Everything you need to know about pension fund investment strategies

How do pension funds formulate their investment strategies? How does the investment process work – and how are both assessed? We explain the principles as well as the most important terms and key figures.

The basis of occupational benefits insurance (2nd pillar) is laid down in the Federal Constitution and governed by the Federal Act on Occupational Old Age, Survivors’ and Invalidity Pension Provision (OPA) (in German). Occupational benefits   are financed  equally  by  employees and  employers.

A pension fund is an independent private-law institution that generally takes the form of a foundation. The highest-level body of a foundation is the board of trustees, It is responsible for overall management of the pension fund, setting its performance targets and ensuring that the pension fund is sustainably managed and stable from a financial perspective.

The investment strategy

What is a pension fund investment strategy?

The investment strategy defines how the pension fund assets are invested. As a first step, an Asset Liability Study (ALM study) will be prepared to serve as a basis. A number of factors need to be taken into account here: the pension benefits that have been promised (financial obligations to active insureds and retired persons), the composition and development of the pool of insureds, the investment return required to fund the fund, and the risk capacity and risk tolerance.

Based on the Asset Liability Study, the investment strategy and fundamental questions regarding the portfolio structure are defined, such as:

• Are the assets managed actively or passively?
• To which asset classes (e.g. equities, bonds, real estate, etc.) will the assets be allocated – and with what weighting?
• What is the necessary liquidity (solvency)?

What is the purpose of the investment strategy?

The purpose of the investment strategy is to

• combine the various asset classes based on their return and risk characteristics in such a way ,
• that this results in the most optimal risk-return scenarios for the pension fund,
• generate the investment income required for financing the pension benefits (taking into account the risk capacity and risk tolerance of the Foundation).

In general, Swiss pension funds are free to choose their investment strategy, provided they comply with the OPO 2 (Ordinance on Occupational Old Age, Survivors’ and Invalidity Pension Provision) (in German) Investment guidelines and the provisions on the maximum weights per asset class.

Who defines the investment strategy?

The Board of Trustees defines the pension fund’s investment strategy. As the supreme governing body of the Foundation, it manages the Foundation on a fiduciary basis on behalf of the insureds and bears responsibility for the financial equilibrium of the Foundation. It forms the basis for investing pension assets and incorporates the investment strategy in the investment regulations. It also sets out the directives for implementation and the principles for monitoring and reporting.

Which asset classes can pension funds invest in?

Pension funds can invest in a variety of asset classes, including:

• Cash and cash equivalents
• Bonds
• Equities
• Real estate
• Infrastructure

Alternative investments are also possible, such as private debt (claims from unlisted debtors), private equity (investments in unlisted companies), and commodities and precious metals. Such alternative investments are subject to certain restrictions.

Permissible investments are described in more detail in the Ordinance on Occupational Old Age, Survivors’ and Invalidity Pension Provision (OPO 2) (Art. 53 ff. OPO 2) (in German).

What do the asset managers do?

Asset managers oversee the operative implementation of the investment strategy of a pension fund. To do this, they use the rules defined in writing by the board of trustees in the investment regulations. The regulations govern: 

• whether the assets are actively or passively managed
• whether exclusion criteria apply, for example in relation to certain sectors, countries or regions
• how the shareholder voting rights are exercised and
• which sustainability and credit rating criteria must be taken into account.

How is the investment performance monitored?

The investment result is checked using various key figures. These enable the board of trustees to assess the success of the asset management. To do so, it compares the investment returns achieved with the previously defined benchmarks and analyses to see whether the investment objectives have been achieved. This raises questions such as:

• Are the risks that were taken commensurate with the risks envisioned in the investment process?
• What is the ratio of risks taken to investment income generated? 
• How much has each investment class contributed to investment performance?
• To what extent has the asset manager contributed to investment performance? 
• Which fees are charged against the investment return? 
• Have the asset managers observed the defined maximum permissible deviations from the reference indices?
• Are the investment ranges per asset class, as provided for in the investment regulations, complied with? 

What do pension funds do with the investment return they generate?

What a pension fund does with the investment income it generates depends on its financial and structural situation . For example,  what funding ratio it has or the ratio of active insureds to pensioners. Depending on the circumstances, the pension fund can pass on the achieved return to active insureds in the form of a higher interest rate or use it to finance current pensions (the so-called technical interest rate on actuarial reserves).

Pension funds are increasingly moving towards transparent participation models. One such example is the interest model used by the AXA Foundation for Occupational Benefits.

Handling investment risks

How does a pension fund deal with fluctuations in the financial markets?

Pension funds have a long-term investment horizon. Short-term fluctuations in the value of investments are offset by the fluctuation reserves that have been created. Pension funds with a good financial and structural risk capacity can pursue a more offensive investment strategy. This means, for example, that they invest more in equities and less in bonds. Since the value of equities is more volatile than bonds, pension funds that have a large equity component should create fluctuation reserves to offset this. This way they can absorb short-term fluctuations. The investment strategy also defines how a pension fund handles risks.

Investment trends

Does sustainability play a role?

Sustainable investments are a big issue for pension funds. For example, the Swiss Pension Fund Association has formulated a Charter (in German) and provides ESG Guidelines (in German). There are no legal provisions regarding sustainability. This makes it possible for every pension fund and the board of trustees to decide how sustainably they want to invest their funds.

Summary: This is how pension funds define their investment strategies

Every pension fund has a different investment strategy that is geared to its individual needs and its risk capacity.

The board of trustees determines the investment strategy by clarifying the promised pension benefits and the fundamental questions relating to the portfolio structure, as well as taking into account factors such as the composition and development of the pool of insureds.

The asset management selected by the board of trustees implements the operational investment process. The board of trustees defines in advance how and which key figures it will use to review the work and investment performance of the asset managers. The primary aim of a pension fund is always to structure its investments to offer the best possible risk/return ratio. The investment strategy doesn’t just determine whether a pension fund is stable. Learn here how you can better assess the performance of a pension fund.