 7. They prescribe that the TER should be published in the
pension funds’ annual and semi-annual reports (if applicable). The TER is generally calculated as follows:
TER % = (Total operating expenses / average net assets) x 100,
where total operating expenses should include the sum of all fees and incidental
costs (e.g., management fees, performance fees, deposit fees, administrative
fees, service fees, custody fees, and potential other fees) charged to the fund’s
income statement on an ongoing basis. These operating expenses cannot be
6 SFAMA – Guidelines on the calculation and disclosure of the Total Expense Ratio (TER) of collective investment
schemes (2008, updated 2015)
7 Binding force of the SFAMA guidelines according to the Guidelines on the calculation and disclosure of the Total
Expense Ratio (TER) of collective investment schemes: “…fund management companies pursuant to Art. 28 et
seqq. CISA, investment companies with variable capital (SICAVs) pursuant to Art. 36 et seqq. CISA, investment
companies with fixed capital (SICAFs) pursuant to Art. 110 et seqq. CISA and representatives of foreign collective
investment schemes pursuant to Art. 123 et seqq. CISA in Switzerland must ensure cost transparency in line with
international standards”.
THE SWISS PENSION FUND SCHEME
8|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
offset against a fund’s investment income. Average net assets are the mean of
the net assets on a given accounting due date.
Due to the specific nature of its investments, pension funds are exempted from
the disclosure obligation of TERs for its private market fund investments: According to the SECA guidelines for the calculation and disclosure of costs of
private market funds, the disclosure obligation of pension funds is limited to the
total expenses, but don’t require the disclosure of a TER. 8 However, it is at the
discretion of pension funds to additionally also publish a TER for its private market fund investments.
Portfolio manii. Difficulties when comparing costs
agement costs
do not cover all Portfolio management costs usually cover all costs that
investment
can be directly charged to a pension fund. These so-called
direct costs can be allocated directly to the pension fund’s
costs
investments. There are also costs that are netted with the
performance of an asset and that are not visible in the cost
calculation. These indirect costs are usually fees and transaction costs that incur
within collective assets (e.g., funds, ETFs), implicit fees in structured products
and, last but not least, all implicit transaction fees (spreads). An independent
study from 2011 9 found that indirect costs constitute up to 70% of total asset
costs. Consequently, the existence of direct and indirect costs makes a comparison of different asset classes difficult. For example, if a pension fund buys a
bond via a third party (e.g., a bank) which acts as an intermediary, the spread
earned by the bank for this transaction is nowhere accounted for, but of course
leads to higher prices and consequently lower returns. A
second field relating to direct and indirect cost structures In some asset
can be found with regard to the execution of governance classes, costs
duties: For example, Private Equity fund managers are are correlated
actively involved in governing their portfolio companies, with perforwhereas fund managers of listed equity funds are typi- mance
cally not involved in steering the business operations. It
is important to note that the transparency of investment
costs can to a certain extent be managed by the pension funds themselves:
when investing in stock funds, for example, pension funds can in some cases
choose whether fees should be netted with the fund’s performance or whether
they should be charged directly as management fees.
An additional – often overlooked – difficulty is that certain direct costs are positively correlated with the performance of an investment (e.g., the carried interest
in private equity 10 investments): the higher the returns, the higher the asset’s
costs. Also, certain asset classes are significantly more resource-intense than
8 SECA – Guidelines for the calculation and disclosure of costs of private market funds (March 2016).
9 c-alm AG St. Gallen – Vermögensverwaltungskosten in der 2. Säule (2011) (on behalf of the Bundesamt für Sozialversicherungen (BSV)).
10 This report includes private debt when referring to private equity unless otherwise stated.
THE SWISS PENSION FUND SCHEME
9|INVESTMENT DECISIONS OF SWISS PENSION FUNDS
other, which, in return, also drives up costs; e.g., sourcing of real estate investments requires more resources than a single stock investment). Lastly, the calculation base for average net assets (the denominator of the TER formula) in
private markets depends highly on the lifecycle of the investments. TERs usually
follow a U-shape in the funds’ lifecycles. Average net assets are lower in the
beginning of a fund’s lifecycle (when not all committed capital has yet been invested) and are also lower towards the end (when capital
There are signif- is being withdrawn and carried interests are being paid).
Thus, annual TER figures might be misleading, which can
icant differlead to under- or overstating the real cost structure of an
ences in peninvestment/asset.
sion fund systems around the
world
The existence of indirect costs, the correlation of costs
with returns in certain asset classes, and the fluctuation
of average net assets depending on the asset’s lifecycles
leads to an often distorted view on the real costs of individual asset classes.
