On 14 February 2022, the Swiss Parliament has voted on a motion to update and change the BVV 2 guidance for Swiss pension funds. The motion had three aims: First, to ensure a higher level of competency of boards of trustees (Article 33) by introducing statutory requirements regarding knowledge in the areas of risk management and the management of assets; second, to ensure better risk management (Article 50) by complementing the current approach of risk distribution with a comprehensive risk management which will be added to the reporting; and lastly, to increase responsibility regarding the management of assets (Article 55) by eliminating asset category limits, as these limits are not appropriate when pension funds differ so widely in their risk structures and some asset classes are quite volatile (equity) or even show prolonged negative returns (obligations).
The fact that the Parliament voted yes, brings the Swiss BVV 2 closer to the investment regulations in comparable countries where statutory regulation in the form of investment limits is increasingly being replaced by the Prudent Investor Rule. Nevertheless, the changes might lead to some uncertainty. Many funds will ask themselves how to best deal with the changes and how to ensure compliance while optimising both the risk/return parameters and investment costs.
Even so the BVV 2 asset class limits can already be overruled today, for many Swiss pension funds, asset class limits have served as a welcome guide for determining their strategic asset allocation. However, with the average pension fund invested heavily in fixed income, equities and local real estate, investment outcomes over the last years were driven by decreasing interest rates and increasing equity valuations. We are currently in a situation in which similar positive return contributions from these two sources are highly unlikely. However, the widespread lack of sufficient investment expertise and the legal framework meant that most funds have not taken adequate action to set up their portfolios for these challenges. In many cases, this has lead and still leads to real consequences for future pensioners who will suffer from the steadily declining expected returns (these will be around the 2% mark in the next years). And it is also future pensioners that would benefit the most from higher returns: Just one per cent higher returns over an employee’s lifespan could lead to a 20% increase in pension benefits.
Scrapping asset class limits could force pension funds to revisit their strategic asset allocation (SAA) and re-evaluate their return expectations. As we can see in other countries, a higher exposure to alternatives, and private markets in particular, has shown good results for some of the world’s biggest pension funds. Below two examples from Canada Pension Plan Investments (CPPI) and Caisse de dépôt et placement du Québec (CGPQ):
In many cases, the current setup of the investment processes and team would need be reconsidered. With less guidance enshrined in laws come not only more opportunities, but also more responsibilities and requirements in terms of skills and resources. When it comes to risk management and the implementation of the SAA, in particular, an increased professionalization leads to an increased need for resource and skills.
Many large pension funds have sufficient internal resources and skills, but smaller and mid-sized funds might need external support. This not only makes sense from the perspective of being able to respond to the changed guidelines quickly, but also from the perspective of benefiting from extensive experience that goes beyond the Swiss market, as well as skills and capabilities in the areas of risk, governance and implementation.
While this support can, to a certain extent, be used in form of advice, for many pension funds, a delegated approach might be more efficient and successful. Limited internal resources will continue to be a limiting factor even when receiving good advice. Delegation, on the other hand, can free up resources by taking care of governance and risk-related tasks as well as implementation of the SAA. Typically, strategic decisions remain within the pension fund trustees. Depending on the delegation partner, new opportunities, e.g. in asset classes that are hard to access, like private markets, can be opened up, often at competitive price points. Even existing relationships with asset managers can be handled more efficiently and fees can be re-negotiated based on the (global) profile and buying power of the delegation partner. Moreover, an adequate delegation mandate provides a rigorous risk management framework ensuring the portfolio proper diversification and suitability to investment guidelines.
Following the vote on the motion, we recommend these three immediate steps: