Wednesday, May 23, 2012

Swiss Pensions Dumping Eurozone Bonds?

Martin de Sa'Pinto at Reuters reports, Swiss pension funds buy emerging market bonds:

Swiss pension funds have been dumping sovereign bonds from troubled euro zone issuers and snapping up those of corporate and emerging markets issuers as they strive for the returns they need to maintain funding ratios, a survey found on Tuesday.

A survey of 326 Swiss public and private pension funds managing 426 billion Swiss francs ($453 billion) found most had failed to achieve the yields needed to meet future liabilities, and would need to take on more risk to do so.

"About 20 billion francs has gone into emerging market bond funds in both hard and local currencies, and a good portion has been switched from (developed market) foreign government bonds," said Peter Baenziger of Swisscanto, which manages $56 billion of assets, and which conducted the annual survey.

"There is also plenty of evidence that funds have been dumping PIIGS (Portuguese, Italian, Irish, Greek and Spanish) bonds and switching to high-grade corporates," Baenziger said.

However, the rush by pension funds and other investors into emerging markets bonds is not without risks, especially if interest rates are pushed higher to prevent the economies from overheating, he said.

"Rising interest rates could create the risk of profit-taking on local currency bonds. In the past this has sometimes created difficulty to deliver dollars, currency controls and, in extreme cases, the collapse of the local currency."

Pension funds will have to take on even more risk to get the returns required to meet future liabilities. Baenziger cited a Swisscanto study showing they need annualised returns of 3.4 percent, against the annual 2.4 percent of the last 10 years.

"But they are in a dilemma, with funding ratios between 95 and 103 percent their risk capacity is not very high," he said.

RAISING THE RISK PROFILE

The need to increase risk could penalise Swiss government bonds on two counts.

Firstly, said Baenziger, the average 0.5 percent yield on 10-year Swiss government bonds would drag on overall returns of funds holding them, forcing them to take on more risk elsewhere.

Secondly, any rise in currently rock-bottom interest rates could hit the value of the bonds.

"There is asymmetrical risk in Swiss bonds at present. The potential is very limited and the risk is high that interest rates could rise." He said the same was true for other European and U.S. bonds.

Also, he said, the Swiss National Bank (SNB) balance sheet has grown five-fold in three years as the SNB sought to keep a rein on the red-hot Swiss franc, creating the risk of inflation, which rose sharply in similar circumstances in the 1980s.

Swiss pensions managers are also likely to raise real estate allocations, where the average fund already parks 20 percent of its money despite soaring property prices. Local rules allow pension funds to hold up to 30 percent of assets in property.

"Net cash flow returns of Swiss real estate are still 4.5 percent, so even if interest rates rise there is a good cushion in these yields, and they are also an inflation hedge," Baenziger said.

"There are some bubbles in privately-held real estate, but pension funds have a good mix between commercial property and housing, and have regional diversification. Allocations would be higher if more were available at reasonable prices.

Pension Funds Insider also reports, Swiss pension funds alter asset allocation after negative results:

A new survey of Swiss pension funds shows that over the year 2011, schemes did not manage to achieve the positive results they had hoped for.

Required yields were not delivered, the survey by asset manager Swisscanto revealed, which led to a continued reduction in cover ratios, though private pension funds manage to report reserves of on average more than 100%.

Swisscanto says that achieving the necessary target yields remains the greatest challenge for those in charge in the current year.

The survey is based on answers from 326 participating funds, altogether representing 2.5 million beneficiaries and fund assets of CHF 426bn.

Reduced cover ratios

The net performance as measured by the survey gives an insight into the current financing situation for pension funds. The figure recorded for 2011 is -0.32%, which has led to a mild erosion of assets. The yields achieved predominantly fall within the -2.5% and +2.5% range. Barely half the participating funds (46%) managed to achieve a positive result.

The asset manager says that occupational pensions in Switzerland have been tarnished by unsatisfying capital gains for several years now. The average yield of all participating funds over a five-year period is positive by only a small margin of 0.2% p.a.

Cover ratios have dropped more dramatically due to pension liabilities with higher interest rates. A drop from 106% to 103% was recorded for private-law funds and from 98% to approximately 95% for public-law funds with full capitalisation.

Recapitalisation measures

The current situation has forced several pension funds to carry out further recapitalisation measures, of which the most commonly named was to reduce rates (for all-inclusive pension schemes), followed by charging recapitalisation contributions from employers and employees.

The prevailing uncertainty is closely linked to haziness surrounding the future of the euro zone. In a time of persistently low growth, low-interest policy carries the risk of deflationary trends, whereas money supply expansion could lead to accelerated inflation. Depending on the expected development, the funds would have to employ completely different strategies.

To protect themselves from inflation the schemes mostly said they invested in real estate or shares. Asset allocation in general experienced hardly any change in the past year, the survey found. The percentage of assets made up by bonds increased slightly from 36.7% to 37.3%, primarily due to exchange rate fluctuations. One in five participating funds also expanded their proportion of emerging market bonds.