The Swiss pension fund system in comparison to other countries
Pension fund systems of other industrialized countries are different to the Swiss
system 11 in many respects. In the UK, employers are not legally obliged to contribute to pension fund payments. Also in the US, there is no obligation for employers to contribute but it is more common for them to do so than in the UK. In
the Netherlands, a country more comparable to Switzerland in terms of size and
population, employers must contribute. Contribution plans (Beitragsprimate)
dominate in the US, while benefit plans (Leistungsprimate) are more common
in the UK and in the Netherlands. The UK, the US, and also the Netherlands
follow the ‘prudent man rule’ according to which there are no official asset allocation guidelines but fund managers need to apply the same caution in their
investments as if they were investing their own money. Switzerland follows a
hybrid approach in which guidelines by the Art. 47ff. BVV2 are mostly also not
binding but deviations from the guidelines need to be sufficiently justified in the
pension funds’ annual reports (see next chapter for more detailed information).
In previous years, asset allocations of pension funds varied considerably among
industrialized countries 12. Equity positions in Switzerland were lower (29%) than
in Anglo-Saxon countries (Australia: 51%, UK and US: 44%, Canada: 41%).
Real estate investments made up a relatively large proportion in Switzerland
(approximately 25%). Swiss pension funds also maintained relatively large cash
positions compared to their peers in other industrialized countries (7%, only surpassed by Australia with 8%). In 2014, Switzerland ranked number 7 (one rank
above Germany) in terms of pension assets (CHF 823 billion); the US ranked
highest by far with assets under management (AuM) of CHF 22,117 billion.
Compared to 2004, Switzerland has lost two positions in the global pension assets ranking. In 2014, Switzerland lost the top position of countries with the highest pension assets as % of GDP to the Netherlands (Switzerland: 142% in 2004
11 KPMG – Asset Management bei Pensionskassen (2011)
12 All information obtained from the Investmentoffice.com – Pension Funds Guide Switzerland (2015)
THE SWISS PENSION FUND SCHEME
10 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
and 121% in 2014; Netherlands: 114% in 2004 and 166% in 2014). 13 Thus,
Switzerland was the industrialized country with the largest %-point drop in assets under management relative to GDP (21%) between 2004 and 2014.
13 Please note that the significant change is in large parts a result of different GDP growth rates: Between 2004
and 2014 the aggregated GDP growth in Switzerland amounted to 26%, whereas as in case of the Netherlands
the GDP grew in the same time period only by 1%.
THE SWISS PENSION FUND SCHEME
11 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
3. ASSET ALLOCATION OF SWISS PENSION FUNDS
The four major asset classes in the portfolios of Swiss pension funds are (i)
fixed-rate assets, (ii) equities, (iii) alternative investments, and (iv) real estate.
Fixed-rate assets have traditionally played a significant role in pension fund portfolios due to the low investment risk attached to them, while equities have played
a less important role in relative terms; particularly compared to Anglo-Saxon
industrialized countries.
Investment guidelines for the major asset classes according to Art. 47ff. BVV2 14
of the four major asset groups are as follows:
Asset
classes
Assets
Asset types
Fixed-rate
assets
Liquidity/cash
CHF/non-CHF
Bonds
CH/non-CH, government/non-government
Other
Mortgages, etc.
Equities
Stocks
CH/non-CH
Alternative investments
Private equity
CH/non-CH
Guidelines 15
(Art. 47ff. BVV2)
Max. 50%
Max. 50%
Max. 15%
Real estate
Hedge funds
CH/non-CH
Other
Derivatives, etc.
Real estate
CH/non-CH,
funds/direct
Other
Satellite investments, etc.
Max. 30% (max.
1/3 non-CH)
Besides differences in investment costs and returns (which are the focus point
of this report), assets also differ in terms of their liquidity, their usual investment
horizons, transaction costs associate to them, and investment transparency.
Bond and equity investments tend to be the most liquid asset classes. They are
traded with high frequency (even daily) and even fund managers adjust their
bond and stock positions regularly. Consequently, the usual investment horizons of bonds and equities are short. Alternative investments and real estate
investments are much less liquid; investments are often held for several years
14 As of 2009
15 Additionally: (i) max. 30% investments in foreign currencies without currency hedge; (ii) no short-selling
ASSET ALLOCATION OF SWISS PENSION FUNDS
12 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
(also for tax reasons) which also raises these assets’ illiquidity risk and commitment risks. The size of transaction costs depends largely on how investments
are made. Pension funds (especially the smaller ones) like to invest via third
parties (sometimes through discretionary mandates) as this saves resources.
Some asset types (e.g., alternative investments) are only made through third
parties (which usually charge transaction costs). In alternative investments,
management fees are usually imposed instead of transaction costs. Naturally,
pension fund managers have the highest transparency over direct investments
while in indirect investments control is mostly given to third-party investors.
The average asset split of the survey participants is presented in Figure 5. The
Figure shows the asset allocation of small-sized (AuM <1 billion), medium-sized
(AuM 1-5 billion), and large-sized (AuM >5 billion) pension funds. Interestingly,
there are only small differences in the asset splits of these three groups.
