Investing in the Swiss market. Ten questions and answers for investors.
Investors look for new answers every year. But the questions often remain the same: What will the next year bring for my investments? What do rising interest rates mean for the Swiss economy? Questions about the big picture in particular should be asked regularly and with discipline. Read the article to find out what they are and what the answers look like.
The latest spike in inflation has shown why cash is a poor choice as a long-term store of value. Rising inflation in the wake of the post-COVID-19 recovery boom and the outbreak of the war in Ukraine have caused the purchasing power of money to decrease significantly. Six per cent fewer goods and services can be purchased in Switzerland today using the same banknote than in December 2020.
Switzerland is actually doing well by international comparison: In the US and the euro zone, the loss of purchasing power in the last two and a half years is more than 16 per cent. Meanwhile, in the UK, banknotes have lost almost one-fifth of their purchasing power. The long-term view reveals an even bleaker picture when it comes to the lost purchasing power of cash. Since 1900, more than 90 per cent of the cash value in Switzerland has fallen victim to inflation. If, for example, only CHF 100 were invested in Swiss federal bonds, that would have paid off: An investment of CHF 100 in 1900 would now be worth around CHF 1,100 after accounting for inflation. The best option back then would have been to invest the money in the Swiss Market Index. Thanks to the appreciating value and dividends, an investor’s purchasing power would have jumped by some 24,000 Swiss francs despite inflation.
The rise in interest rates since the beginning of 2022 is due primarily to the return of inflation. Because a higher inflation rate reduces the purchasing power of money more quickly, investors who lend money want to be compensated for this risk, and therefore demand higher interest rates. At the same time, central banks are increasing their key interest rates in order to rein in inflation, which also increases the price of borrowing money overall. Interest rates will therefore fall substantially only if the inflation risk has been reduced in a credible manner. Factors such as higher government spending on the energy transition and enhanced military defense, baby boomers entering retirement, and labor shortages are likely to keep the inflation risk higher than it has been in the last two decades. In light of this, it seems rather unlikely that interest rates will revert to pre-2022 levels in the near future. Conversely, the risk of another spike in interest rates seems to be limited, as inflation in Switzerland has already returned to an acceptable level.
1 To the extent that these materials contain statements about the future, such statements are forward looking and are subject to a number of risks and uncertainties and are not a guarantee of future results/performance.
Not even Switzerland has been immune to the fastest rate hike cycle in 30 years. Real estate owners feel the higher interest rates directly in their household budgets owing to larger mortgage interest payments. Tenants, on the other hand, feel the interest rate hikes indirectly in the higher rents, because regulations tie rents to interest rate levels via the mortgage reference rate. However, it is difficult to estimate how much monetary policy has put the brakes on the economy as a whole. After all, the impact of interest rate changes can be extremely diverse and, in some cases, contradictory. For example, higher interest rates may hurt borrowers, but they benefit savers, which ultimately means an aggregate net zero effect. Even corporate investment decisions are largely independent of changes in the interest rate environment, because the willingness to invest is based more heavily on the expected return on investment, the future business situation, and the entrepreneurial outlook. All told, higher interest rates in Switzerland are likely to cause only a minimal economic slowdown. However, the interest rate risk should not be taken lightly, because an additional financial burden on households does have the potential to further exacerbate poor sentiment.
Interest rate increases by central banks in response to high inflation have significantly changed the environment for bonds, and the rise in yields has increased their attractiveness substantially. Furthermore, in countries such as Switzerland, the interest rate landscape has been under the influence of negative interest rates for years, meaning that bonds are underrepresented in many portfolios. Some investors are only just now taking a second look at them as an asset class.
Currently, bonds with good creditworthiness are to be preferred, i.e. from the investment grade segment. Bonds with lower ratings offer higher returns but accordingly have a higher credit risk and are more susceptible to economic slumps. Bonds in foreign currencies, such as euro and US dollar, currently have higher yields than comparable bonds in Swiss francs do. Note though that the risks associated with currency fluctuations should be taken into account, as currency hedging often wipes out any real returns. However, they can be used sensibly if foreign currencies already account for a portion of the portfolio. In that case, bonds with solid quality can offer long-term stable returns in the corresponding currency.
The rise in interest rates has led to a trend reversal on the housing market. Once again, it is much more expensive to own than to rent. As a result, demand for owner-occupied property has plummeted. Thanks to the continued decline in new construction activity, however, supply remains scarce and this severely limits the potential for correction. Price growth has already halved within the year and is likely to slow down further. Price dips in the low single-digit range per annum cannot be ruled out in the near future. Established homeowners generally do not have to worry, thanks to strict financing rules and expectations for manageable price declines.
This means that residential property remains expensive for new buyers. In the case of multi-family homes containing rental apartments, however, investors should expect a decline in prices before the current year is over. But due to the persistently high demand for rental apartments and the simultaneous decline in construction activity, vacancies will take another tumble and rents are likely to rise as a result. This will mitigate the emerging price corrections. The Swiss housing market therefore remains on course for a soft landing.