The dilemma Swiss pension funds face is the same one that pension funds across the developed world are all struggling with, namely, how to increase yield in a low growth, low interest rate environment.

In the UK, pension savings hit their lowest level in eight years, sparking a fierce debate over 'money printing' as the crisis in the eurozone could spark more quantitative easing:

Quantitative easing has not cut the value of most pension funds, the Bank of England's deputy governor claimed today as he warned that a deepening of the eurozone crisis would make more money-printing necessary.

Defending the Bank's asset-purchasing scheme to pension fund bosses - who have complained that QE has depressed bond yields and ratcheted up their costs - Charlie Bean said that QE had also raised share prices.

That meant the impact of QE was neutral for a fund which was not in deficit before the financial crisis. In the longer run, gilt yields were likely to rise, he said, but offered no timescale for this.

Mr Bean's comments look set to inflame an angry debate between the Bank, pensions experts and pension fund managers.

QE has been blamed for both worsening final salary pension scheme deficits through its effect on bond yields and for harming pensioners because it drives down the rates on annuities, which provide a fixed income for life.

Deficits in FTSE 350 schemes doubled last year to £67billion, according to JLT Pension Capital Strategies Limited.

And the National Association of Pension Funds (NAPF) - whom Mr Bean was addressing today - said in March that the latest bout of £125bn QE had pushed final salary pension funds £90bn deeper into the red.

It also calculated that the first wave of QE, which started in March 2009 and pushed gilt yields down by around 100 basis points, would have increased pension fund liabilities by around £180bn.

Meanwhile, annuities, which pay an income in retirement in return for a lump sum, have seen payout rates falls by 20 per cent since QE began.

Mr Bean's MPC colleague David Miles drew an angry response earlier this week with a similar claim that QE is not as damaging to pensions as campaigners have suggested.

Miles, who was the only member to vote for more QE last month on top of the £325bn already undertaken, argued that QE also boosts share prices and the capital on government bonds, which means losses on annuities are offset by a bigger pension pot.

Miles wrote that an increase of around 19 percentage points in the value of a pension pot would cancel out the 1 percentage point fall in annuity rates since March 2009.

But Ros Altmann of Saga called the analysis 'deeply disturbing'. She replied that the Bank of England was 'living in an academic parallel universe that ignores reality' and rubbished Miles' figures.

'It is astonishing that the Bank is trying to deny the damage done by its policy of quantitative easing.

'Since 2008, gilt yields have fallen by 2.5% point, which means liabilities have risen by 50% - and assets have certainly not risen by anything like that amount. Therefore, QE has caused final salary scheme deficits to rise sharply.

'Falling annuity rates have permanently impoverished over a million pensioners. In the real world, annuity rates are down 20% and asset prices have not risen.'

But Mr Bean today warned that the Bank would have to pump more cash into the economy later this year if economic conditions deteriorate substantially.

As minutes for the last monetary policy committee meeting showed only Mr Miles voting for £25bn more QE, Mr Bean stressed that the Bank was ready to act to counter the impact of a deteriorating eurozone crisis on the UK economy.

He said that at the least the situation on the continent had pushed back the date for reversing the QE programme.

Arguments from other members clearly left the door open to further QE, according to Capital Economics' Samuel Tombs.

'Although David Miles remained the sole voice on the Committee calling for more QE,' he said, 'the Committee went as far as considering the case for more stimulus.

'Furthermore, the eurozone crisis has intensified since the meeting, while the Committee did not know about April's sharp fall in inflation at its meeting.

Accordingly, it still looks like it won't take much to tip the Committee into doing more QE.'

In today's speech to the National Association of Pension Funds, Mr Bean said, 'With the present heightened uncertainty associated with the problems in the euro area, the likely future date for us to commence selling gilts has receded somewhat.

'And if conditions do deteriorate significantly, we may need to re-start the programme of purchases.'

Official inflation data this week showed the headline rate to have dropped to 3.0 per cent in April, relieving the Bank's fears that price pressures were remaining too high, and raising the probability of more QE.

Yesterday, the International Monetary Fund urged the Bank to slash rates from their long-standing record low of 0.5 per cent to zero in order to bolster the UK economy against external shocks.

There was more evidence for caution on the outlook for UK growth today with data showing the biggest fall in retail sales in more than two years.
I agree with Mr. Bean and think that UK monetary authorities need to continue with quantitative easing to counteract savage fiscal austerity programs and cushion the blow from a eurozone slowdown. It may be painful for savers and pensions in the short-run but longer-term, yields will rise significantly once the eurozone economies pick up.

Today, all eyes will be on EU's summit and what will happen with Greece. Below, Bloomberg's Sara Eisen reports that if Greek leaders decide to leave the euro, they would likely only have 46 hours to complete the transition over a weekend. Sara looks at the issues the Greek government would need to deal with in that timeframe. She speaks on Bloomberg Television's "Inside Track."

The media loves sensationalizing macro events. Markets remain edgy but as I stated, it's time to look beyond Grexit and start loading up on risk assets like commodities (coal and nat gas in particular), financials, tech (networking in particular), and emerging market debt and shares.

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