Liquidity is unattractive in light of negative interest rates. Consequently, the average share of cash in pension fund portfolios is currently only at 5%, down by
2-3 %-points from previous studies. But how do pension fund managers invest
this excess cash?
Bond positions are smaller than in surveys from previous
years 16. The average position is 30%, while in previous The importance
years they ranged between 30-40%. According to evi- of bonds has dedence from our survey, this is a reaction of fund manag- creased; stocks
ers to negative interest rates. However, some funds still are still popular
maintain 50% bond positions (which is the official Art. 47
maximum) and others even exceed it. Medium-sized
pension funds seem to maintain the lowest bond positions. It could be that medium-sized funds are faster than larger funds in their reactions to changing market conditions and they also react earlier than small-sized funds that often have
their investment teams outsourced.
Average stock investments still make up about one third of total investments and
only very few funds invest more than 40% in stocks. The share of stock investments is fairly stable across all pension funds that participated in this study.
Alternative investments (predominantly private equity) are slowly starting to attract greater attention (total average of 8% as compared
to 5% in previous studies) and also real estate investLarger pension
ments have increased (22%). However, both asset clasfunds are more
ses have still not reached their regulatory maximum
likely to invest in
(15% and 30%, respectively). Many pension funds even
private equity
still do not invest in alternative investments at all. About
25% are currently not invested in private equity and
more than 60% have not allocated any capital to hedge fund investments.
16 We are predominantly referring to the reports KPMG Asset Management bei Pensionskassen (2011) and the
Credit Suisse Schweizer Pensionskassen – Perspektiven in der Demografie und im Anlagemanagement (2014).
ASSET ALLOCATION OF SWISS PENSION FUNDS
13 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
Among the survey participants, the largest private equity investment in relation
to total investments is 15% and the largest hedge fund investment is 11%. The
analysis suggests that the likelihood of investing in alternative investments increases with the size of the pension fund. The average alternative investment
position is only 5% of total investments among smaller pension funds, while it is
60% higher (at 8%) among larger ones. Interestingly, smaller pension funds are
more engaged in real estate investments than larger funds.
Figure 5: Current asset allocation of participating pension funds (in %)
ASSET ALLOCATION OF SWISS PENSION FUNDS
14 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
4. INVESTMENT PARAMETERS OF SWISS PENSION FUNDS
ACROSS ASSET CLASSES
A diversified portfolio seems to be the primary investment concern for fund managers (Figure 6). 76% consider portfolio diversification as very important and
only 3% don’t see it as one of their prime concerns. To ensure that portfolios are
diversified, fund managers seek low risk correlations between their investments. 36% of survey participants conPortfolio diversification is the sider the macroeconomic situation (e.g., interest rate levmost important els) to be very important and 44% find it at least important.
Regulatory guidelines and investment costs seem not so
investment demuch
of a concern for the funds. Interestingly, a fairly large
cision driver
group of 41% even considers the regulatory setup as not
too important or even unimportant, while investment costs
play at least a somewhat important role for 74% of the pension funds.
The importance of portfolio diversification is likely owed to the fact that pension
funds are asked by their investment committees to follow the investment guidelines suggested in Art. 47ff. BVV2 (and in that sense, regulatory guidelines as
presented in Figure 6 overlap with portfolio diversification). Also, as finance theory teaches us, diversification minimizes risks. Fund managers, independent of
official guidelines, are usually keen to minimize risks for their stakeholders.
The influence of macroeconomic factors on pension funds has been discussed
in the introduction of this report. Hence, it is not surprising that the macroeconomic situation is seen as the second most important investment criteria. However, we will see later in this chapter that the current negative interest rates do
not impact investment decisions as much as one might expect. The fact that not
more fund managers consider the macroeconomic situation as important is line
with this finding.
0%
Portfolio diversification
76%
Macroeconomic situation
21%
38%
Regulatory guidelines
44%
21%
Investment costs
38%
15%
0%
10%
Very important
15%
35%
59%
20%
30%
Important
40%
60%
Not so important
70%
80%
3%
6%
26%
50%
3%
90%
Unimportant
INVESTMENT PARAMETERS OF SWISS PENSION FUNDS
ACROSS ASSET CLASSES
0%
100%
15 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
Figure 6: Investment decision criteria
The asset allocation of Swiss pension funds is to a certain extent predefined by
the regulatory guidelines of Art. 47ff. BVV2 (see previous chapter). However,
fund managers still have considerable freedom on how they structure their portfolios and, with this, there are numerous ways how fund managers can assess
the suitability of a certain asset class over other asset classes.
The risk-return-ratio seems to be by far the most important driver for fund managers in the assessment of assets (Figure 7). Risk is primarily understood as
performance risk and is defined as an asset’s volatility (standard deviation).
However, it can also refer to illiquidity risk or commitment risk. These latter risk
categories are usually harder to assess, let alone quantify. 97% of survey participants seek to invest in assets that bear low investment risk in relation to the
assets’ expected return. The optimization of risk-return-ratios is also called portfolio efficiency; one of the principal ideas in finance theory.
