Jonathan Stapleton looks at how the £21bn Railways Pension Scheme (RPS) has transformed its approach to investment over the past 18 months
- RPS trustees introduce a new governance structure to oversee investments
- The scheme changes the way it uses external fund managers
- Pooled fund range revamped to core offering of five funds
Managing any pension scheme is complex – but running a £21bn shared-cost scheme with around 110 different sections and large numbers of external fund managers is probably more challenging than most, especially in the current economic environment.
Indeed, it was the recognition that the scheme was facing a period of lower returns that led the scheme to overhaul its investments in order to fund the scheme into the future.
Chris Hitchen (pictured above), the chief executive of RPMI and Railpen Investments (see biography below), says the shared cost nature of the scheme – which means costs are shared between employers and employees on a 60:40 ratio – and the fact that many of the scheme's sections are still open to new members, means the scheme has a huge need to focus on long-term affordability.
He explains: "Frankly our members can't afford for us to just put the scheme into lower-risk assets. We have to go for return."
It was this focus on return that led the scheme to launch its Investment Transformation Programme around 18 months ago – a programme that has overhauled governance, internal teams and investment structure at the fund.
Replacing the investment committee
One of the decisions the RPS's trustee board, the Railways Pension Trustee Company, made was to disband its investment committee and replace it with an investment board with full delegated authority to invest scheme assets.
Hitchen explains: "We came to a realisation that, in order to really provide excellent long-term performance, we needed to move to a different governance structure.
"As a result, the trustees disbanded their own investment committee and replaced it with the Railpen Investment Board (RIB), which has full delegation to invest the assets to meet the scheme's requirements."
The RIB is chaired by Paul Trickett – formerly EMEA head of investment at Towers Watson and managing director at Goldman Sachs Asset Management – and comprises a mix of independent and trustee appointed directors (see box at bottom of this page).
Hitchen says the change in governance structure – and the inclusion of four external directors on the board – will help to challenge and advise the scheme's investment team, RPMI Railpen, allowing them to really own the portfolios in a way that hadn't previously been possible.
He says: "It is no longer the case that we can say, we wouldn't do it this way but the trustees or investment committee have decided; it is now really down to us to do what we think is the right things to generate long-term returns."
Investment leadership team
As part of the ITP, the scheme has also set up an in-house investment leadership team, comprising Chris Hitchen; chief investment risk officer Richard Williams; investment director Paul Bishop; and investment director Ciaran Barr – a team that effectively becomes the chief investment office of the pension fund's operations.
Barr (pictured left) says that as part of the restructure – and a shift from single asset to multi-asset funds – the scheme has also overhauled the way it organises its 25-strong team of investment professionals
"Now the vast majority of the scheme is in multi-asset funds, the way in which you manage this is different," Barr explains. "We now organise the team according to the types of investment activity you might do – whether that is researching ideas or implementing a portfolio."
Barr says there are now between ten and 12 different functions within the team, which are reviewed regularly.
He says: "It is very flexible and much more fluid than a normal organisational structure. But it seems to work. It has been in place for a year now and the feedback we've got from the team is that they like it."
RPS's investment transformation programme will lead to an office move over the coming weeks as well as a significant expansion of the scheme's in-house investment team. Hitchen expects the number of investment professionals in the team to expand from 25 to around 40. The number of middle/back office investment staff will increase from around 50 to 80.
Despite this expansion, Hitchen says the scheme has "no plans" to build the investment team much further than this.
He says: "This is the size we would like to be. We very much want to have one team, one portfolio as far as we can – we need to have enough expertise but, strangely, not too much because we need it all focused in the same direction."
New investment approach
The railways scheme has operated a pooled fund approach to investments – with each individual section choosing from a range of different pooled funds, managed by the scheme's in-house investment team and managed largely by external asset managers.
As part of the ITP, the scheme has consolidated its range of 14 pooled funds to just five funds and five sub-funds (see chart below).
While the scheme retains its flagship growth fund – which runs around £13bn of assets and targets a return of inflation plus 4% over the long term – it has closed many of its single asset funds, replacing them instead with a range of "building block" funds, focused on accessing different sorts of risk premia, that cater for both open and legacy sections of the schemes.
Hitchen said the fund has introduced an illiquid growth fund, which looks to provide returns of inflation plus 5-6%; as well as a long-term income fund, which targets returns of inflation plus 0-2%, and aims to provide an income. As well as this, the scheme has also launched a de-risking platform.
