The Swiss franc was the strongest G10 currency last year, appreciating by around 12.2% against the Bloomberg Dollar Spot Index. However, 2023 is by no means an isolated case, but a very typical year for our small economy with the world’s strongest currency. Because other countries have systematic government budget and current account deficits, which are often accompanied by higher inflation rates, currencies such as the US dollar, the pound sterling and the Chinese renminbi are tending to depreciate against the franc. For investors, these are highly volatile cornerstones of a long-term investment strategy.

In Switzerland, not only politics but also the budget situation is balanced. Monetary and fiscal policy is geared towards stability. The democratically enshrined debt brake is proving to be effective, whereas in Germany, for example, it is not even understood by the government itself. In economic terms, Switzerland regularly achieves trade surpluses. Price stability is so firmly anchored that deflation has repeatedly occurred in recent years. Half of the last 14 years have seen slight deflation: 2009 (-0.5%), 2012 (-0.7%), 2013 (-0.2%), 2014 (-0.01%), 2015 (-1.1%), 2016 (-0.4%) and 2020 (-0.7%). Inflation in 2023 (+1.7% in December compared with the same month of the previous year) is considered relatively high by Swiss standards. The increase in 2023 was due in particular to higher prices for electricity, gas and for housing rentals. In contrast, prices for petroleum products, combined offers for fixed-line and mobile communication and medicines decreased.

Due to the overall moderate long-term inflation path, the Swiss Confederation can offer long-term capital at favorable conditions. Switzerland remains a haven of stability and solidity. This is why bond investors receive a yield of just 0.6% on ten-year Swiss bonds at the end of the year. In early January 2024, yields have increased some 20 basis points on average and moved the benchmark yield upwards to 0.8%.

Abroad, comparable government bonds offer much higher yields (January 11, 2024): 4.0% in the US, 4.1% in Australia, 3.8% in Italy, 3.8% in the UK, 3.3% in Greece and 2.2% in Germany. However, we advise against investing in such bonds in general, as there is not much left after the cost of currency hedging.

Inflation in the US fell to 3.1%, while in the eurozone it recently dropped to 2.4%. It is therefore highly likely that there will be several central bank key interest rate cuts this year. The bond markets have already anticipated some of these in the fourth quarter of 2023. After the rally in Swiss Confederation bonds, it is likely to be difficult to achieve a better performance than the coupon yield this year through passive behavior.

More significant, however, is the fact that the risk-free long-term interest rate has fallen to 0.6%. This is the benchmark when it comes to trade-offs between risk-free and risky investments.

Anyone seeking a balance between risk and return will have to consider whether they are satisfied with the expected yield premium they receive on equities or real estate, for example, compared to a risk-free Swiss Confederation bond – and whether this is also the case after taking into account the presumably higher susceptibility to fluctuation.

We exclude the historically special period from December 2020 to June 2022. During this period of sharp interest rate hikes by the Swiss National Bank, the Swiss Confederation bond index total return was miserable: -20.1% (!).

If the Swiss market portfolio is made up of SMI shares today, this results in an expected return of 6.7%; an amazing 6.1% more than with risk-free bonds. The 6.1% is also a risk premium because the investor is likely to experience fluctuations in this portfolio – with the exception of the period from 2020 to 2022 – which are generally higher than those in a portfolio consisting exclusively of government bonds.

The security of the market portfolio can also be enhanced by adding real estate at the expense of the equity allocation. However, this also reduces the return prospects somewhat, but the fluctuations in income are lower due to the stable rental income. At around 2.4%, the net cash flow return on average Swiss real estate investments is higher than the return on Swiss equities, but significantly lower than that of equities.

On the other hand, real estate investments are legally protected against inflation, which creates the potential for rents to rise over a longer period, whereas bonds as nominal values are unlikely to outperform the inflation rate in the coming years.

The Capital Asset Pricing Model, which is based on the modern portfolio theory of Harry Markowitz, the Nobel Prize winner who died in June 2023, essentially contains the investment recommendation of diversification: you should not put all your eggs in one basket.

