Caisse Geneva’s approach to risk

The Caisse de prévoyance de l’Etat de Genève (CPEG), the CHF12.6 billion ($12.7 billion) pension fund for the Swiss Canton of Geneva runs a fundamental investment strategy shaped around harvesting the premia from its equally split allocations to bonds, equities and real estate, explains CPEG’s CIO Grégoire Haenni. Strategy eschews any tactical deviations, ‘riding out’ the market rather than trying to capture or call it, although Haenni has a keen eye on risk.

Recently this resulted in pro-active anticipation of the Brexit fallout, reducing the UK equity allocation ahead of the UK referendum on EU membership in 2016.

“The UK’s vote to leave the EU could have led to an implosion of the Eurozone and we sold part of our UK equities ahead of the vote to protect the portfolio. We bought them back after the market correction,” he says.

The UK’s Brexit saga is still playing out, but he believes the tremendous challenge the country has faced trying to leave the EU, has put other European countries off.

“We still think it’s a risk, but it’s just limited to the UK. Italy has stopped mentioning it. Other countries are less willing to leave the EU now.”

Now he is mindful of heightened risk in the equity allocation because of the late cycle.

“In equity we have to make sure we don’t alter the risk profile of the portfolio by overweighting the asset class,” he flags. “We are doing macro analysis to identify the potential risks that could derail the overall performance.” The portfolio is a mix of passive and active strategies and doesn’t include any thematic investment. “If there are sector rotations it could impacted thematic investment,” he says.

Haenni and his 12-people investment team is also navigating another enduringly challenging European issue: rock-bottom European bond yields. He believes that European bonds still play an important role in the portfolio for their protection against deflation.

“We could have an inflationary spike, but it would be short lived. We believe the deflationary cycle is here to stay and this is a good reason to keep the fixed income allocation in place,” he says. However, CPEG has started to look elsewhere for fixed income returns and is developing a high conviction strategy that focuses on capturing returns via increased risk focused on different bond maturities and qualities in investment grade Asian sovereigns and corporate bonds.

“We think Asia is the future; somewhere it’s still possible to find quality and where investors are rewarded for risk.  We have built a case for our investment committee.”

CPEG’s funded status has also just improved on the back of additional government funding, currently above 60 per cent. The government plans to inject between $4-5 billion into the fund that will bring the whole portfolio to around $17-18 billion, raising the funded ratio to 75 per cent in line with the average among other Swiss funds.

“It’s great news; we don’t believe our asset allocation will change because the bulk of the additional money is composed of a loan from government. Our one third, one third, one third structure won’t change dramatically.”

The fund targets a “predictable and stable” 2.8 per cent annual return reduced at the end of 2016 from 3 per cent. Around 30 per cent of CPEG’s assets are managed passively vs 70 per cent active. Around 50 per cent of assets are managed internally, including the fund’s active real estate allocation comprising mostly direct residential investments in Geneva, making CPEG the biggest investor in Geneva property.

“Residential is a good hedge against the economy and financial markets,” he says.

Haenni works with 34 external managers in relationships characterised by a very low turnover.

“We are more patient with active strategies and less patient with passive strategies. In the active allocations we’ll wait and monitor allocations during market cycles and make decisions after 3-4 years. Passive is just replication and we are much more rapid in our decision making here.” He works hard to ensure CPEG’s costlier active strategies, exacerbated by low yields, do add value and that higher fees are covered by outperformance.

“There is a big pressure to reduce costs going forward,” he says.

CEPG also asks its managers to integrate its ESG strategies as the fund pursues a bold ambition to lead ESG investment amongst Swiss peers.

“We want to be a pioneer in Switzerland,” he says.

He fund recently carried out a carbon footprint of its listed securities, analysing 7000 companies covering 95 per cent of its equity book and 85 per cent of its bond portfolio. It has now followed up that footprinting with “direct action” to reduce its carbon footprint, says Haenni.

It will exclude coal producers from its investment universe and is exploring a dedicated green bond strategy given their increasingly attractive yields and diversification benefits.

“The green bond market has evolved since its launch in 2007 and we think the market is deep enough; it is also easier now to check projects are properly green.”

He is finalizing analysis on any future portfolios size and says that once it is approved and signed off, CPEG will start a beauty contest, either investing in a fund or specific strategy. Elsewhere a new ALM study will also measure the carbon footprints of the different asset allocations.

“We are the first pension fund to perform a top down carbon footprint of our asset allocations” he enthuses.

The pension fund is also integrating ESG in the real estate allocation by improving energy efficiency in its properties and educating tenants on water and electricity usage. It is giving the portfolio an edge in an increasingly competitive market, particularly from insurance companies that have lower long-term returns, he says.

“It is becoming harder and harder to identify real estate projects that make sense in terms of expected return. Prices have gone up, the trend is going to continue and it has constrained our ability to build out this allocation. ESG integration is a way of putting effort into finding solutions in an asset that is richly priced across the board.”