Ciaran Barr says the previous pooled fund structure had become increasingly complex since the rail industry's privatisation around 20 years' ago – with more and more pooled funds launching as more sections came into the scheme. He believes the reorganisation of the fund range has allowed the scheme to "start with a blank sheet of paper" and think of the best way to invest for the 21st century.
He explains: "The focus on risk premia, as opposed to asset classes, cuts through some of the things you might normally think about and makes life a bit simpler."
Hitchen adds: "We are no longer looking to put together portfolios of investment managers, or portfolios of assets even, we're looking to put together portfolios of return drivers... and, having decided we want access to a particular return driver, we'll just go about implementing that in the simplest, most efficient and cheapest way we can."
Rethinking external fund management
The change to the RPS's pooled fund range has also led to an overhaul of how external fund managers are utilised and paid.
As part of the ITP, the scheme looked at the fees it paid managers – finding that additional underlying fees charged by its managers were around 300-400% of the £70m upfront fees it pays.
As a result, the scheme decided to change the relationship with its external managers to get better value.
Hitchen says: "Frankly, if we are being completely honest, we had a model that over the course of 25 years had become increasingly complex in terms of the number of external managers we were using – we were always looking for the next more exciting idea, and often paying more for it than the previous one.
"We have now gone back to basics – recognising that part of our job is to leak as little value as possible to external parties, and to try to keep as much of the return that's generated for our members and employers. It is not that we won't pay for skill, but we just need to be very sure that we've identified a unique source of skill before we pay."
Barr adds: "This is not about the scheme abdicating itself from the financial management community and saying we'll do it all ourselves, absolutely not. We're just saying we have a different approach to what we've done in the past. If you want to work with us, great, if you don't, that's also fine."
The new strategy will mean the railways scheme will do much more of its investment in-house going forward – substantially reducing the number of external asset managers it uses constructing its own portfolios of stocks and bonds and holding them for the long-term.
Barr says one example of this new approach is how the scheme has reduced its exposure to hedge funds – pulling out of more than half of its 80 hedge fund investments so far.
He explains: "So many hedge funds are simply doing strategies that we can replicate ourselves at much lower cost," he says. "We need to be very confident we can't do it cheaper elsewhere before we invest."
Despite this, Hitchen says that the scheme will continue to partner with third-party specialists in private markets but look towards a more co-investment approach, where it can gain a competitive advantage and also use some of its experience, for example in sustainable ownership and corporate governance, to the deal.
Barr explains: "We are trying to avoid situations where we are blind price takers, so that's one of the disciplines that we're putting in place. There are certain investments where you would just be a price taker; you can't influence the fees, you can't influence the terms, it's either take it or leave it. Those sort of investments have a much higher hurdle for us."
He adds: "We don't want to be sold product. We don't just want people rocking up with their idea that they've got because they've got to close at £1bn and they've got to get as many institutional investors in on day one, and here's the fees. That doesn't interest us. We much more want, going forward, to have a group of asset managers, that we use who we can partner with whenever we want to do something a certain way."
Completing the transformation
Hitchen says the RPS team identified a list of more than 400 things it needed to do to complete the transformation – some trivial, others which were multi-layered processes – and have already got through around two-thirds of the tasks.
He hopes this process will be largely complete by the end of this year – but says there will still be things to do, especially around bringing people onto the team and embedding the new culture.
Hitchen explains: "There are a number of cultural things that we're trying to embed and that takes time. But we're moving in the right direction and in another 6-12 months, I hope we are a substantial way along that journey."
CV: Chris Hitchen
Position Chris Hitchen is chief executive of RPMI, which runs the UK rail industry's pension arrangements for 350,000 beneficiaries, and Railpen Investments, which manages assets of £21bn.
Hitchen is also a trustee member of NEST, the UK-wide DC scheme, and is a Director of the Pensions Quality Mark.
Previously Hitchen was chairman of the National Association of Pension Funds between 2007 and 2009; and participated as an advisory board member in Professor John Kay's 2012 review of short-termism in the UK stock market, for the Department for Business, Innovation and Skills.
He is a Fellow of the Institute and Faculty of Actuaries and began his career at Aon Consulting in 1986. He joined RPMI in 1998 as investment director before becoming chief executive in 2004.
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