Their slow, steady investment strategies and high weighting to domestic assets, means most Swiss pension funds are not venturing outside their home market in current downturn. However, the gradual move to global diversification is
by no means off the cards in the long term. Lynn Strongin Dodds reports

istorically, Swiss pension funds have not strayed from their home turf when investing in real estate. Despite a new, more relaxed regulatory regime, this is likely to remain the case for the short-term. Opportunities may present themselves in the wake of the financial crisis, but these ever-cautious institutions are not rushing to make any forays across geographical borders.

Instead, institutions are asking questions, doing their homework and laying down foundations for their global push, according to Marcel Salzmann, head of institutional sales at Invesco Switzerland. "We are definitely seeing an increase in interest from Swiss pension funds for investing in international real estate," he says.

"This trend is mainly driven by a long-term strategic decision to diversify from local to global, but also due to the regulatory changes at the beginning of the year. Swiss pension funds like to make long-term preparations from the beginning and to feel comfortable with market conditions before they make a move. However, it is a question of timing, and if they do it, they want to do it right."

Ulrich Kaluscha, Zurich-based managing director of 4IP Management, a Sal.Oppenheim group company, adds: "There has been a movement towards diversification, but at the moment Swiss pension funds are sticking to their home market, because it has produced steady, stable returns.

In many ways it is a catch 22 situation, especially as about half of the Swiss pension funds are underfunded. On the one hand, they need to invest in riskier assets to generate higher returns, but on the other they do not want to abandon their conservative approach and lose money. Psychologically, it seems to make sense to focus on Swiss real estate, but this approach neglects the fact that after the correction very interesting opportunities outside Switzerland will be available."

The other obstacle is the so-called denominator effect, which has made property look top heavy in portfolios due to the significant drop in equity prices, according to Kaluscha. In some countries this could precipitate pension funds to sell properties to whittle down their holdings. In Switzerland, many funds are well below their targets and, as a result, prefer to sit tight until the volatility ebbs.

Switzerland operates a three-pillar system of state-provided, occupational and private pensions. On the corporate front, Swiss pension funds differ from those in other countries in that they are established as separate legal entities, independent of the sponsoring employer.

In January, new rules came into effect, tightening the responsibilities of trustees over the investment process, while loosening the alternative asset allocation reins. For property, the maximum investment ceiling has been reduced to 30% from 50%, while the overseas slice has been increased to from 5% to 10%. Edouard Stucki, senior investment consultant at Watson Wyatt, says: "Although the past regulations allowed pension funds to invest up to 50% in real estate, this did not reflect their behaviour.

The average asset allocation was about 14%, which was in line with the Edhec [French business school] risk study of last year, which said that between 12% to 15% is the optimal level. The Swiss, though, tend to have a higher allocation to property than pension funds in other countries."

The largest chunk - or around 60% of a Swiss pension fund's real estate portfolio - is invested in multi-family residential properties, followed by smaller stakes in office and retail. Multi-family dwellings may not be at the glamorous end of the market, but in the current climate their stable 5-6% annual returns have never looked better.

"They are a classic Swiss investment theme," says Ulrich Braun, head of property research at Credit Suisse. "This is because two-thirds of the population lives in these types of properties, so the vacancy rates and rental income are secure. They may not have had the double digit returns that some markets enjoyed over the past two years, but this has also meant that their downside risk was protected."

The other main attraction is that they are literally in a pension fund's backyard. Most of these residential properties are located about 10-20 kilometres from the institution's headquarters.

While most pension funds invest in existing properties, some have also shown an interest in greenfield sites. Last year, Bundes Publica, which has CHF32.5bn (€21.8bn) in assets under management, acquired land from the government in Bern for an undisclosed amount to build two four-story high buildings to accommodate 47 residential flats.

Meanwhile, private pension plan Swatch Group also bought a residential field with plans to construct around 90 rental houses. Looking ahead, the multi-family residential sector is expected to remain the most popular as the global economic recession has taken its toll - and is expected to continue to - on the local office and retail sectors.

Vacancy rates are expected to rise with rental income falling. Residential will not be immune and rental growth could dip due to a drop in inward migration, especially in Zurich and Geneva, according to a report from Wuest & Partner, a large real estate consultancy. But the sector is unlikely to experience a reversal in the overall price trend due to the excess demand for rental apartments that still exists in the country.

As for global investing, the general consensus is that pension funds will gradually - that being the operative word - increase their holdings. Peter Bänziger, head of asset management and institutional clients at Swisscanto Group, does not believe the new investment guidelines "will have an immediate impact on the investment rationale of Swiss pension funds".

He says: "On average, Swiss pension funds have only 1.1% invested in global real estate and that should increase over the long term." Salzmann notes: "Up until recently, Swiss pension funds viewed global real estate as a satellite and not a core investment. This is beginning to change, but it will take time especially in this current environment."

Robert Stolfo, director of business development at Invesco Real Estate, adds: "I see a parallel to the German markets in the late-1990s, in that pension funds had a very high percentage of direct holdings and then they started to go abroad.

The difference with the Swiss though, is that once they decide to invest, it will be a truly global allocation. They will not just look at cross-border opportunities in Europe, but also in Asia and North America."