Net returns (gross returns net of costs) are seen as another important measure.
78% of survey participants agree that net returns are important for the comparison of assets, while 38% agree that cost-return-ratios are important. 32% of the
participants consider gross returns as a useful way to compare asset classes
and 31% also look at the plan investment costs. Another criteria considered an
important decision driver occasionally mentioned by survey participants is an
asset’s contribution to the value at risk.
The fact that risk and returns of investments are more important to pension funds than costs is a sign for the so- The risk-returnphisticated approach that Swiss pension fund managers ratio is the most
take for their investments. Also, the stronger explanatory important asset
power of net returns in comparison to gross returns is com- assessment
prehended by fund managers. However, approximately measure
30% of the fund managers view gross returns and investment costs as legitimate assessment criteria and carefully
assess the conclusions they draw from them. If at all, such measures can only
be insightful for comparisons for investments within the same asset class but
not across.
INVESTMENT PARAMETERS OF SWISS PENSION FUNDS
ACROSS ASSET CLASSES
16 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
100%
0%
3%
13%
90%
9%
80%
28%
36%
41%
70%
60%
34%
50%
97%
40%
32%
28%
78%
30%
20%
38%
32%
31%
Gross returns
Investment costs
10%
0%
Risk-return-ratio
Net returns
True
Cost-return-ratio
Sometimes true
Never true
Figure 7: Criteria that are most useful to assess asset performance
There is a clear long-term orientation in the investment decisions of Swiss pension funds (Figure 8). Many of the participating pension funds state that they
regularly review their portfolio structure but adjustments are done rarely. Consequently, a large share of funds (38%) changes the asset allocation of their
investment portfolios less than once a year and 27% do so about once a year.
Only a small proportion of 12% undertake adjustments
semi-annually or even more often. Interestingly, 24%
change their portfolio structure irregularly, depending on Changes in asexternal shocks (e.g., the introduction of negative interest set allocations
rates) or on unforeseen investment opportunities that oc- follow a longcur. Some pension funds mentioned that they haven’t sig- term approach
nificantly adjusted their portfolio structure in the last decade or even longer.
The long-term approach to asset investments is to a large extent owed to the
nature of the assets that pension funds invest in and the investment guidelines
they have to adhere to. However, it is also a result of the generally cautious
investment approach of many fund managers. This cautious approach in most
cases leads to a minimization of investment risk but, on the flip side, it also
means that it takes a long time for fund managers to react appropriately to external shocks or unforeseen investment opportunities. Consequently, it can happen that returns and investment costs are negatively affected by the pronounced
long-term investment approach.
INVESTMENT PARAMETERS OF SWISS PENSION FUNDS
ACROSS ASSET CLASSES
17 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
Approx. quarterly
9%
Approx. semi-annually
3%
Approx. annually
27%
Less than annually
38%
Irregularly
24%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Figure 8: Frequency of (substantial) portfolio adjustments
The extent to which investments are long-term oriented depends significantly on
the individual asset classes. Figure 9 shows that investments in alternative assets, private equity in particular, are usually done by fund managers with the
prospect of not selling the positions within less than three years after the investments. This pattern is highly driven by the investment solutions provided within
the individual asset classes. For example, it is part of the core private equity
business model that committed capital is typically locked
in for many years. The lifecycle of private equity funds is Private equity
approximately eight to ten years. Thus, investors com- and real estate
mit the capital during the fund raising period for a period have the longest
of up to ten years. During the first three to five years PE investment horifund invest the capital by acquiring portfolio companies zons
and spent approx. three to five years actively managing
the companies before selling the investment again. This
long-term investment approach is also reflected in Figure 9 as 79% of participating pension funds state that their investment horizon is longer than three
years. Also real estate investments (especially direct investments) are naturally
done with a long-term orientation (78% longer than three years).
Stocks are usually the most liquid asset class in pension fund portfolios. 25% of
survey participants invest in stock with the intention to sell their positions within
one year after investment. Only 50% expect to hold their positions for more than
three years. The time horizon of bond investments is somewhere in between.
41% of pension funds plan to sell their investments after one to three years.
Only 13% plan to do so after less than a year.
INVESTMENT PARAMETERS OF SWISS PENSION FUNDS
ACROSS ASSET CLASSES
18 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
100%
90%
80%
47%
40%
50%
70%
78%
79%
60%
50%
40%
30%
25%
47%
41%
20%
10%
25%
13%
13%
9%
Hedge funds
Real estate
8%
0%
Bonds
13%
13%
Stocks
<1 year
Private equity
1-3 years
>3 years
Figure 9: Typical time horizon of investment decisions
The impact of the negative interest rate environment on investment decisions
Like other investors, pension funds have also been hit hard by the introduction
of negative interest rates. The deficient cover of Swiss pension funds is increasing in light of these negative interests. According to a study published by UBS 17,
asset reserves of pension funds could be used up by 2024 if negative interest
rates (and weak stock markets) continue. This is reason for concern. Pension
funds will have to increase the contribution of employees to the pension fund
system in the mid-term. In the short-term, pension funds can react by adjusting
their portfolio structures in hope of higher returns.
