PPF head of investment strategy Ian Scott tells James Phillips about the fund’s in-sourcing programme, recruitment, and investment risk management.
The Pension Protection Fund's (PPF) investments have undergone an overhaul over the past few years, with many assets and their management being brought in-house amid a rapid expansion of the overall team and its expertise.
Head of investment strategy Ian Scott has been at the heart of the transformation through much of this period, joining the lifeboat fund in October 2016, aiming to improve opportunities to the fund, while boosting its overall effectiveness.
Alongside these developments, it has faced an extremely volatile market, not least in UK assets, and the uncertainty that has come with geopolitical events. Scott explains how the process of in-sourcing has gone, how the PPF has managed these risks, and what have been the key drivers of its success.
Over the past few years, the PPF has embarked on a programme of insourcing much of its investment capabilities, both in terms of allocation and processes.
Most recently, it has brought its cash, credit, tactical trading, foreign exchange (FX) operations in house - bolstering its expertise with hires including Claire Curtin as head of ESG, and Purna Bhudia as head of credit.
But Scott says the pace of change has now slowed. He says: "We've probably reached something of a plateau in a way. We've done the things that we thought we were going to do, and the future will potentially have more insourcing, but we're not pushing ahead with anything right now.
"We recognise that there are certain activities that, through economies of scale, people externally can do more cheaply. That's not to say we won't do those things - they are under consideration - but at the moment we're not on the threshold of anything."
Over half of assets are now managed internally - but this figure hides the significant workforce running investment processes. Scott, for example, notes that FX trading is not considered within this.
"There is more activity that's happening in house than necessarily the pounds and pence assets."
And this decision was carefully considered, Scott notes. "We've taken a pretty studied view. We spent quite a bit of time working out exactly how we're going to do it, making sure we've got the right people doing it in a progressive way - not doing everything overnight.
"It's taken a bit of time, only moving on to the next one when the last one is fully bedded down, and not having too much pressure on the organisation."
Precision and flexibility
The drive for this agenda was to facilitate much more efficient, effective, and bespoke trading.
"The first thing to say is that we didn't have cost as our number one driving force - and we've said that from the start. What's been interesting going through the process is that, at each point in time, we've realised that having these things in house just makes it much easier for us to tailor the activities that we've been doing to the specific needs of the PPF.
"We can provide a better service by not relying on more off-the-shelf solutions. That's been the best aspect."
Scott says there is a "list of things" that the PPF has been able to make more personalised, immediately noting the effect on its overlay strategy, managing the asset allocation to a target through time.
"By using external parties to do that, there was clearly a sort of communication gap. You give them a set of rules that you would like them to apply, and they do that and that's fine.
"But by doing it in house, if the market has moved from Friday's close to, say, Monday lunchtime, we can respond to that. There's a degree of flexibility there which was more difficult in the previous arrangements.
"When we're trading securities for the tactical positions, or making longer-term strategic adjustments to the portfolio, we now have the trading capabilities to do that. We have a tighter control over the pricing. We have a better feel for what's going on in the market, because the people that are sat right next to us are having those conversations with the counterparties."
The teams are able to feedback to each other more regularly and effectively, encouraging learning and better planning.
"It's always one step removed if there's somebody else having the conversations. Sometimes, talking to people externally, we may not have known exactly who was doing the trading in a large asset management organisation. A lot of it is about precision and communication."
This growth has necessitated an expansion of the PPF's investment personnel - and the acquisition of an office on Cannon Street in the City of London.
"If you were to look at the profile of the people that we've hired to the various desks over the last year or two, it is top drawer. They are very well respected. It's not just the numbers, but it's the experience and the quality of the individuals that we've been able to hire."
CV: Ian Scott
Position Ian Scott joined the PPF as its head of investment strategy in 2016. He is the inaugural post holder and his role includes implementing tactical trades and medium-term shifts from the strategic asset allocation as well as liquid asset portfolio management.
