Unlike in the UK, Swiss pension funds are only allowed to use derivatives to a limited extent. But dangers lurk elsewhere.
Things are going awry in the UK at the moment due to the controversial economic policies of short-term prime minister Liz Truss. Now there are even fears that people's pensions are at risk.
The disaster was triggered by British pension funds, which in their search for yield during the low-interest phase, increasingly included riskier investments such as corporate loans, real estate and shares in their portfolios. They hedged the associated risks with derivatives using borrowed money and British government bonds as collateral.
Vicious Circle
For as long as the markets had confidence in the British economy, all went well. However, with the government's growth plans, which consisted of cutting taxes by creating more government debt, distrust rose along with risk premiums on government bonds. In turn, the prices of these securities fell.
This caught some pension funds on the wrong foot and seeing as their collateral deposited as government bonds were worth less, creditors demanded further backing. Pension funds obtained these funds by selling their liquid securities, i.e. British government bonds.
This vicious circle was only broken when the British central bank stepped in and acted as a stopgap by buying up divested government bonds.
Leverage in Switzerland
A similar scenario wouldn't be possible in Switzerland. Within Switzerland's three-pillar system, regulations for the second pillar only permit investments in derivative financial instruments if no leverage is exerted on the overall assets of the pension fund.
However, leverage is allowed for alternative investments as well as for individual real estate or for regulated collective real estate investments.
Buyers' Strike
Since several pension funds have increased their exposure to real estate in recent years, a future storm cannot be ruled out. However, so far there are no signs that real estate markets are facing a stress test due to pension funds stocking up on leveraged products.
What could cause concern, however, is that various real estate funds recently had to call off their plans for a capital increase. The reason being that none of the listed funds had a premium of at least 10 percent over net asset value. Such low premiums do not result in positive rights prices and existing investors would have to accept a disadvantage due to the costs incurred and the dilution.
Shortfall and Risk
Many Swiss pension funds have had to draw on the thick padding they have built up in recent years. At the end of September 2022, 480 pension funds were not in a position to cover 100 percent of their pension obligations, figures from the Swiss Federal Supervisory Commission for Occupational Retirement, Survivors and Disability Pension Plans showed.
Accordingly, 55.6 percent of Swiss pension funds are facing a shortfall and a restructuring risk, compared with a negligible 0.1 percent at the end of 2021.
Who Will Pay?
Nonetheless, the figures overstate the dangers, as the significant increase in interest rates of around 1.3 percentage points in Switzerland as of the end of September 2022 is impacting the valuation of obligations positively.
As long-term investors, pension funds are legally allowed to ride out shortfalls to a certain extent. But the time for overconfident investing in the hope of achieving higher investment returns is finally over. Now the boards of trustees must turn their attention to more uncomfortable issues - including the question of who will plug the holes in the event of a significant shortfall.