Negative interest
rates still have
limited impact on
investment decisions
Still, over 60% of the survey participants claim that the
negative interest rate policy imposed by the SNB only
has a low to medium impact on their investment decisions and 15% even say that they have no impact at all
(Figure 10). After all the media coverage and expert
opinions on the potential effects of the negative interest
rates, this is at least surprising.
Potentially, fund managers believe that a portfolio adjustment is not an effective
remedy in the light of a generally difficult investment environment. Alternatively,
pension funds might simply not consider the negative interests to be as much of
a serious challenge as often claimed by industry experts. Investment restriction
guidelines (Art. 47ff. BVV2) cannot be the hindering factor as most pension
funds have not yet reached the investment limits of the asset classes.
17 UBS House View – Meeting the challenge of negative interest rates (2016)
INVESTMENT PARAMETERS OF SWISS PENSION FUNDS
ACROSS ASSET CLASSES
19 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
15%
24%
Strong impact
Low to medium
impact
No impact
61%
Figure 10: Impact of negative interest rates on investment decisions
Nonetheless, some evidence does exist that fund managers adjust the
weighting of the asset classes in their portfolios in comparison to periods with
higher interest rates (Figure 11).
Not surprisingly, bonds are going through a difficult phase and 81% of survey
participants say that they are giving them a lower weighting. This investment
activity outlook was to be expected as yield-to-maturities are low (or even negative) and, what comes on top, is that a shift in the Fed’s interest rate policy
would result in even lower prices for existing bond instruments.
Stocks are given a stronger weighting by 39% of participants. This would probably be even higher if stock markets had developed more favorably in the first
months of 2016.
Alternative investments are given a much stronger weighting, especially private
equity, by 65% of all participants. Private equity, as the most prominent asset
group within the alternative asset class, has so far shown no signs of weaker
results in light of negative interest rates. On the contrary, low interest rates have
a positive impact on private equity deal flow as private equity firms can finance
their investments with cheaper debt. Leverage gives them the chance to extract
larger value from their investments. However, pension
fund managers should be aware that there is evidence
Private equity is from academic literature 18 that private equity firms tend
given a stronger to overpay for their portfolio companies when access to
weighting by
credit is easier; the main reason being that firms are less
65% of survey
picky with respect to their investment targets. Investment
participants
returns might suffer from these overpayments.
18 See, for example, Axelson et al. (2013)
INVESTMENT PARAMETERS OF SWISS PENSION FUNDS
ACROSS ASSET CLASSES
20 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
100%
0%
3%
9%
18%
90%
35%
80%
44%
70%
52%
60%
36%
81%
50%
40%
65%
30%
20%
45%
39%
10%
16%
0%
3%
Bonds
Stocks
Stronger weighting
Private equity
Hedge funds
Same weighting
Less weighting
53%
Real estate
Figure 11: Impact of negative interest rates on pension funds’ portfolio structures
INVESTMENT PARAMETERS OF SWISS PENSION FUNDS
ACROSS ASSET CLASSES
21 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
5. THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
The importance of the total expense ratio (TER) in the assessment of pension
fund costs has already been underlined several times in this report. TER is the
most widely accepted cost measure in asset management.
TERs vary widely among Swiss pension funds as costs and also average net
assets are often very different from asset class to asset class (see chapter ‘The
Swiss Pension Fund Scheme’ for more information) and are highly depended
on the individual portfolio structure. The average TER among the survey participants is 0.58%. 75% of these were portfolio management
costs (0.44%), followed by administrative costs (0.11%),
The average
and a small share of 0.04% of other costs that include marTER of Swiss
keting and advertising costs (Figure 12). According to the
pension funds
survey, total TERs can range from 0.11% (bottom 10%) to
is 0.58%
1.13% (top 10%), while management costs range from
0.09% (bottom 10%) to 0.91% (top 10%).
Figure 12: Current cost split of pension funds
The survey provides (weak) evidence that larger pension funds (in terms of assets under management) tend to have higher TERs; the trendline goes slightly
upwards (Figure 13). However, when excluding portfolio management costs, the
trendline changes direction and goes slightly downwards. This is evidence of
economies of scale suggesting that larger pension funds operate more efficiently (administrative and other costs in relation to assets under management
are low) but portfolio management costs drive their TERs. This is no surprise,
considering the fact that larger pension funds tend to invest more in costly asset
classes, such as private equity (see Figure 5 for evidence).
THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
22 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
Total expense ratio (in %, mean values)
1.20
1.00
0.80
0.60
0.40
0.20
0.00
0.5
100-500
1
1.5
500-1,000
2
2.5
1,000-5,000
3
3.5
>5,000
4
4.5
Assets under management (CHF million, mean values)
Linear (TER total)
Linear (TER excl. mgmt costs)
Figure 13: Relationship of assets under management with the total expense ratio
Why high direct costs are not necessarily a bad sign
The survey shows that portfolio management costs vary significantly depending
on the type of asset class. While low investment costs are naturally desirable,
high costs are not necessarily a reason for concern. Often costs are disguised
as indirect costs (e.g., spreads). These costs are netted with an asset’s returns
and are not captured as actual costs in the pension fund’s income statement.
Consequently, assets with high indirect costs might often falsely be perceived
as less costly.
Also, pre-investment sourcing efforts by the different
asset managers differ significantly from asset class to
asset class. We can roughly differentiate between (i) in- Alternative
vestments that require low sourcing efforts as decisions investments
are made fast with little prior screening (e.g., ETFs, in- require higher
dex funds), (ii) assets that require medium sourcing ef- pre-investment
forts as some screening is required but investment sourcing efforts
teams can lever on existing analyst reports and expert
opinions (e.g., stocks), and (iii) assets that require high sourcing efforts as they
include due diligences and thorough pre-investment screening (e.g., private
markets or real estate investments). The latter two asset groups require a time
and labor-intense screening process before any investment is made. Levels of
information asymmetries are typically higher as compared to investments in
publicly listed asset. In some situations, these high sourcing efforts may not
even lead to a successful transaction as a third party is outbidding the investment managers. Yet, the cost of the due diligence process have to be borne by
the investors leading to higher TERs of the underlying collective investment
THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
23 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
schemes. These high investment sourcing efforts naturally come with significantly higher direct costs compared to assets with low and medium sourcing
efforts (as also reported by the participants of our survey). Additionally, ex-ante
monitoring costs following an (initial) investment may also vary significantly as
a PE fund for example typically acquires a controlling position in company, which
allows to actively govern and manage the asset. Besides acting on the board of
directors, PE fund managers are also involved in enhancing different value creation strategies on the operational level contrasting a listed stock portfolio in
which the portfolio manager is typically not involved in actively governing or
managing the company.
Figure 14: Illustration of the levels of pre-investment sourcing
efforts
In the long run,
private market
investments
generate by far
the highest net
returns
The high direct costs are to a large extent also driven by
substantial incentives for private equity fund managers
(so-called carried interests). Carried interests are usually
around 20% of all capital gains. The general public (and
institutional investors) are often scared off by these high
compensations. However, one should bear in mind that
these incentive models are largely performance-based. Carried interests are
only paid out if a pre-defined return threshold (often 8%) has been surpassed.
Based on financial year 2015 figures, we see in Figure 15 that indeed the asset
classes with the highest costs (measured in TER) also generate the highest net
returns among our survey participants. The return figures are based on the average annual (net) returns achieved in 2015 by the Swiss pension funds participating in this survey. Please note, that the results are a point of time assessment (2015) and may vary on a year to year basis. For example annual returns
THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
24 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
of private equity investments may fluctuate depending on the maturity structure
of individual portfolios (e.g., J-Curve effect). All asset classes were exposed to
the same economic environment in 2015, yet, some (e.g., international stocks)
might be exposed to a higher degree than others (e.g., Swiss real estate investments).
It is remarkable to note that net returns (returns net of costs) of the assets with
high TERs are higher than net returns of asset classes with lower costs. In private equity, average investment costs of 5.8% are overcompensated by gross
returns of 12.1%, which results in net returns of 6.4%; the highest net returns of
all major asset classes. Only net returns (4.5%) of real estate investments come
close to this. Mean net stock returns, in contrast, are only at
0.3% and net bond returns are even negative at -0.1%.
TERs are
positively
correlated
with net returns
In the discussion of cost-return-ratios, we should not forget
that one cost category is not accounted for in these calculations as it is usually hard to quantify: opportunity costs that
come in form of illiquidity costs and commitment costs. Once
an alternative investment has been made, the money is usually bound for several years and cannot be reinvested ad-hoc when other attractive investment opportunities open up. The size of opportunity costs is different
for every pension fund and pension fund managers need to assess for themselves whether the premiums that alternative investments pay justify their individual opportunity costs. Nevertheless, the fact that alternative investments
have constantly generated significantly higher returns than more liquid asset
classes over the last years suggests that the commitment risk of pension funds
has been relatively low.
14%
12%
10%
8%
6.4%
6%
4.5%
4%
2.9%
2%
0%
0.1% 0.1%
-0.1%
Bonds
0.6% 0.2%
0.3%
12.1% 5.8%
7.3% 4.4%
4.9% 0.4%
Stocks
Private equity
Hedge funds
Real estate
-2%
Gross returns
Investment costs
Net returns
Figure 15: Investment costs and gross and net returns by asset class based
on realized returns in 2015 (in %)
THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
25 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
The combination of high costs and high returns of individual asset classes has
implications for the overall portfolio returns of pension funds. The linear trend
line in Figure 16 shows a clear positive correlation between portfolio management costs and portfolio net returns.