Previously Scott was previously head of global and European equity strategy at Barclays Investment Bank from 2013 to 2016. From 2008 to 2012, he was managing director and global head of equity strategy and quantitative research at Nomura International. Prior to this, he was chief global and European equity strategist at Lehman Brothers between 2002 and 2008 and a European equity strategist at the same firm from 1995 to 2002. He started his career as an economist at Postel Investment Management in 1991.
He continues: "We can hire 360 degrees from this office. Realistically, asking someone to travel from one side of London to another is not really optimal. There are more people coming through this office - we have a constant stream of people coming to see us.
"Obviously, people used to come to Croydon and see us, but there's the more casual interaction that, perhaps, somebody might have previously thought ‘Well, I'm not going to go all the way down to Croydon for that'."
In particular, it has boosted how the PPF can deal with prospective asset managers, particularly if they have flown into London.
"We would feel less, in a way, encumbered to them. It's much easier for them to pop [into Cannon Street] as part of their day of visiting people in London rather than taking what was often three hours of their time to come to Croydon."
But has it had any effect on the investment teams' relations with the wider PPF? Scott is adamant this is not the case.
"People rotate and come through the office quite regularly, particularly areas that we have contact with," he says. "They'll come and spend a day or week here, and it becomes a bit more of an event. There'll be that interaction that perhaps you wouldn't have had in Croydon, because they're there every day and you're there every day.
"It's probably enhanced some of those relationships."
Faring the storm
There is no way to deny that the markets have been particularly volatile over the last few years, not least in the value of sterling and gilt yields. Last year alone, the implied volatility of sterling rose considerably around the dates of various votes on Brexit, as well as the general election.
Scott is not reticent about the impact this has had on UK-based investments.
"There's a limit to what we can do," he says. "We're invested for the long-term. But, we have a natural bias away from sterling assets, because all of the liabilities are in sterling. We don't find UK assets - particularly those with economic exposure - particularly attractive, because we want to diversify away from our liabilities.
"So in times when there's been quite a lot of uncertainty about how things are developing in the UK, we've been a bit slower to commit capital in the UK. We haven't taken a big view around it, but probably been a bit slower than we would otherwise be."
Whatever happens, the PPF wants to remain some flexibility.
"The best word to describe our general approach to managing money is ‘cautious'. You can interpret that in a number of ways, but we don't feel it's appropriate for us - at this stage of a cycle and with valuations across the market the way they are - to be taking decisions that we are sort of forced to hold in an environment where things change.
"We want to have a bit of flexibility, which we've got, and we want to be, perhaps a little bit more nimble than we would have been in other circumstances. We've tried to be as nimble and as responsive as we can to things as they change, rather than essentially saying ‘well, this is the way it's going to be' and then being wedded to a particular path."
However, the aspect of the investment strategy that has had the biggest impact is its diversified nature, Scott explains - but again, he says there is not much that can be done.
"The main action, which certainly served us very well through the referendum period, was we diversified away from the UK. That does make us much less vulnerable than many of the funds that we insure. That's the whole point, right? We try to have an asset allocation which is different from the average fund. Having a globally diversified portfolio - diversified across assets, diversified across regions, and with a bias away from the UK - really puts us in a reasonable spot.
"The second thing is, we hedge all of the interest rate and inflation liabilities that we have on our balance sheet, again, through that period around the referendum. And from the end of 2018 - when 20-year gilts were yielding about 1.7%, and in the summer they hit 80 basis points. That hedging puts us in a very strong starting position when we're thinking about issues like Brexit and UK-specific events."
All-in-all, the fund's investments have performed well. In the year to March 2019, it recorded a 5.2% return - over three and five years, the return was 8.2% and 11.5% respectively.
"We're ahead of target over one, three, and five years, so the investment performance remains pretty good given the risk constraints that we have. The fact that we hedged on the interest rate side helped deliver those returns - and the diversified nature of the fund."
But he also notes the alternatives allocation, where returns have been "pretty good". This includes the Thames Tideway Tunnel, a 25km ‘super sewer' and is an investment the PPF describes as "attractive for a fund of our size" with additional ESG benefits.
Is there one element of the investment strategy that he can point to?
"Over that year, pretty well everything did reasonably well so - a bit of everything."
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