Markets’ love affair with the Swiss franc (CHF) as the key defensive currency of choice continues, as risk aversion dominated the markets in the year so far, mainly due to ongoing debt crisis in the eurozone.

But investors are ignoring some key risks for the CHF if significant stress emerged from the Eurozone and there is no better currency than the NOK in a risk off situation, said a recent note from HSBC Global Research.

“On all metrics that we consider the NOK is more defensive than the CHF. However, the market has been buying the CHF in a frenzy of defensive activity whilst ignoring the NOK. We believe this is a mispricing,” said HSBC.

Switzerland’s indirect exposure to the Eurozone is very high, and rushing into the CHF does not offer safety from a break up scenario or any systemic problems owing to its giant sized banking sector.

The bank said that NOK would be less exposed in such a scenario and advices switching out of CHF into NOK. Currently, NOK also looks undervalued compared to CHF.

“It seems strange to us that since the beginning of the year the NOK has been trading as a proxy for the EUR, with EUR-NOK trading in a tight 3 percent range,” the bank said.

NOK outperforms on budget and current account

On the rates and inflation front, there is barely a cigarette paper between the Switzerland and Norway economies. In an environment of nominal returns the NOK just about pips the CHF.

CHF inflation is 0.4 percent giving a negative real return of 0.15 percent, whereas NOK has a real positive return of 0.65 percent. So if one were to hold the currency in a real deposit account the NOK pips the CHF, it said.

The key policy rates in Norway currently stand at 2.25 percent compared to Switzerland’s at 0.25 percent. Even in real terms the NOK comes out on top.

On the budgetary front, Switzerland is expected to post a surplus in 2011, which puts the CHF in an excellent position compared to its G10 counterparts.

However, when comparing this to the Norwegian budgetary position, an embarrassment of riches becomes apparent – Norway, helped by oil, has an excellent budget surplus.

“So, from this perspective it is not difficult to understand why the CHF has been one of the best performing currencies this year. However, it is hard to explain why the NOK has lagged the CHF,” the note said.

In terms of gross debt to GDP ratios, both the countries appear equals, having the ratio at around 50 percent.

But, looking at net debt to GDP ratio, Norway is the clear outperformer. While Switzerland maintains its strong position, Norway is in a league of its own as its net debt to GDP is a surplus of over 150 percent. Finally, the two countries have excellent surpluses with regard to their current accounts.

This is absolutely incredible and shows why the NOK should not be trading in a tight range against the EUR,” HSBC said.

NOK less exposed to eurozone

According to the BIS data, Swiss banks’ exposure to Greece, Ireland, Portugal, Spain and Italy combined is $56bn, about the same size as French banking exposure to Greece alone. Of the total exposure, around 50 percent of claims are against banks and the private sector and nearly 20 percent of claims against sovereigns are secured with guarantees and collateral.

“Nevertheless, if one is buying CHF for protection against a disaster scenario of a banking crisis or a Eurozone break up, one has to ask how the CHF banks could remain immune to systemic contagion,” the bank said.

On this front the CHF does not offer protection at all. So from a pure currency perspective it seems to make sense to buy and own NOK. Here one would have a currency that would be immune from both a banking crisis and a euro break up scenario.

In case of Norway’s Government Pension Fund (GPF), which owns a lot of Eurozone assets compared to country’s banks, the direct holdings of sovereign government bonds in the peripheral part of Europe are small. The holdings of Spain, Greece, Ireland and Portugal government bonds by the GPF constitute only 1 percent of its overall portfolio.

However, the GPF also holds a substantial portion of Eurozone banks bonds and equities, which would feel the strain from contagion.

“Do we have the same potential problem as Switzerland where the direct exposure is small but the indirect exposure is large? We would argue no. The difference is that one is a fund where it can absorb losses without a material impact on the economy and the banking system,” the note said.

For those worried about a European break-up and systemic banking problems that rushed into the CHF should for all intents and purposes have their holdings in NOK. NOK has beauty, but not everyone sees it.