With the end of negative interest rates, there is no lack of alternatives to real estate investments. From 2015–2021, Swiss real estate bonds generated a yield premium in excess of 290 bps vs. ten-year sovereigns. However, this premium fell considerably in the course of the interest rate reversal. That said, the nominal view exaggerates the picture. Depending on the expected inflation and the extent to which price rises can be passed on, the yield premium recently still amounted to around 300 bps in real terms. At the start of 2022, investors were still willing to pay a premium of more than 40 per cent on the net asset value of listed real estate funds. At the end of July 2023, the average premium was still 11.3 per cent. Various funds with a focus on commercial real estate are even being traded at discounts. Real estate investment companies that are heavily focused on commercial real estate also have an average discount of 2.4 per cent. The listed investments have thus anticipated the correction that is now threatening direct investments. This means an opportunity to buy, especially for investors with a longer investment horizon.
The Swiss equity market has a significant “foreign” component. After all, the top 20 listed companies in Switzerland on the blue-chip Swiss Market Index (SMI) generate more than 90 per cent of their revenue abroad. The US alone accounts for 33 per cent of all revenues, according to estimates by data provider FactSet. In addition, with a share of 6.3 per cent, China is more important than the home market with 5.7 per cent in terms of turnover for listed Swiss companies. Germany, Japan, France, the UK, and India are other important sales markets for Swiss companies. The big five names on the SMI – Nestlé, Roche, Novartis, Zurich Insurance and ABB2 – paint a similar picture. This means that an investment in the Swiss market already accounts for global diversification to some degree – at least in terms of regional sales exposure and thus the global economy.
2 The individual company mentioned on this page is meant for illustration purposes only and is not intended as a solicitation or an offer to buy or sell any interest or any investment.
Maintaining a certain “home bias” can be useful for various reasons. Nonetheless, Swiss investors should also be invested in foreign equities. Diversification is a key advantage of investing in foreign equities. With regard to regional sales exposure, the Swiss equity market is relatively well diversified, but not in terms of sector exposure. For example, the Swiss equity market is dominated by companies in the healthcare sector, and the consumer staples sector. Investors who invest exclusively in Switzerland therefore have disproportionate exposure to fluctuations in these sectors. By contrast, the percentage of technology companies in the Swiss equity market is relatively small. As a result, in years of strong growth in the technology sector, the Swiss SMI underperforms the global equity market significantly.
The Swiss equity market continued to perform less dynamically than the global equity market in the first half of 2023, mainly due to its lower exposure to technology stocks. A globally diversified equity portfolio can also help with risk hedging if Switzerland and its companies should experience a severe crisis. Investing in foreign equities also gives investors greater exposure to the growth of emerging markets, such as countries in Asia that are enjoying stronger growth than the global economy. For all these reasons, Swiss investors should not simply pass up foreign equities.
The Swiss franc has been the strongest currency in the world for over 100 years. Despite intermittent ups and downs, the euro has lost more than a third of its value compared with the Swiss franc since the turn of the millennium alone, and the US dollar has lost over 40 per cent. The reasons for the Swiss franc’s strength are the following:
- The Swiss franc is a safe haven in times of crisis
- Inflation is lower in Switzerland than abroad, even on a long-term average.
- The Swiss franc is in demand thanks to Switzerland’s stability and the high credibility of the Swiss National Bank (SNB).
- Switzerland is generating a surplus in foreign trade, which means constant demand for the Swiss franc.
It is therefore highly likely that the Swiss franc will remain a strong currency in the future, but will still undergo periods of weakness. Currency developments should also be taken into account when making an investment decision. Appreciation reduces the value of an investment abroad, while devaluation leads to profits. Currency risks can be hedged. The costs of hedging depend directly on the interest rate difference between the currencies: The greater the difference in interest rate levels between Switzerland and abroad, the more expensive it will be. The interest rate difference, in turn, is linked to exchange rate expectations: Strong currencies mean lower interest rates. Given the latent upward pressure on the Swiss franc, the interest rate level here is usually lower than abroad, as we are currently seeing. The answer to the question of the degree and type of hedging thus depends on various factors such as interest rate and exchange rate expectations, the investment horizon, and the risk ability of each investor.
Sustainability is gaining momentum worldwide. In this country as well, speeding up environmental regulations is just a matter of time. This is not only because Switzerland has to meet certain obligations. Political pressure from the general public is also increasing, as voter approval of the Climate and Innovation Act shows. In addition, Switzerland is well positioned to benefit from the opportunities of climate change: A relatively low dependency on fossil fuels, a high level of innovation, and a dynamic corporate landscape suggest tangible transition opportunities. Companies would be well advised to confront the sustainability issue as soon as possible, and investors can help to actively promote such companies.
4) All investments have an impact – positive or negative. By investing sustainably to goal is to maximize the positive and minimize the negative impact on society and the environment. Consideration of ESG criteria may lead to results that deviate from traditional investments. It is possible that the data from the ESG data providers may be incorrect, unavailable, or not immediately updated and therefore may experience some time lag. While the investment process includes ESG considerations, it also applies other metrics (such as dividend levels and quality).
The Credit Suisse “Climate Change” Supertrend identifies companies that play an important role in the transformation to net zero – whether with renewable energy production, power storage technologies, building efficiency solutions, or electric vehicles. If you prefer to invest sustainably through bonds rather than equities, there is a steadily growing market for green bonds. The proceeds from the issue of green bonds are earmarked for financing environmental projects. In addition to the federal government, cantons, and financial services providers, companies – often from the real estate sector – have started to issue such bonds in Switzerland more frequently.