Portfolio management costs (in %)
1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
-1
0
1
2
3
4
5
Portfolio net returns (in %)
Linear (Portfolio management costs)
Figure 16: Relationship of net returns with portfolio management costs (in %)
The key message of this chapter is that high TER figures for a given asset class
do not necessarily correlate with lower net returns, but in turn are accompanied
by higher gross return levels. However, the survey reveals that these figures are
not in line with the perception of fund managers on cost-return rations (Figure
17).
More than 50% of the fund managers perceive the cost-return-ratio of bonds
and stocks as ‘good’, while almost 60% are satisfied with the ratio for real
estate investments. Only very few fund managers believe that bonds, stocks,
and real estate investments deliver cost-return-ratios that are too high. Interestingly, the cost-return assessment is much more diverse for alternative investments. In case of private equity, 19% of the pension fund managers are satisfied
with the cost-return ratio, whereas 24% see room for improvement (bad and
fairly bad). For hedge fund related investments, pension fund managers are
even more concerned (40%) with the cost-return ratio. In addition, for both asset
classes – private equity and hedge funds – a significant part of pension funds
managers is indifferent regarding the cost-return assessment (24% vs. 20%).
We can only speculate about the reasons for this discrepancy between perception and hard figures with regard to delivered returns. An explanation for the
favorable opinion of fund managers on the cost-return-ratios of stocks might be
that stock returns have only recently deteriorated. The general fund manager
perception might still be based on the high stock returns of previous years.
Generally, the results are evidence to assume that costs play a more significant
role for fund managers in the assessment of asset classes than what might be
reasonable (and more than what Figure 7 suggests) respectively are not put into
THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
26 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
the context of individual asset classes. Why is this the case? Fund managers
might be aware that they actively promote lower returns in order to achieve lower
asset costs. Potentially, the investment teams of pension funds have to adhere
to guidelines on how high portfolio management costs can be. It is also possible
that fund managers are not fully aware of the relationship
of costs and return as presented in Figure 15.
TERs should
The survey results underline that the TER – which captures
be used as a
an investment’s performance management costs in relation
benchmark
within individ- to the average net assets – has limited explanatory power
if compared across different asset classes as each asset
ual
class relies on different cost and return structures. Addiasset classes
tional, the composition of each portfolio is different (e.g.,
high or low share of alternative investments). It leads to a misguided assessment of cost efficiency if investment portfolios of pension funds are only benchmarked on the basis of aggregated TERs. Every pension fund manager should
always assess costs in combination with net returns within individual asset classes, but not across. In this context, the net-return perspective of asset investments should be given a stronger emphasis. Our survey shows that net returns
are already an important investment decision driver (see Figure 7). However,
1/3 of fund managers still believe that gross returns give an indication on an
asset’s attractiveness and that investment costs an insightful assessment criteria. However, an isolated view on gross returns or direct investment costs should
play no role in the investment decision of pension funds given the distorted picture that these measures might convey.
100%
90%
0%
4%
4%
4%
7%
44%
33%
0%
4%
11%
27%
29%
24%
60%
50%
20%
40%
30%
13%
14%
80%
70%
10%
33%
52%
20%
52%
57%
20%
10%
19%
20%
Private equity
Hedge funds
0%
Bonds
Stocks
Good
Fairly good
Indifferent
Fairly bad
Real estate
Bad
Figure 17: Fund managers’ opinion on cost-return-ratios of individual asset classes
Figure 7 showed that risk-return-ratios are an important investment decision
driver for Swiss pension fund managers. Based on this finding, Figure 18 displays the perception of risk-return profiles within each asset class. Real estate
stock markets and private equity are highly appraised by pension fund managers regarding their risk-return trade-off: Astonishing 93% of investors assess
THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
27 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
100%
90%
3%
0%
10%
21%
13%
80%
70%
0%
13%
20%
38%
34%
60%
50%
0%
3%
3%
7%
27%
45%
10%
57%
40%
30%
27%
31%
55%
20%
10%
31%
14%
17%
20%
Private equity
Hedge funds
0%
Bonds
Stocks
Good
Fairly good
Indifferent
Fairly bad
Real estate
Bad
Figure 18: Fund managers’ opinion on risk-return-ratios of individual asset classes
the risk-return profile of real estate investments good or at least fairly good.
Stocks come second with an aggregated share of 76%. Private equity is in the
same range and benefits from a favorable or at least fairly good risk-return assessment of 74% opposing the rather critical cost-return validation of Figure 17.
