Monthly Report 01/2025

The European Central Bank (ECB) is likely to cut its key interest rate in half to 3.0% this year, thereby also reducing the external value of the euro and increasing competitiveness. Over the last two years, the euro has lost 4.9% against the franc.

The exchange rate development of the dollar was associated with much greater fluctuations. In 2023, the dollar lost a little over 9% against the Swiss franc in waves. In the first five months of 2024, it recovered this again, but lost everything again by the end of September. In the final quarter, the dollar gained 8% and is now only 2% lower than two years ago. But the depreciation pressure remains.

The corresponding exchange rate development is far from stable. In recent years, the rate of inflation in the US has always been higher than in Switzerland. Depending on the method of measurement and the time period, the average of the inflation differential is 2.3 percentage points. From the past ten years, it can therefore be roughly deduced that the annual depreciation potential is around 2.3%. There may be deviations in the short term, but not in the long term.

As in the eurozone, key rates in Switzerland are also expected to fall further. By contrast, growth in the US is likely to be higher, which should also be accompanied by higher inflation rates. Expectations of key rate cuts in the US are therefore significantly lower, which also suggests that the dollar is likely to remain relatively strong for a few quarters.

In recent years, the US productivity and growth gap with Europe has widened across countries and sectors. In Switzerland, with its low inflation rate, the Swiss National Bank could again lower its key interest rate when it assesses the monetary policy situation in March 2025. This would certainly somewhat reduce the structural upward pressure on the Swiss franc.

However, we currently rule out larger cuts and a return to a renewed negative interest rate period. Inflation rates in Switzerland will remain low for the time being. The average 10% reduction in electricity prices is likely to lower the inflation rate by 0.2 percentage points. In addition, rents will fall due to a reduction in the reference interest rate for rents.

Credit markets are not squeamish. They mistrust the fiscal policy of the (new) US administration and sold government bonds en masse. When large investors quickly sell off paper, it can have massive consequences. This can also affect the most liquid of all capital markets, the market for US Treasury bonds.

In the fourth quarter of 2024, massive sales of Treasury bonds led to a performance of -3.1%, the worst quarterly return since the disastrous bond year of 2022. Thus, the relevant index is again significantly lower than in the summer of 2020, despite substantial interest income. This also applies to the world bond index, which is a whopping 11.3% lower in Swiss franc terms than five years ago.

What can also be deduced from the chart: the supposed security of high-quality bonds briefly resulted in the smallest valuation corrections in February/March 2020 (outbreak of the pandemic). By contrast, corporate bonds with a moderate risk profile suffered significantly more, temporarily losing almost 20%. But these bonds soon began to recover. In less than 12 months, they had returned to their original level and were back on a growth trajectory.

The Global Bond Index and the Swiss Bond Index (SBI) have not yet reached this point. The recovery potential of government bonds and top corporate bonds is often overestimated. The SBI, for example, is still around 4% below its 2020 peak. For the Global Bond Index, the gap is as much as 16%. Even after ten years of a global pandemic, several outbreaks of war and two recessions, the result is hardly impressive: the SBI gained 0.5% p.a., while the Global Bond Index lost 0.7% annually. Both indices thus failed to maintain the purchasing power of the nominal monetary value.

Against this backdrop, it is not surprising that capital is increasingly flowing out of government bonds and into corporate bonds, which offer more attractive yields. The fundamentals remain convincing, even if the risk premium over government bonds has fallen to a historically low level.

Some turn to private markets (private credit, private loans, private debt, direct lending) where higher yields are available. However, liquidity is very limited in this area. As a rule, investors make multi-year commitments. But even in liquid markets, there are relatively attractive sub-segments such as leveraged loans and AT1 bonds. For example, we achieved a return of 17% last year on the AT1 bond issued by Luzerner Kantonalbank. Subordinated bonds from (Swiss) insurance companies have also pleased numerous bond investors.

The bond solutions are tailored to the investors’ risk appetite. Investors with a low risk appetite hold significantly more of the structurally conservative ZIF. As the risk appetite increases, the share of ZIF in the portfolio is reduced and the share of COF, as a so-called “high-risk security”, is increased.

