Pension funds January 2019

The investment environment remains challenging

Once again, a difficult market environment must be expected for investments in 2019. Picture rawpixel, Unsplash

After a difficult 2018, pension funds expect the investment environment to remain challenging. Nonetheless, turbulent times give rise to new investment opportunities. In his outlook for 2019, Bernd Barth, Client Advisor, demonstrates where to spot those opportunities and what needs to be taken into consideration.

Indeed, there is no doubt that 2018 was an overly demanding year for pension funds an investment perspective. Amid this challenging environment, negative investment returns were recorded on the income side, negative interest rates on savings balances and, to a large extent, on the pension annuities on the expenditure side, are among the factors weighing on the pension fund’s funding ratio and will eventually therefore be lower than at the beginning of 2018.

Year of change

Looking back, 2018 was a transitory period in financial markets. During the first half of the year, the much-vaunted recovery in growth slowed and political concerns began to dominate the markets. As a matter of fact, despite the robust and sustained economic growth, even the U.S. stock market has begun to weaken.

Will 2019 be another difficult year?

For 2019, a difficult market environment for investments is again to be expected, although recovery prospects are not unlikely in the first quarter. This development is the result of negative scenarios in the second half of 2018, which are not really compatible with the still robust dynamics of global economic growth. The weakening of monetary policy, however, requires greater selectivity in the allocation of the investment portfolio.

Defensive quality becomes more attractive

The strong differences in valuation between regions and countries are visible on the stock markets. However, their use requires a willingness to accept risk monitoring against standard benchmarks. Although the Swiss equity market is one of the markets that is relatively well valued, its defensive qualities should enable it to outperform the European average over the coming year.

Are we going back to normal?

In the European Monetary Area, efforts to normalise monetary policy are still in their infancy, but are expected to intensify during the year. The ECB - and, in its wake, the Swiss National Bank (SNB) - should take the first steps in the second half of the year to bid farewell to the current negative money market rate regime. This will put an end to the prolonged trend of the US dollar's appreciation. In this context, Swiss investors hedging their exposure to currency risk related to US investments hope that hedging costs will gradually decrease, which increased significantly again in 2018 to reach well over 3% against the US currency.

Is the trend to illiquid investments continuing?

However, the increase in long-term interest rates has not been sustainable. Swiss Confederation bonds are currently showing even more negative returns than a year ago. This continues to make bonds unattractive and explains the trend towards alternative investments, such as real estate, private equity or (Swiss pension fund infrastructure), which has been going on for some time now. However, the potential opportunities of these investments are also offset by risks that are often underestimated, as they only arise in adverse market conditions. This means that a sale is often only possible with a high discount.

The chart shows the development of the share of illiquid investments in the asset mix of the 2nd pillar. Source: Complementa Risk Check-up 2018

Opportunities in selected real estate markets

In the Swiss real estate market, the strong activity in construction and the decline in immigration are also increasingly affecting the residential real estate segment. This reflects in particular the development of listed real estate funds. The average premium (Agio), which expresses the difference between the stock market valuation and the accounting valuation, is now 15% and is well below the values of more than 30% in 2017; it is worth looking beyond the borders, for example in Germany: there too, a similar number of housing units are available, but unlike Switzerland, vacancy rates have been falling for ten years. But the real estate markets of some Asian countries and emerging markets, given population growth and increasing urbanization, also expect double-digit returns that far exceed the increased risks.