Swiss pension funds are still mainly invested in domestic real estate and there are no signs of this changing despite some experts calling for more diversification. Barbara Ottawa finds out why

"Yes, I do envy the Migros pension fund for its real estate exposure," said Markus Hübscher, head of the SBB pension fund for the Swiss federal railways. At the first Swiss Pensions Conference organised by the Swiss CFA society, Christoph Ryter, head of the Migros pension fund (MPK), noted that other pension funds are probably wishing they had a similar exposure to Swiss real estate to that of his fund.

The pension fund for the large retailer Migros is investing 25% of its CHF16.3bn (€12.6bn) total AUM directly in Swiss properties, most of which is managed in-house. Both in 2008 as well as in 2009 this part of the portfolio returned almost 5%.

The Swiss Federal Railway (SBB) pension fund invests only 5.6% of its CHF13bn in Swiss real estate and none of it directly.

This is not typical for Swiss pension funds which, according to data collected by investment manager Swisscanto, had 18.5% in real estate at the end of 2009. This is roughly also the average allocation over the last five years, of course always relative to the performance of other asset classes in the portfolio.

Around 96% of this real estate exposure was invested in Swiss property, of which 60% was held directly.

Interest in foreign real estate is still small, with around 4.3% having been invested indirectly in non-CHF-denominated property at the end of 2009. However, the share has almost doubled over the past five years, confirmed Beat Gerber, head of the balanced portfolio at Swisscanto.

Still, Gerber does not see a major trend towards more regional diversification in the property portfolios; and Hans Brauwers, head of the association of Swiss real estate investment foundations, AFIAA, explains why: "Switzerland is like the land of milk and honey. Swiss pension funds have been focused on this market and they have not been disappointed. Furthermore, the Swiss franc is very strong and consistent, which makes foreign holdings unattractive because of currency effects."

Nevertheless, Brauwers sees "more interest" in foreign real estate as pension funds want to diversify and are testing again the asset class that burnt them during the crisis. For example, MPK suffered an 18.8% loss on its CHF196m foreign real estate portfolio in 2009.

Stephan Kloess, co-founder of the now university-owned Center for Urban & Real Estate Management (CUREM) and head of consulting firm KloessRealEstate, notes that "a lot of talks are taking place as generally the interest in international diversification is given". But he warned that in certain areas European property yields are back to the average long-term level and that investors should be cautious about what to buy and be "very attentive regarding timing".

He adds: "Based on the experiences made during the last cycle and due to the complexity of the indirect real estate holdings market investors should have a stronger focus on manager selection and controlling of their investments."

He sees a lot of "peer group behaviour" when it comes to direct real estate investing in Switzerland with some institutional investors buying at initial yields of 4% or less. "This is basically not a problem now, but what happens when interest rates are rising. Based on this the pricing of a lot of investments is not risk adjusted."

For Gerber this is less of a problem as interest rates are likely to rise slowly and there is "a lot of leeway" between the current level of 1.9% for 10-year Swiss government bonds and the average yield.

And many analysts believe that despite the high level of prices in regions such as Zürich or Geneva average Swiss property prices have only one way to go: up.

If immigration keeps steady at the current rate (90,000 in 2009) it will help push the Swiss population from the current 7.7m to over 10m within the next 10 years.

Gerber points out that the massive price increases in and around Geneva and Zürich have occurred with low interest rates and an expanding population. "This is not like in the 1990s' property bubble," he notes.

Professor Donato Scognamiglio, managing director and partner at the Swiss real estate consultancy IAZI, even goes as far as to say that interest rates are too low. "This leads to nonsensical projects and it seduces people into making investments which they probably should not make."

As a case in point he mentions "pension funds buying a 30-year-old house at a yield of 5%", which in net yield means 3% excluding renovation costs.

Gerber also confirms that sustainability is becoming more important in Switzerland, which might further decrease the future value of old properties. But he adds: "At the moment we are lacking a unified label for green property investments and we cannot just use foreign labels as we have completely different building standards [in Switzerland]," Gerber adds.

So interesting objects are getting harder to find in Switzerland. Investment foundations are few and most often closed or they are demanding high entry fees. A few pension funds turn to foreign real estate and some are engaging in asset share dealing, transferring their direct property holdings to funds and then buying shares in the fund, notes Gerber.

Other pension funds are starting to manage their property portfolios more actively and are including developments, which some large pension funds have been doing for a long time.

A case in point is BVK, the public pension fund for the canton of Zürich, which has invested CHF3.6bn (20% of its portfolio), directly in Swiss property and around CHF400m indirectly in international holdings via the AFIAA, of which the BVK is a founding member.

With a dedicated real estate team of seven people the fund is also employing architects and developers to realise projects such as a shopping centre in Winterthur or a four-generation housing project in the same area.

Thomas Schönbächler, head of the BVK's management board, notes that the fund is currently "defensive" when it comes to purchases in Switzerland because of the pricing situation. "But over the long term the market outlook is good," he adds.

Swiss real estate holdings are a "stabilising factor" for Schönbächler. In 2009 this part of the portfolio yielded 6% (compared to a total portfolio return of 11.2%), and in 2010 (for which no performance figures were available at time of writing) real estate was also "a driver of performance", Schönbächler, adding: "We are interested in counter-cyclical developments but we are not interested in taking part in real estate trading," Schönbächler says.