Although it is generally considered unwise for equity investors to focus too much on the stocks of domestic companies, the strength of the Swiss franc puts such arguments into perspective.

"Would you roam forever onward? See the good that lies so near." When it comes to money, this saying can certainly be applied to the conservative approach of Swiss private investors. After all, a large proportion of their personal assets consists of real estate, claims on insurance companies and pension funds, as well as bank deposits and cash. While they hold a total of almost 12% of their financial wealth in equities and investment funds, their portfolios contain almost no structured financial products. As various surveys illustrate, Swiss investors are fairly down to earth even in this area. This is because even when Swiss private investors buy equities, they tend to turn to companies that they know and whose shares can be traded in Swiss francs on the domestic stock market.

Criticized despite their success

In fact, investors have done fairly well with this strategy over the last few years – yet they are still often the target of criticism. Many investment advisors and investment strategists argue that it is quite foolish to concentrate such a large proportion of total assets on the small Swiss market. When so much money is tied up in domestic real estate, insurance companies and pension funds, private investors should at least ensure broad international diversification of their investments in equities and investment funds, as experts such as Daniel Kalt of UBS explain. The bank's chief economist and chief strategist for Switzerland warns investors against the pitfalls of intuition and urges them to opt for a strategic alignment of their investments with medium-term return targets. He also says that investors must stick firmly to this approach. Kalt explains that investors who miss the best trading days harm their portfolios.

He adds that firstly, the right blend of different asset classes ensures that long-term market trends can be reliably identified and exploited. Secondly, he says that this enables the risks of large price fluctuations in individual assets to be mitigated via targeted diversification across different securities or currencies. To make his point, Kalt refers to the share price of Volkswagen and to the price falls on the Swiss stock exchange after the Swiss National Bank scrapped the exchange rate floor of 1.20 Swiss francs against the euro on January 15, 2015.

Volkswagen shares suffered losses of up to 40% in September because the company was forced to admit that it had manipulated emissions tests for diesel engines. In January 2015, the Swiss Market Index (SMI) plunged by up to 15% because investors were worried about the negative consequences of the Swiss franc having appreciated by up to 20%. The expert goes on to argue that investors would be in a better position to weather unexpected events such as these if their investments were more broadly diversified internationally.

Will the Swiss franc weaken?

In Kalt's opinion, from a Swiss investor's perspective it makes sense to buy foreign securities in any case, as he believes the Swiss franc is overvalued and because growth – and therefore earnings – prospects are much higher in other countries than in Switzerland. He expects a weaker Swiss currency and solid performance by foreign stock markets in future.

Nannette Hechler-Fayd'herbe largely agrees with this view. She argues that the international diversification of equity investments generally lowers the overall risk in an investor's portfolio. The "diversification contribution" is often higher than the currency risk, explains the Credit Suisse investment strategist.

As a result, when buying foreign stocks (in contrast to bonds) it makes sense not to hedge some or all foreign exchange risks. Hechler goes on to say that the closer the exchange rate of a currency is to "fair value" and the lower the interest rate differentials versus other currency areas, the wiser it may be to arrange "foreign exchange insurance". However, from the perspective of Swiss investors, the Swiss National Bank has made life harder through its removal of the floor against the euro and the introduction of negative interest rates. Finally she says that the strong Swiss franc and "large interest rate differentials" often make it expensive to hedge foreign currency risks.

Home bias as an alternative

Hechler says that in such cases it may sometimes make sense for Swiss investors not to buy foreign securities and instead to buy the shares of domestic companies. She comments that the oft-criticized home bias, i.e. the natural preference for buying domestic securities, sometimes represents an attractive alternative to expensive currency hedging.

However, she also draws attention to the disadvantages. For example, she explains that home bias may lead to what are referred to as cluster risks. Indeed, such risks cannot be dismissed out of hand. If investors gear their equity portfolio to an index such as the SMI, they are risking considerable uncertainties. After all, the price trend of this equity market barometer is dominated by a small number of stocks such as Nestlé, Novartis and Roche. If one of these companies were to find themselves in the sort of difficulty recently faced by Volkswagen, it would be very difficult to avoid losses in value in a relatively one-sided portfolio such as this. Structural changes within an industry would have a particularly large impact. It is little wonder that some investors have become nervous over the past few weeks following news about political discussions on the design of pricing policies in the pharmaceuticals sector.

Organic diversification of companies

The widespread criticism of an excessive focus on equity investments in the domestic market is generally based on portfolio theory. This states that the distribution of investments across various asset classes that are, as far as possible, statistically independent of one another can increase returns while keeping risks the same. As a result, the theory states that it also makes sense to spread an investor's financial assets across many international markets. However, experience shows that this theory is not always borne out in practice. For example, the prices of various securities classes can be more unstable in relation to each another than is often expected. As far as currencies are concerned, the strength of the Swiss franc has led to Swiss investors with foreign holdings suffering large-scale losses in many cases.

Many experts expect the Swiss currency to weaken somewhat in the near future and recommend foreign investments, partly also because of the sharp drop in prices, particularly in the emerging markets. Nonetheless, the long-term trend of Swiss franc strength is an argument against this, as are the significant transaction costs and possible information deficits that can arise in the case of foreign investments. Furthermore, there are other good reasons for Swiss investors to stick with domestic stocks despite their high valuations.

This is because many companies in Switzerland have a broad international footprint and are therefore to all intents and purposes organically diversified. They may also be in a better position than investors to cope with foreign exchange risks. At least they have the option of developing an operating response to the change in the relationship between currencies – an option unavailable to investors.

Financial Personality Test

If you want to find the right investment strategy, it’s important to assess your risk tolerance correctly. That’s where the UBS Financial Personality Test comes in.