Swiss Pension Funds Hold Bonds for Risk Management

Swiss pension funds face a structural gap between required returns and available yields. Most institutions need a net return of 1.5 to 2.5 percent per year to cover promised obligations. The gross yield on 10-year Swiss government bonds is currently around 0.4 percent. The overall domestic-currency bond market yields no more than 0.9 percent according to the Swiss Bond Index. This creates a challenge for sustainable financing of pension liabilities.

The role of bonds in these portfolios has shifted significantly since the 1990s. In the early 1990s, interest rates were high and required returns were low. Pension funds could meet obligations with minimal risk by holding high-quality bonds. They could also credit additional interest to active members without taking on investment risk. Inflation eroded purchasing power for retirees during that period despite high nominal rates.

Bonds Serve Risk Management Functions

Bonds are no longer held primarily for return generation. They perform specific functions in modern portfolio management. One key function is hedging liabilities through duration or cash-flow matching. This aligns assets with guaranteed pension obligations. Another function is diversification of equity risk. This reduces overall portfolio volatility when risk-bearing capacity is limited.

Corporate bonds provide additional returns and issuer diversification. They allow for outperformance in portfolio implementation. They also diversify counterparty risk compared to holding only government debt. This approach supports stability in a low-interest-rate environment. It helps manage the gap between asset growth and liability obligations.

Historical Context of Bond Allocations

In 1996, cash, bonds, and mortgages accounted for roughly 60 percent of total assets. This figure may overstate the actual allocation due to reporting rules. Investments were only required to be reported at market value from 2005 onwards. Before that, accounting standards did not fully reflect market fluctuations. This historical context explains the large initial bond holdings.

Pension funds also benefited from gains from member departures in the past. When members changed jobs, they often lost part of their accumulated savings. This provided an additional funding source for the funds. These gains reduced the pressure to generate high investment returns. Regulatory changes have since eliminated this source of funding.

Expected Returns Favor Equities

From a pure return perspective, equities outperform bonds ex ante. The expected return of an asset class equals the risk-free rate plus its risk premium. The equity risk premium over Swiss government bonds has averaged around 4 percent. At a 5 percent interest rate, expected equity returns are around 9 percent. At a negative 1 percent rate, expected equity returns drop to 3 percent.

Bonds always offer a lower expected return than equities. They are never attractive purely in terms of expected returns. Their value lies in risk management and liability matching. This aligns with the findings reported by GN auto markets/bonds: corporate bonds. The strategy prioritizes stability over maximum yield. It ensures the long-term solvency of pension obligations.