Dynamic Investment Strategies for Swiss Pension Funds

Abstract

Swiss pension funds have to guarantee a minimum return on the mandatory pension capital on a yearly basis. To be able to pay out the guaranteed rate with 100% certainty, financial theory suggests to follow a pro-cyclical dynamic investment strategy. In reality, Swiss pension funds have followed static investment strategies. In contrast to dynamic strategies, static investment strategies are not influenced by the current risk-taking capacity of the fund. In this study, we analyze four different dynamic strategies and compare them with a static buy-and-hold strategy. The dynamic strategies analyzed are a classic portfolio insurance with call options, two CPPI-type strategies and a straddle-like investment product called Reverso. The assessment of the dynamic investment strategies is based on a Monte Carlo simulation for a hypothetical pension fund. We apply expected maximum shortfall as risk criterion and expected growth rate of funding ratio as reward criterion. We show in this study that dynamic strategies can be an attractive alternative to a static investment strategy in some circumstances. The analyzed dynamic investment strategies have the potential to offer a more attractive risk-return spectrum than a static buy-and-hold strategy for the risk and return measures used in this study. For any acceptable level of risk, there is a dynamic strategy that yields a higher expected growth rate of funding ratio. However, dynamic strategies should not be seen as panacea for the issues faced by Swiss pension funds as other factors, such as transaction costs, need to be taken into account when choosing an investment strategy.