Market development 2023
Due to the strong recovery on the stock markets, Swiss pension funds can look back on a good first half year. In the third quarter, particularly in September, as well as in the first month of the fourth quarter, pension funds unfortunately lost returns. A key driver was the significant rise in yields to maturity on 10-year US government bonds (“higher for longer” narrative), which led to losses on both equity investments and foreign currency bonds. In contrast, there was no comparable rise in interest rates in Swiss bonds. Accordingly, the performance of this asset class has been significantly better than that of foreign currency bonds since the beginning of the year.
Mirroring the rising yields, foreign currency bonds posted a negative annual performance of -3.1% up to the end of October (-2.8% in the third quarter and -1.0% in October; Bloomberg Global Aggregate TR Hedged in CHF). The performance of Swiss franc bonds was better. The SBI AAA-BBB TR Index generated a return of +4.2% from the beginning of the year to the end of October (+0.1% in the 3rd quarter and +0.6% in October).
The Swiss stock market showed a negative trend from April onwards. The year-to-date performance of the SPI Index was mainly driven by the weak performance of the index heavyweights Nestlé and Roche (-3.3% in the third quarter and -5.2% in October). The situation was somewhat different for global equities. In particular, US equities in particular recorded significant gains up to the end of July. The MSCI World TR (hedged in CHF) achieved a return of around 16% up to the end of July. From August to October (-3.7% in the third quarter and -2.9% in October), the markets then developed negatively. Thanks to the very strong returns in the first half year the year-to-date performance as of end of October still stood at +5.8%.
Over the course of the year, it has become apparent that the price appreciation of unlisted Swiss property has slowed, and devaluations have been made in some cases. At the end of October, the annual return of the KGAST Real Estate Index was +1.8%. Considering the year-to-date returns achieved up to October 2023, it seems obvious that the excellent returns of 4.9% to 5.7% (KGAST Real Estate Overall Index) for the years 2019 to 2022 will not be achieved in 2023 as a whole. At the same time, pension funds that are planning to increase the allocation of non-listed Swiss real estate now have more opportunities to implement that. This year’s pension fund study also showed that around 36% of participants already invested in Swiss real estate are considering a further increase the allocation to direct and/or unlisted Swiss real estate in the future. In previous years, however, it tended to be more difficult to achieve the respective strategic target quota for unlisted Swiss real estate investments mainly due to the low interest rates.
Swiss Pension Funds in 2023
After an extremely poor 2022, the first eight months of the current year were much more pleasing. Swiss pension funds achieved a return of almost 4% in this period. Accordingly, there was great confidence that the year would end on a positive note again. In the third quarter and especially in October, the recovery on the stock markets was slowed considerably. According to projections, the annual return of Swiss pension funds fell to 1.5% by the end of October. The returns in September (-0.8%) and October (-1.5%) were sharp setbacks. This also effects the coverage ratio of pension funds. Due to the target return, i.e. the return that must be generated in order to keep the funding ratio constant, the average funding ratio fell by -0.2 percentage points to 103.8% despite a slightly positive return, which corresponds to a setback of -3.2 percentage points compared to the mid-year value. As a result, the situation for funds with coverage ratios below 100% has not improved noticeably compared to the beginning of the year. As at the end of October, just under 9% of the funds are likely to be underfunded.
Reserves were hit hard last year. The pension funds will have to use part of their returns to build up reserves both in the current year and in the coming years. This is also likely to be reflected in the interest on savings capital. If there is no further upward trend on the financial markets by the end of the year, the interest rate is likely to be at a similar level to 2018. At that time, the pension funds paid an average interest rate of 1.5% on the savings capital of active insured persons in defined contribution plans.
Changes in the asset allocation
The share of Fixed Income investments has fallen sharply in recent years. As of end of the third quarter of 2023, the ratio of fixed-income investments including liquidity averaged just under 36% of assets under management. Due to the higher interest rate level this figure could rise again in the future. The equity allocation is back above 30% and therefore slightly above the historical average. New highs were reached for real estate investments at the end of 2022. At the end of the third quarter 2023, the relative real estate quota fell again slightly to just over 23%.
Outlook
In the near future, pension funds will continue to face challenges. Although inflation rates are decreasing worldwide, they still remain at elevated levels. The growth outlook has also deteriorated, although a soft landing still seems possible. The global purchasing managers’ indices are clearly in contraction territory as at the end of October (Germany in particular, at 40.8, and Switzerland, at 40.6, but at the same time the PMIs might bottom out.
Rising global government debt presents a medium to long-term challenge, particularly considering the rise in interest rates. Therefore, investors are well advised to build a well-diversified investment strategy that includes property and alternative investments in addition to equities and bonds. Besides the return and risk characteristics, the illiquidity and cost ratio must also be carefully balanced.
Authors
Ueli Sutter (r) & Andreas Rothacher (l)