Recent academic literature which has investigated the risks attached to private
equity investments in comparison to public market inPension funds are vestments (e.g., the S&P 500), has found for example
that private equity investments are often even less risky
satisfied with the
than investments in listed equities. Over the course of
risk-return profile
the last 20 years, PE investors could expect a 5-10%
of real estate,
stocks and private outperformance net of fees over the lifecycle of PE
funds in comparison to investments in public equity in
equity investthe S&P 500 in North America and Western Europe. 19
ments
This helps to explain, why investors may critically assess the cost parameters of private equity investments, but are much more convinced of the asset class against a risk-return background. However, the percentage of asset managers being absolutely satisfied with the risk-return profile
is significantly higher in case of stocks (31%) as observed for private equity
(17%).
The high satisfaction with the cost-return-ratios of bond investments stands in
contrast with the low satisfaction of risk-return-ratios: 44% of the pension fund
managers perceive bond returns as a bad or fairly bad when controlling for underlying risk. Given the current negative interest environment it is not surprising
that asset managers are not satisfied with a combination of low bond returns
and a stable (or even increasing) counterparty risk. This picture also holds to
some degree for hedge funds with 27% of pension funds managers being not
19 See, for example, Harris et al. (2015)
THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
28 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
satisfied with the generated returns against the underlying risk (20% fairly bad
and 7% bad).
Nevertheless, as pointed out earlier, there are not only performance risks attached to assets. Other risks such as illiquidity risks and commitment risks play
an important role in investors’ asset assessments. These types of risks are undoubtedly higher in alternative investments and real estates in comparison to
equity and bond investments, yet, the expected returns are also higher (see
Figure 15).
THE RELATIONSHIP BETWEEN PERFORMANCE AND COSTS
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CONCLUSION
Given volatile capital markets, low interest rates and an ageing population Swiss
pension funds currently face difficult times. High net returns are critically to successfully meet these challenges. Both absolute returns achieved in different asset classes as well as cost structures drive the decisive net return performance
of pension funds.
Rightfully, the cost structures of pension fund investments were in the focus of
many discussions during recent years. However, one aspect underrepresented
in this discussion was the link between overall cost-ratios and the underlying
returns. It is widely known that different asset classes yield different returns for
its investors, but – due to scope and depth of rendered services - also costratios vary significantly between asset classes.
Do high cost-ratios (measured by TER) also negatively correlate with returns?
This survey argues that a high TER of an asset class is not necessarily a sign
for lower net returns. In contrast, this survey shows that the asset class with the
highest overall TER also achieves the highest net returns. Should pension funds
therefore stop focusing on the cost perspective of their investments? Not at all,
cost awareness remains important to generate high net returns. Yet, instead of
comparing it on an aggregated portfolio level, pension funds should assess cost
efficiency on the level of an individual asset class and not across different ones.
As asset allocation differs significantly between pension funds, an overall low
cost ratio might appear compelling on first sight, but less so after a cost-return
comparison. A single-sided focus only on aggregated TER levels leads to wrong
incentive structures for pension fund managers as it favors asset classes with
low TERs, which may not necessarily generate high net returns. This untapped
potential for higher returns can be freed up by addressing cost awareness in a
more differentiated manner.
CONCLUSION
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CONTACT INFORMATION
Prof. Dr. Stefan Morkoetter
University of St.Gallen
St.Gallen Institute of Management
in Asia Ltd. Pte. (SGI-HSG)
Tellstrasse 2
9000 St.Gallen
111 Amoy Street
Singapore 069931
Email: [email protected]
Phone: +65 6850 7338
Mobile: +65 9482 4101
www.sgi.unisg.ch
CONTACT INFORMATION
Thomas Wetzer
31 | I N V E S T M E N T D E C I S I O N S O F S W I S S P E N S I O N F U N D S
REFERENCES
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Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts, Journal of Finance 68, 2223-2267.
Bundesamt für Sozialversicherungen (BSV): URL http://www.bsv.admin.ch/.
Bundesamt für Sozialversicherungen (BSV) (2011): Vermögensverwaltungskosten in der 2. Säule, Forschungsbericht 3/11.
Credit Suisse (2014): Schweizer Pensionskassen – Perspektiven in der Demografie und im Anlagemanagement.
Harris, R. S., T. Jenkinson, and S. N. Kaplan (2014): How Do Private Equity
Investments Perform Compared to Public Equity, Working Paper, Oxford Private
Equity Institute.
Investmentoffice.com (2015): Pension funds guide Switzerland, published by
Market Tools.
KPMG (2011): Asset Management bei Pensionskassen.
Schweizerische Nationalbank (SNB)
Swiss Funds & Asset Management Association (2015): Guidelines on the calculation and disclosure of the total expense ratio (TER) of collective investment
schemes.
Swisscanto Vorsorge AG (2016): Schweizer Pensionskassenstudie.
UBS (2016): UBS House View – Meeting the challenges of negative interest
rates.
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