The Professional Pensions Guide to Risk Reduction takes a look at how to reduce risk in volatile markets.
Volatile market conditions continue to cause trustees and corporate sponsors major headaches. Turbulent equity markets are making it difficult for schemes to generate the returns they need while falling gilt yields are also playing their part in increasing scheme liabilities. The case for de-risking has never been better.
However, is now the right time to de-risk and if so, how should it be carried out? Increasing funding gaps may put many trustees off taking such action but what are the viable options for plugging this gap when equities are so volatile - it's difficult for trustees and scheme sponsors to know which way to turn.
In this Guide to Risk Reduction we take a look at some of the different options available to those considering de-risking their defined benefit scheme. Choosing the right option will depend very much on the risk tolerance of the trustees and scheme sponsor as well as other factors such as strength of covenant as well as the likely cost of these strategies.
Buy-ins, buyouts, longevity swaps and enhanced transfer value exercises are all well-known methods for de-risking DB schemes. The cases for solutions such as buy-ins and buyouts in particular have all been well outlined and much debated. We expect to see these markets continue to grow in the coming years.
Market timing is all important with these transactions and for now their cost may be prohibitive for many pension schemes. Other schemes may simply not be in an advantageous funding position to be able to take advantage of these methods.
However, moving towards a position where a full buyout can be achieved is likely to be the preferred end-game for many schemes.
The main emphasis for many schemes over the coming years will be to get the scheme to a point where they can carry out a buyout. Liabilities need to be reduced and there are many options available to schemes looking to do this. Liability driven investment (LDI) is one such strategy which is discussed at length in this supplement. F&C's Nisha Khiroya and Marius Penderis discuss how it can prove to be a useful tool when it comes to adopting a glide-path approach to de-risking.
Adopting a glide-risk approach can help not only when the scheme needs to reduce risk but also when the scheme is unable to de-risk to the extent it needs and so must make a higher allocation to riskier assets in a bid to improve funding position.
However, the concerns with adopting a glide path approach is that firstly it presents an either/or choice between matching and return seeking assets. In addition what happens when the actions taken do not proceed along the glide path? Khiroya and Penderis believe that by using LDI funds as part of the process these challenges can be overcome. See pages 8-9 of the guide for more details of their reasoning.
So for the coming years pension scheme de-risking looks set to remain a key topic for trustees and scheme sponsors. It is good to see there are so many different options out there for schemes and it is to be hoped that the industry can continue to provide innovative solutions to help schemes no matter what their size or funding position.
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