Pension Fund: Investment strategy in uncertain times

The 2022 investment year presented institutional investors with a number of challenges: volatile stock markets, high inflation and the related interest rate hikes by many central banks.

Simon Aschwanden: In terms of overall performance, 2022 was profoundly negative, although in the last quarter it did improve again. Inflation and the related interest rate hikes, the war in Ukraine, the energy crisis, disrupted supply chains and the COVID-19 pandemic in China: over the past year, there was quite a bit going on. As equities and bonds recorded high losses – both of which, of course, make up a large part of a pension fund's investment strategy – pension funds have been affected by this development. Therefore, a performance of minus 10 percent will not be uncommon. In times of turbulence, however, it is important not to change the otherwise proven course and to stick to the investment strategy. After a bad investment year, it's easy to forget the good returns achieved in the previous investment years of 2019, 2020 and 2021. Dealing with fluctuations is part of the core business of a pension fund. And looking at 2021 and 2022 together, it was more or less a zero-sum game from a performance perspective.

Simon Aschwanden: The cover ratio is a figure that is only meaningful for a specific reporting date and not for a long-term system, such as occupational retirement provision. Therefore, short-term fluctuations in this ratio are not significant. At the end of 2021, we had historically high coverage ratios in the market, even though certain pension funds actually had coverage deficiencies at the end of 2022. From an economic perspective, i.e. when valuing obligations at risk-adjusted market interest rates, the financial situation of some pension funds is nevertheless looking significantly better again due to the rise in interest rates.
A sustainable investment and benefit policy is crucial for the long-term stability of a pension fund. I don't see any problem here with Vita's solutions: Our retirement provision models are robust and can handle market fluctuations.

Simon Aschwanden: Unfortunately, no – not all pension funds have been doing their homework because, for example, they have not lowered the technical interest rate, not reduced the redistribution, or their investment strategy does not match the risk capacity. If such pension funds are now suffering coverage deficiencies, something has been missed and there is indeed cause for concern. What worries me personally is the increasing redistribution. 2021 was a very good investment year with an average performance of 8 percent, insured individuals earning an average of 3.69 percent interest, and pension fund coverage ratios reaching all-time highs. Nevertheless, redistribution by the Occupational Pension Supervisory Commission was still estimated to be around 200 million Swiss francs. Source: (OPSC, 2022c, p. 1) If, despite excellent framework conditions, redistribution still occurs, this is a clear indication that the system has not been designed sustainably. And significantly higher redistribution will almost certainly be reported again for 2022.
This is why Zurich and Vita are campaigning for more fair play in the occupational retirement provision system. Together they are working to ensure that personal responsibility and efficiency pay off for companies and that insured individuals can count on a sustainable retirement provision solution. We offer investment strategies that have the potential to grow the value of retirement savings capital. And we focus on pension planning solutions that ensure that as much of the investment income as possible reaches the insured and is not redistributed.

Markus Leuthard: Time and again in the past, there have been significant corrections on the stock markets. We are familiar with these situations, which are triggered by crises, growth fears and panic. 2022 was characterized by inflation and rising interest rates. This scenario is not new but hasn't occurred since the 1970s. As a result of this, most assets were devalued, and we too recorded losses on equities and bonds. Some illiquid investments, such as real estate, have been relatively stable so far. How these will develop over the next few months remains to be seen, however, since the correction often occurs at a slower pace and at a later date.

Markus Leuthard: We have continued to develop our investment strategy and, for example, successively increased the investment categories Real Estate Switzerland and Infrastructure. Such measures help in an inflationary environment, as real assets are less affected by inflation. We have also increased liquidity so that we can take advantage of opportunities in the market, should they arise.

Markus Leuthard: The goal of any pension fund is to secure obligations and pay out pensions in the future. All of them face the same challenges. This long-term perspective allows us to invest some of the assets in more illiquid investments. At the same time, however, we have to ensure short- and medium-term liquidity. You could say that we are a long-term investor with a short-term constraint. For the Vita Collective Foundation, the liquidity requirement for meeting pensioner obligations is not too high, as we have relatively few pensioners compared to the market. Our retired person ratio is around 15 percent.

Sébastien Dirren: During turbulent times, it is important for a pension fund, and for private investors as well, to focus first on their strategic allocation. This should be set up in such a way that it can withstand times of crisis. A clear investment strategy makes it possible to keep a cool head and generate the returns needed to achieve long-term goals. Nevertheless, it may be advantageous to marginally adjust the portfolio in a second step to take advantage of current opportunities. This can be done by tactically changing the allocation or by making adjustments to the actively managed portfolio. Disciplined portfolio restructuring is also a source of stability during turbulent times, while staying true to your strategic direction.

Sébastien Dirren: Recent structural changes in the markets, such as volatility, inflation and changing interest rates, may also affect the coming cycle. It is thus important to first review the strategic allocation. This does not involve a fundamental change, but it should be examined whether broader diversification would be beneficial. For example, exposure beyond traditional risk premiums (equities, bonds and Swiss real estate) could prove favorable if volatility and inflationary pressures persist. In addition, asset classes such as infrastructure and private debt can provide a hedge against rising interest rates and inflation. A broader diversification of the illiquidity risk can enhance strategic allocation while leading to greater stability and higher expected returns. This is an approach that the Vita Collective Foundation applies continuously and in a disciplined manner. It may also be beneficial to rethink some of the dogmas that have worked very well so far in central-bank-driven environments, but which may be less appropriate in the coming years. This includes, for example, excessive reliance on passive asset management. And ultimately, there are also long-term trends that go beyond individual asset classes, which are likely to offer not only attractive returns but also risk mitigation. For example, it might be beneficial to analyze the implementation of strategic allocation from a sustainability perspective.

Markus Leuthard: This year will be exciting. The extent to which growth will slow down remains to be seen. Higher interest rates are making bonds more attractive again. We have gotten used to falling interest rates and volatility in the stock markets over the last 40 years. Inflation came as a surprise. Fixed income is once again a legitimate investment option.

Simon Aschwanden: It's important to maintain a long-term perspective and keep the focus on performance parameters. A clearly defined and consistently pursued strategy is very important, as it can help to avoid having to make hectic corrections in turbulent times. It may also be useful to bring in experts for this purpose, to assist with strategic planning and implementation. I would advise against increasing the technical interest rate -– this would indeed increase the cover ratio, but in my opinion it's too soon.

Sébastien Dirren: My advice for 2023 is to ignore those who give advice for 2023, extend your investment horizon and broaden your investment universe. This will allow the portfolio to be optimally positioned for the next cycle.