This also explains the different return contributions of the bonds last year. In Revo5, the allocation of the COF is 11%, and due to the fund performance of +7.3%, this resulted in a return contribution of +0.8% to the total return. In Revo4, this contribution was even +1.2% due to the higher allocation of the COF (16%).

It is the CIO’s responsibility to determine the allocation. Quite rightly, the ZIF’s allocation is higher when risk appetite is low. These bonds do not yield high returns, but they correlate negatively with equities. If the economic wind changes direction, the economy slides into a recessionary phase with correspondingly negative effects on share prices. At the same time, however, it is to be expected that the prices of high-quality corporate bonds will rise, thus ensuring a balance.

With its 315 bonds, the ZIF is thus positioned like an insurance policy that benefits in recessionary economic phases. In addition, liquidity in this market segment is outstanding. This is another reason why the corporate bond market in the US, as in Europe, is particularly popular with institutional investors. Demand remains strong because normative limits are often set on the purchase of equities and government bonds are significantly less attractive.

By contrast, private investors and family offices hold a significant proportion of lower-rated bonds with higher yields. This is a relatively small market that has actually shrunk in recent years. This goes some way to explaining why credit spreads have narrowed in recent quarters. Should demand weaken somewhat, there is a risk that spreads will widen again.

In our view, the spreads for some corporate bonds no longer adequately reflect the actual risk involved. We also remain cautious with regard to emerging market bonds. This makes disciplined selection, which helped us achieve a fund performance of +7.3%, and diversification with 202 bonds, all the more important.

The starting position is excellent. Zurich Airport is involved with Noida Airport in the south of the Indian capital, Delhi. Many expect the airport to open at the end of April 2025. We tend to believe that it will be delayed by a few weeks. Nevertheless, it remains a project of gigantic proportions.

The alternative to Indira Gandhi International Airport, 72 kilometers away, did not begin until June 2022. The airport, which is scheduled to open in spring 2025, will initially have a capacity of 12 million passengers per year. Noida International Airport Limited plans to increase this to 70 million passengers per year in the coming years (by way of comparison, around 31 million passengers travel through Zurich Airport each year). The goal remains to gradually establish a modern, user-friendly and digital flagship airport with four terminals and six runways in order to successfully operate the fourth largest airport in the world by 2030 in the region of the global economy with the strongest growth.

The airport has already triggered a series of follow-on investments that improve connectivity by means of expressways, national highways and underground lines, and make the entire region a better place to live. With the new airport soon to be put into operation, the surrounding area is experiencing a real and steady increase in value, in which Flughafen Zürich AG will also participate. However, this is not adequately reflected in the moderate share price.

The Bern-based electricity supplier BKW is also valued moderately. Its equity, which is cautiously valued on the balance sheet, is currently likely to be around CHF 5.3 billion. On the one hand, the company is concerned with energy supply, and increasingly with wind and solar energy (62% of electricity production, plus hydropower, where Switzerland is known to still have more potential). In line with its “Solutions 2030” strategy, BKW aims to expand abroad, primarily with wind power and solar energy, and to achieve annually an EBIT of around one billion francs by 2030.

On the other hand, longer-term purchase contracts provide a solid foundation for the trading business. We must not forget that Switzerland still relies on electricity imports during the winter months, because there are practically no Alpine solar plants. Striking a balance between the need to protect the mountain landscape and the stated need for renewable energy is a key challenge for BKW. And the third business pillar is the services division, where profitability leaves something to be desired. However, topics such as energy efficiency and the expansion and renewal of infrastructure will allow BKW to grow for a long time to come.

In Switzerland, it is important to stand out from the passive index. Because the diversification offered by the large companies (Nestlé, Roche, Novartis, UBS) that dominate the SMI is too low. We do not weight the companies equally. The simplification of passive investing has failed. Numerous funds that were equally weighted in the Swiss index have since been closed and dissolved. One that is still tradable has lagged the SMI by more than 23% over the last three years.

