Swiss franc bonds: Back in the spotlight by virtue of higher interest rates

After an interest rate drought that persisted for years, the Swiss bond market is becoming more attractive again from a yield perspective. Taking into account the current hedging costs, interest rates on Swiss franc bonds are even higher than those on EUR or USD bonds. This is a convincing argument for investors to consider the domestic market. In addition, the robustness of the Swiss economy and its companies leads to a low default risk and a relatively stable performance.

For investors looking for additional returns, the question arises as to how they can achieve them without taking on too much risk. The risk/return profile of a typical Swiss bond portfolio can be improved by adding further sources of return.

A practicable approach is to combine Swiss franc bonds with a proportion of convertible bonds and a strategic overweighting of duration (implemented using long-dated Swiss franc bonds). This combination offers additional risk premiums and, at the same time, efficient diversification, which improves the risk/return profile. Compared to the SBI (Swiss Bond Index), the risk remains within the same range, despite the addition of further sources of return (see illustration).

^{Source: Fisch Asset Management}

In practice, the implementation would look like this: The majority of the portfolio allocation of 70-100% would be covered by positions from the SBI. The index is characterised by investment grade quality, i.e. every bond included must have a rating of at least BBB- or higher. It includes all bonds issued in Swiss francs that meet certain criteria in terms of maturity, issue volume, etc. As the index consists of almost 1,800 individual positions, investments are made, in practice, through focused selection. Fundamental credit analysis is essential in order to make an advantageous selection. Complete research coverage of all positions in the index is helpful.

Global convertible bonds, hedged in Swiss francs, could accordingly have an allocation of between 0-30%. They fulfil several functions in the portfolio that go beyond yield generation. Although convertible bonds alone are more volatile than "traditional" bonds, their asymmetrical yield profile and, in particular, their long-term negative correlation with long-dated, secure Swiss bonds mean that they do not increase the volatility of the overall portfolio. This is particularly true if high credit quality and a balanced profile are emphasised when selecting convertible bonds. Due to the bond component, these convertible bonds offer a certain degree of capital protection and still allow participation in the performance of the underlying shares via the embedded conversion right.

Active management is essential in order to provide the ability to react during turbulent times. Typically, the negative correlation between convertible bonds and duration turns undesirably positive in times of high and rising inflation, which increases the risk. This must be taken into account through tactical positioning in order to control the overall risk of the portfolio in inflationary phases.

Swiss bond investors no longer have to look far for attractive returns. In addition, compared to the Swiss Bond Index, higher returns can be achieved with comparable risk by adding convertible bonds and a longer duration.