Although pension funds keep costs low through purely passive investment solutions, it is difficult to achieve return and sustainability targets.
The 2023 performance was above the average of Swiss pension funds in long-term comparison. According to the 2024 study by the Swisscanto pension fund, they achieved an average return of 5.1%, but the ten-year average is 3.5%. This is why pension funds are under constant pressure to generate the highest possible returns to enable their subscribers to maintain an adequate standard of living after retirement.
At the same time, administrative costs should be as low as possible, because they in turn reduce performance and thus rents as fixed costs. In order to generate the highest possible returns with low administrative costs, Swiss pension funds are increasingly relying on passive investment solutions. But even these involve costs that should not be underestimated. Considering costs, passive funds systematically underperform the benchmark.
Risk premiums make the portfolio robust
Enhanced indexing solutions can be used to achieve optimization in this context. The investment universe is determined by the selection of a benchmark index before defining different market segments combining sector and geographical area within this investment universe. This could be, for example, biotechnology in the North American pharmaceutical market. The portfolio is constructed using strategic risk premiums representing a minimum of 50% of the allocation and including Value and Quality. These are supplemented by the risk premiums of Growth, Long-term Momentum, Profit Momentum and Short-term Momentum (reversion to the mean). A ranking of companies with favorable return potential is then established within the selected segment. Companies that do not perform well in terms of risk premia are excluded from the portfolio.
Ultimately, pension funds may not have the expertise to meet the sustainability goals they set for themselves on the portfolio side.
It is important that risk premiums are complementary, through correlations that are moderately to negatively correlated with each other, in order to make the portfolio as robust as possible. To ensure this resilience over the years, the weighting of risk premiums is regularly reviewed on the basis of their weight in the performance of each segment, and, if necessary, adjusted. If it turns out that the weight of Value is too high within a segment compared to the benchmark index, then its weight is reduced in favor of Quality, for example. The extent of these adjustments depends on each segment: for example, the North American healthcare equipment and services segment, the weights of the explanatory factors of performance remained largely stable and did not require significant changes in the risk premium weightings. In contrast, in the North American biotechnology segment, which is characterized by a high frequency of innovation and therefore greater volatility, more drastic changes in these risk premium weightings are more common.
Compared to traditional passive investment solutions, pension funds can thus generate a solid excess return, thereby covering management costs and laying the foundation for pension fund stability. At the same time, the costs of such a solution are very low and the tracking error remains similar to that of an ETF.
Tailor-made decarbonization trajectory
Enhanced index solutions also present a decisive advantage over traditional passive vehicles in terms of regulatory requirements for taking into account sustainability criteria: the portfolio can be modeled, or personalized, in such a way as to achieve the specific CO2 emissions reduction objective of the pension fund. Such a degree of personalization cannot be achieved with a purely passive fund.
Ultimately, pension funds may not have the expertise to meet the sustainability goals they set for themselves on the portfolio side. Asset managers who offer improved index investment solutions can support pension funds in sustainability with tailor-made solutions.