We generally analyze at the company level. Of course, we are also interested in overarching key figures such as the solid earnings growth expected in the US (+14% in 2025), in Germany (+12%) and in Europe in general (+8%). But these must be seen in relation to valuations. If a highly valued company “only” increases its profits by 14%, we prefer a low-valued company that grows significantly. We attach great importance to analyzing the respective business model and try to correctly assess the upside potential and downside risks. This means that we continue to hold securities such as:

Nestlé (-21% total return in 2024): the downside risk here seems considerably lower than the upside potential. The biggest disappointments of the world’s largest food company should now be priced in, although consumer-sensitive stocks are having a hard time anyway due to inflation. However, it will take patience to get the supertanker moving more dynamically under the new CEO.

Sika (-20%): The stock is among the three biggest losers in the SMI, but we remain loyal to it. We expect accelerated growth and rising margins for the global market leader. Sika grew most strongly in the Americas (2024: +11.2%), benefiting from the relocation of production facilities back to the US and the boom in new data centers.

Lonza (+53%): The pharmaceutical contract manufacturer is benefiting from the US Biosecure Act, which is aimed at the use of active ingredients produced in China by companies such as Wuxi.

Swiss Re (+48%): Under the leadership of new CEO Andreas Berger, the reinsurer has embarked on an impressive path. In the past, misguided strategic decisions have repeatedly set the market leader back. That is now over. In addition, persistently high US interest rates and rising premiums in a growing market for reinsurance protection are ensuring record profits.

Holcim (+37%): We expect the success story to continue with the spin-off of the US business, which is booming and can look forward to a correspondingly high valuation in New York. With low-emission building materials and recycling, Holcim should once again succeed in increasing margins while growing sales.

Zurich (+30%) and Swiss Life (+26%) are developing into an attractive future for different reasons. We achieved an above-average return with Axa (+23%) because we reduced the position at a price level of 34 euros and increased it again at 30.6 euros (now the price is back at 34 euros).

And in emerging markets, we carefully select fund managers who behave in a way that is consistent with our values and who approach the Indian equity market in a similar way to how we approach the Swiss market. This has helped us to significantly outperform the respective emerging market benchmark over several years. Last year, we achieved a return of +20% and +21% respectively with our equity funds.

Blackrock, the world’s largest asset manager, recently devoted a separate annual outlook to the private markets asset class. The demand for private market investments is increasing because they can be used to diversify sources of return. There are still pension funds such as the federal Publica, which allocate 0% in private markets, while the professionally managed Swiss Accident Insurance Fund (SUVA) already allocates around 10%. In some American pension funds, the allocation reaches up to 25% and in some places exceeds the allocation of publicly traded equities.

Blackrock has analyzed that the areas of private equity, private credit, private infrastructure and private real estate will experience a new era of growth. Driven by higher investment activity, lower financing costs and higher demand for long-term capital, the best days for private markets are yet to come. The projected private markets could grow from $13 trillion today to more than $20 trillion by 2030. Blackrock believes that private credit will increasingly replace bank lending and, like private infrastructure, will grow the fastest.

Particular opportunities are emerging in AI: investors can access the transformative possibilities that AI offers through private infrastructure investments, as well as debt capital, private equity and real estate. The variety of investment opportunities is rapidly increasing, including geographically. 86% of all companies with annual revenues of more than $250 million are privately held and only 14% are listed. A series of profound changes in global demographics, energy demand, digital technology and supply chains are further driving investment in private markets, including for better diversification.

Transaction activity is also increasing in both the M&A and IPO markets, which should lead to more exits and distributions in private equity. We already pointed this out in last month’s report. What is new is that the Swiss private market provider Partners Group, which is among the top 10 globally, is launching a multi-private market model solution together with Blackrock. It includes private equity, private credit and real assets in a single diversified portfolio for alternative investments. Partners Group’s shares got off to a good start in the new year.

Depending on the risk appetite, we have been supplementing our Zugerberg Finanz solutions with private market investments for several years. We start with 4% in these asset classes for risk class 2 and the allocation increases to 7% in risk class 5. Last year, the respective investment vehicle achieved a total return of between 15% and 20%.