The CAPM shows how the expected return can be increased for a given risk or how the risk can be reduced for a given expected return. Of course, even today, after almost 60 years since the CAPM was developed, we still incorporate such ideas into our actions.

Most large Swiss investors use the global bond index (“Global Aggregate Total Return Index Hedged CHF”), hedged in Swiss francs, as a benchmark for their bonds. This has enabled them to achieve a net return of -6.0% over the past five years. This is exactly the same as the five-year return of the Zugerberg Income Fund. Converted to a single year, this results in an annual return of -1.2%. However, the same return should not obscure the fact that the path to this result was different.

The global bond index is dominated by government bonds, which proved to be more stable in value, especially in March 2020 (explosion of the global coronavirus pandemic). By mid-June 2021, however, the Zugerberg Income Fund had made up for this difference. Following the outbreak of war in Ukraine, the ZIF fell more sharply than the World Bond Index. Once again, it took around five quarters before the difference was made up again.

The ZIF always has a good quality rating. It currently has an A- rating. With its high proportion of government bonds, the World Bond Index has greater value stability in crises, but also loses attractiveness when the global economy stabilizes.

The ZIF is characterized by higher credit risk premiums compared to the corresponding government bonds. Companies are eliminated through active trading if financing difficulties become apparent. Over the past five years, there have been around 1’000 transactions in the ZIF.

The Swiss Bond Index is an exotic index worldwide because it is extremely small and hardly diversified. It is essentially dominated by Swiss bonds. This helped it to (unsustainably) outperform the global bond index in the second half of 2023. Overall, however, the return over the past five years was still a meagre -3.7% (-0.74% annually). Moreover, the recovery potential in the Swiss Bond Index appears to be virtually exhausted, while it remains intact in the Zugerberg Income Fund.

The five-year balance sheet for the Credit Opportunities Fund looks positive with a return of +5.4% (+1.1% annually) – despite the pandemic, war, inflation, a persistent negative and zero interest rate phase and sometimes extreme financing difficulties for real estate and retail companies. Overall, the patience to remain invested has paid off. The recovery potential continues.

Over the next two years, it will be a matter of carefully managing the portfolio above the previous high. Since the bond fund was launched around eleven years ago, it has generated a positive return of +2.0% per year. It has been awarded the highest rating (five stars) by the fund rating agency Morningstar for its long-term outperformance.

A year ago, the mood was gloomy for property owners. The entire real estate sector was concerned about “fair” market prices in an environment of inflation-driven interest rate hikes. Financing costs rose in line with the SNB prime rate. SARON-based mortgages soon cost 2.5%. Real estate appraisers often applied even higher rates.

The valuations of properties fell accordingly, whereby the price effect was greater for residential properties than for commercial properties. The higher sensitivity of residential properties can be derived from the higher duration. The duration is lower for commercial properties. Typical characteristics such as fixed contract durations (e. g. 5 years) or higher inflation indexation for commercial leases reduce price sensitivity.

Now, with falling inflation rates and the prospect of lower borrowing costs, the picture has fundamentally changed. Swiss franc swap rates fell massively in the fourth quarter. In the 4-year segment, the swap rate fell from 1.70% to 1.07% (-62 basis points), while in the 10-year segment the decline was even more pronounced from 1.83% to 1.19% (-64 basis points). The change was most noticeable in the very long-term segment, where swap rates fell from 1.89% to 1.21% (-68 basis points) in the 20-year segment and from 1.83% to 1.14% (-69 basis points) in the 30-year segment.

The swap rates serve as the benchmark for lending banks, insurance companies and pension funds. For a typical mortgage loan, a customer-specific margin of around 0.8% can be added. This means that longer-term mortgage loans can once again be fixed somewhere around 2%. This level is having a strong stabilizing effect on the the Swiss real estate sector. It has an impact on various real estate submarkets that could hardly have been dreamed of this new environment just a few months ago. Swap-based mortgages have become a lot cheaper than SARON-based ones.

