The Great Drift

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Investors are packing their bags as cold winds ravage traditional asset classes

Come the start of winter, homeowners across Switzerland will grab their shovels in preparation for the seasonal snow fall.

But this year the Swiss are preparing for another great drift. As chilly financial headwinds dry up equity market returns, investors across the country are moving towards alternative assets in search for diversification.

The Long Winter

Conditions in traditional asset classes have been unwelcoming for some time. Swiss nominal rates have been negative since 20151, leaving cautious investors unable to park capital in cash while they make up their minds. This, in turn, has even worse effects on cash and low-yielding, low-return assets once Switzerland’s (albeit mild) inflation is taken into account.

Swiss investors have a reputation for caution and an affinity for secure income-bearing assets. If you walk into many high-street banks, prices will be displayed on screens on the walls. But Swiss 10-year government bonds are also negative, and investors – in Switzerland and globally – have been compelled to seek other sources of return to meet their investment goals.2

Thankfully there is an alternative route. Switzerland has a reputation for offering one of the most diverse and expertly managed sources of alternatives in the world, and investors are making tracks towards it.

For the pension funds at the forefront of the movement, this diversification has borne fruit, with leveraged buyout funds in-particular outperforming public markets across all major regions.

These conditions have underpinned a global migration over the past 20 years with the seven largest pensions markets recording a 20% drop in equity allocations, coinciding with a 19% bump in flows towards real estate and other alternative categories3. Swiss investors are at the movement’s vanguard, with one of the highest exposures to alternatives in the world, with only the US having a comparable exposure (see chart 1).

But as more investors join the drift, incumbents are looking for new pockets of diversified revenue.

A brave new world

Today’s alternatives landscape bears little resemblance to the place intrepid investors arrived a decade ago. Hedge funds, Commodities and Private Equity—which accounted for more than 90% of Swiss Pension funds’ alternative allocations in 2010—have lost their dominance. Today these asset classes capture close to 55% of the money flowing towards alternatives as the country’s pension funds look towards private debt, insurance-linked securities and infrastructure in search of ever-greater sources of reliable and diversified returns (see chart 2).

Preqin Private Capital in Switzerland

Source: Thinking Ahead Institute, Global Pension Assets Study 2019, February, 2019

Whatever their allocation has been over the broad piste of alternative investments, those willing to venture beyond their investment comfort zone have been well rewarded. In aggregate, alternatives have beaten total investment market growth over three, five and 10 years, globally. This remains true when we drill down into the Swiss market. One study of the private equity (PE) investments of more than 500 Swiss pension funds found that PE funds outperformed the broader public stock market by between 9% and 19% over their lifetimes, giving an average rate of return of 9% - comfortably ahead of major public market equity indices4.

But there’s still more to play for, as the alternative landscape remains relatively unexplored for many: exposure among individual end investors is still lower than the proportion of alternatives in the market as a whole. Many people are understandably reluctant to go off piste from those tried and tested asset classes that have served them well in the past. Investors are wary of certain features associated with alternative assets, such as illiquidity and downside risk, which we’ll explore in the alternatives myths and misconceptions.

Nevertheless, the ground has shifted under public assets, with cheap money leading to high valuations and low yields. Rather than being a frightening journey into the unknown, those willing to explore this alternative landscape could be rewarded with positive income at reasonable valuations.

1 Bloomberg, Switzerland Government Bonds 10 Year Note Generic Bid Yield, December, 2019

2 Bloomberg, Switzerland Government Bonds 10 Year Note Generic Bid Yield, December, 2019

3 Source: Thinking Ahead Institute, Global Pension Assets Study 2019, February, 2019

4 The Journal of Private Equity, Daniel Steger, The Returns of Private Equity Funds: A Swiss Perspective, February, 2017

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