Deficit contributions and favourable asset returns in recent years have led to improved funding positions and our analysis suggests buying out scheme liabilities with an insurer is now a realistic medium-term goal for the majority of FTSE 350 companies
Managing risk when approaching the endgame
During 2018 there was a continuation of the de-risking trend within the investment strategies of the FTSE 350's defined benefit (DB) schemes, particularly away from the equity investments that have served many well in recent years, as schemes aim to lock-in returns and take advantage of improved funding positions to reduce risk.
However, our data also suggests that a number of schemes that appear to be close to buy-out are still running significant risks within their investment strategies. For example, those schemes potentially able to buyout in the next five years have, on average, at least 27% of their assets invested in growth assets, suggesting schemes may be missing an opportunity to take risk off the table.
With global growth slowing, ongoing trade disputes between the US and China and geopolitical risk threatening asset values, being overly exposed to growth assets when nearing the endgame could jeopardise schemes' ability to proceed with a buyout transaction.
Furthermore, schemes' funding positions continue to be threatened by long-term interest rates falling. Since December last year, long-term interest rates have fallen by over 1%, potentially increasing scheme liabilities by close to 20%. Our analysis shows that neutralising the impact of this unrewarded risk through investment decisions not only increases contribution certainty, through reduced funding level volatility, but also increases the likelihood of schemes reaching their endgame objective.
Long-term strategic thinking
DB scheme sponsors should be proactive in engaging with trustees to put in place a long-term target. Once this has been agreed it will facilitate long-term strategic thinking on the evolution of the investment strategy. Sponsors and trustees can then work together to implement a strategy that accounts for risk tolerances and the time horizon for reaching the endgame.