It is now clear that the residential property market will brighten up. The reluctance of potential homeowners, which was understandable in 2023 in view of increased inflation and mortgage interest rates, will subside in the coming months. The typical spring real estate fairs are likely to see brisk transactions again. The recovery in the market values of apartment buildings is also foreseeable. On the one hand, vacancy rates will continue to fall in 2024, and on the other, according to real estate expert FPRE, “the high demand in many regions should ensure an increase in achievable market rents”.

We also see further potential in our infrastructure investments. Lower long-term interest rates ensure lower capital costs and therefore higher cash flows. In addition, there are various performance improvements such as more passengers, higher retail volumes and higher rental income for Zurich Airport. This should lead to a higher valuation.

We previously looked at the low risk-free interest rates and the high probability that interest rates will remain low. This is probably the most important factor that will support the stock market.

To illustrate this idea, let’s look at an example. We find a company that generates reliable, robust profits due to its market position. We are not assuming an increase in profits. But of course we would be happy to see the current share price or company value on the capital markets as high as possible because we are already invested.

Future earnings can be discounted using the “discount” factor, i. e. the time value of money is taken into account using the risk-free interest rate. A risk premium is added as compensation for the systematic risk, but to illustrate the effect of lower Swiss Confederation yields on share price valuations, we exclude the risk component.

If a company makes a profit of CHF 10 per year over the next 30 years, the present value of the company, i.e. the present value (PV) of all future profits, is calculated as follows using a discount factor of 3.0%:

With a discount factor corresponding to the yield on the long-term Swiss franc (0.6%), the same calculation method produces a present value of 273, which is 39% more.

From this it can be learned that the interest rate used to discount future income is of paramount importance in the calculation of the present value. What you also need to know: Most professional players are currently still assuming structurally increased inflation rates and interest rates. They are reluctant to adjust their models and may therefore miss out on the current trend of real assets appreciating as interest rates fall.

Whether we use the “right” interest rates or not is not the decisive factor here. What is important is that the lower the discount factor, the higher the present value. This factor is strengthened if we can assume rising valuations in the near future.

In the case of a market-leading company, it can be assumed that it should be possible to increase profits sustainably in the coming years due to organic and acquisition-driven growth impulses with simultaneous productivity improvements and lower financing costs. Such companies (e. g. Nestlé, Sika, Schneider Electric, etc.) enjoy a firm place in our portfolios.

Over the past ten years, listed private equity has outperformed the equity markets by more than 70%. This corresponds to an annual excess return of around 6% compared to listed companies. However, you also need to have a higher appetite for volatility and risk in order to use such vehicles in a portfolio.

There is no possibility of using listed private equity in our risk category 1. We have excluded this because we want to use particularly low-risk securities and try to keep the volatility of the corresponding portfolio as low as possible.

As our risk appetite increases, so does the corresponding use of “alternative investments” in our portfolio strategy. In the balanced strategy R3, the weighting is 6%. Some may say it is “only” 6%, while others consider this to be a substantial figure.

In any case, depending on the risk classification, the corresponding portfolio weighting has led to an outperformance of up to one percentage point compared to an allocation to Swiss equities in 2023.

The diversification effect should also not be underestimated. This results from the fact that more and more companies have decided not to be listed on the public markets.

In terms of content, our Listed Private Equity portfolio component is essentially broadly diversified through a fund, as we reported last month. This includes around 30 private market investment companies, which in turn hold at least ten companies on their balance sheets. The fund is thus based on an estimated 500 portfolio companies.

They are selected and promoted in their growth by well-known investment companies such as the Canadian Onex (which brought the successful SIG Group to the Swiss stock exchange), the British HgCapital (which has several outstanding IT companies for the European SME market) and the American KKR (which is world-famous for its excellent private market portfolio).

This broad diversification across a wide range of sectors and geographical markets makes this portfolio component very robust. However, because these are structurally smaller and medium-sized companies with a certain amount of debt capital, interest rate sensitivity remains significantly higher than in the case of cash-generating US companies such as Apple and Microsoft.

The prospects for listed private equity in the current year have improved significantly due to the trend towards lower interest rates. In addition, the IPO window has reopened and M&A transactions are likely to increase again.