Why Switzerland? Marwan Naja, AS Investment Management January, 2010 I. Executive Summary Swiss Equities Have Outperformed: Here is a fact you probably did not know: The Swiss equity market has arguably been the best performing developed world market over the past 20, 10, 5 and 2 years. The SPI Index, which incorporates over 200 Swiss stocks, is the best performing index in Swiss Franc (“CHF”), US Dollars (“USD”), Euro (“EUR”) and British Pounds (“GBP”) over the past 20 years1,10 years, 5 years, and 2 years when compared to similar broad-based total return indices in the United States (S&P 500 Total Return), the United Kingdom (FTSE 350 Total Return), Germany (CDAX), France (SBF 120 Total Return) and Japan (TOPIX Total Return)2. For most of these periods the magnitude of the outperformance is significant. Furthermore, the Swiss market has exhibited attractive risk characteristics including lower volatility than comparable markets. Figure 1: SPI 20 Year Performance (red) Compared to Major Developed Indices in CHF3 1 The 20 year comparable excludes the EUR which has not existed for that duration and the French SBF 120 TR which was established in 1990 and has underperformed the SPI over the 19 year period. 2 The Swiss market is the best performer in our local currency comparison (stripping out the foreign exchange effects) over 20 years and marginally trails the FTSE 350 for the 10 year, 5 year and 2 year comparisons. 3 Source of all graphs is Bloomberg unless otherwise indicated. Why Switzerland? AS Investment Management Contents I. Executive Summary ............................................................................................................ 1 Swiss Equities Have Outperformed .................................................................................... 1 Swiss Franc Attractive ........................................................................................................ 3 Swiss Environment & Stability ........................................................................................... 4 II. Swiss Equities .................................................................................................................... 6 Key Comparison Assumptions ............................................................................................ 6 Currency ............................................................................................................................ 6 Normalization .................................................................................................................... 6 The Indices ........................................................................................................................ 6 Volatility .......................................................................................................................... 16 Size, Liquidity & Valuation ............................................................................................... 17 Diversification.................................................................................................................. 18 Conclusion ....................................................................................................................... 18 III. Swiss Currency ............................................................................................................... 20 Historical Strengthening .................................................................................................. 20 Fundamental Equilibrium Exchange Rate (FEER) .............................................................. 20 Real Effective Exchange Rate (REER) ................................................................................ 21 Purchasing Power Parity (PPP) ......................................................................................... 22 The Euro .......................................................................................................................... 23 IV. Swiss Environment & Stability ........................................................................................ 24 Reserves ................................................................................................................... 24 Public Debt ............................................................................................................... 24 Budget ...................................................................................................................... 24 Tax Environment ...................................................................................................... 24 Unemployment ........................................................................................................ 25 Access to inexpensive capital .................................................................................... 25 Flexible and highly efficient labor market ................................................................. 26 IV. Conclusion ..................................................................................................................... 27 Contact ............................................................................................................................... 28 www.as-im.com Page 2 Why Switzerland? AS Investment Management Over the past two decades most Swiss investors eagerly looked outside their country to diversify away from local equities while the Swiss market continued to be one of the most resilient markets in the world. In fact, for most Swiss investors staying local would have likely generated very good results, lower volatility, less lockups and less side-pockets. Figure 2: Volatility since 2000 for Select Indices (SPI – Red, SMI – Black) Swiss Franc Attractive: One cannot consider Swiss equities without having a perspective on the underlying currency. The Swiss Franc has also been a solid long term performer. The purpose of the CHF currency analysis in this paper does not support any short or medium term trading conclusions. Rather it indicates that there is fundamental long term support for this currency. At a time when the US and Europe are facing dramatic budget deficits, monetary easing, regulatory ambiguity and fiscal stress, the Swiss Franc may not be a bad place to be. Figure 3: USD-CHF Exchange Rate since 1971 with Moving Averages (5, 10, 20 years) www.as-im.com Page 3 Why Switzerland? AS Investment Management Switzerland has a significant and consistent structural current account surplus. For 2009, the current account surplus is expected to represent roughly 6% of GDP according to the IMF which also forecasts that this level will gradually climb back up to 10% by 2014. Both the IMF and the Petersen Institute models have accurately predicted the gradual appreciation in the CHF over the past decades. There is nothing to indicate that this structural CA surplus is under threat. Looking at other models like the Real Effective Exchange Rate (REER) and Purchasing Power Parity (PPP) models, the CHF often appears to be overvalued. However, these models have been erroneously expecting a devaluation of the Swiss Franc for decades. The CHF has indeed been strengthening. Swiss Environment & Stability: Swiss companies compete internationally, but operate out of a stable and business-friendly environment. Investors considering investing in the Swiss equity markets also need to satisfy themselves that this environment is stable and sustainable. Here are some key indicators to illustrate this stability: Unemployment is currently at 4.1%4, higher, as a result of the current economic crisis, than the ten year average of 3.0%5, but well below levels in Europe and the US. Switzerland has a manageable public debt level. With a GDP of approximate CHF 542 billion6 in 2008, Switzerland has approximately CHF 225 billion7 gross public debt (about 41%). The Swiss National Bank boasts approximately USD 86 billion in foreign reserves and approximately USD 33 billion in gold reserves8. There has been a government budget surplus for almost a decade. Including the cantons, the level was at CHF 5.6 billion9, or about 1% of GDP in 2008. Inflation has consistently been low at an average of 1% over the past decade. On major socio-economic factors such as education, investment in R&D, crime rates and literacy, among others, Switzerland constantly ranks very highly in the developed world. Switzerland has witnessed a long period of political stability. The last armed conflict was in 1847, when a one month civil war between Catholics and Protestants resulted in approximately 100 casualties. Flexible and highly efficient labor market with one of the world’s lowest industrial action (strike) rates10. 4 http://www.seco.admin.ch/themen/00385/00387/index.html?lang=fr 5 Bloomberg 6 http://www.bfs.admin.ch/bfs/portal/fr/index/themen/04/02/01/key/bip_gemaess_produktionsansatz.html 7 http://www.bfs.admin.ch/bfs/portal/fr/index/themen/18/03/blank/key/schulden.html 8 https://www.imf.org/external/np/sta/ir/che/eng/curche.htm 9 http://www.bfs.admin.ch/bfs/portal/fr/index/themen/18/01/key/02.html www.as-im.com Page 4 Why Switzerland? AS Investment Management Reasonable tax regime for corporations and individuals. Switzerland has one of the lowest corporate tax burdens in the OECD11. Access to inexpensive capital. For example, rates on 1 month deposits have been under 3% for over 15 years. 10 http://www.nationmaster.com/graph/lab_str-labor-strikes 11 Paying Taxes 2010 – The Global Picture, International Finance Corporation, Price