Calum MacKenzie, Philippa Allen, Pavan Bhardwaj
At the end of March, Professional Pensions held a webinar in association with Aon to discuss how pension scheme investors can adapt their investment strategy, asset allocations and governance for a post-2022 world.
The webinar panel - which comprised of Aon partner Calum Mackenzie and senior portfolio manager Philippa Allen, in addition to Independent Governance Group trustee director Pavan Bhardwaj - discussed key considerations for investment strategy after what has been a particularly volatile 12 months.
The panel, chaired by Professional Pensions editor Jonathan Stapleton, also talked about the role for diversification and dynamic asset management to protect and grow portfolios as well as how to ensure governance models are robust and flexible.
Listen to the webinar in full here.
What do you see as the key considerations for investment strategy in 2023?
Calum Mackenzie: In one of his poems, Yeats wrote that the world has changed, changed utterly. That's the way a lot of pension fund sponsors and trustees are feeling at the moment, and you've got winners and losers coming out of the higher interest rate environment. For pension funds that managed to maintain their hedges, or were maybe underhedged going into that scenario, they have seen a big improvement in funding positions. And then there are those that didn't do so well through last year, so they may have had their hedges cut.
Now it's really down to schemes reviewing their strategy - goals, time horizon, the amount of return and risk being taken, et cetera. And then it's reviewing the governance model.
What do you see as the role of diversification and dynamic asset management to protect and grow portfolios?
Philippa Allen: It's important to make sure you've got a wide range of tools in your investment toolkit. That should include strategies that perform in a range of environments so you can protect capital and also generate returns even if markets aren't doing so well. Things we look at are gold, safe haven currencies, tail-risk protection, and more traditional sources of diversification like duration. Building the right type of diversifier strategy is something we've worked on a lot to get right for our clients.
Additionally, when things are changing quickly, you can add significant value by being dynamic. This applies to the hedging side of portfolios. Last year's gilts crisis really highlighted the importance of being able to raise cash from the most flexible part of your portfolio and get it across to your liability-driven investment (LDI) managers quickly.
It also applies to changing the mix of assets in your growth portfolio to protect against risks and capitalise on opportunities that arise.
What are the governance aspects of this? How do you ensure governance models are robust and flexible?
Pavan Bhardwaj: I'd start with a review of governance and reflect on how existing models performed over that period. Appointing a professional trustee, a lot of schemes have already done that, but there's been a definite spike in the level of interest from larger schemes actually since 2022 and most are looking to appoint a professional trustee for the first time. That's purely on the basis of the experience they had over the liquidity crisis last year.
Some schemes will actually want to take a further step and move to a professional corporate sole trustee model. It's not for every scheme but they are becoming more popular and can lead to a more nimble and efficient governance model. The other option is delegated investment. If I look back towards the end of 2022, the schemes with delegated management in place generally had an easier time of it. There was a lot less burden and stress on those trustees.
I think we will see an acceleration of the trend of more schemes potentially adopting professional and sole trusteeship and/or fiduciary management.
What do you think have been the implications for investment strategy following the gilt shock, the rising rate environment of the past year, and indeed the banking crisis of recent weeks?
Calum Mackenzie: We had the recent announcement from the Bank of England around the minimum collateral requirements, for the first time bringing segregated LDI into that space as well. They are looking for 250 basis points minimum collateral requirement. And then there are requirements from the offshore regulators; Dublin and Luxembourg authorities are recommending 300 basis points.
You will see a much-reduced level of leverage in these LDI strategies than you did last year. One experienced investor I work with does not want their leverage levels increased at all. And they've got 1,100 basis points of collateral, three times what the regulator is asking for! They could take it down a bit but they won't.
How do you think being dynamic can help schemes navigate some of the things they're seeing today?
Philippa Allen: If you aren't set up to make changes quickly enough, you can't avoid risks as effectively or benefit from the opportunities that arise. A good example of something we do for our clients in terms of actively managing their exposures is the currency exposures they have. For our clients, most of what we invest in is hedged back into sterling but we look at the overall level of foreign currency exposure our clients have - it tends to mainly be through the US dollar - and we can change that up and down depending on our view on markets.
Last year, when we became very concerned about the market outlook, we increased that level of foreign currency for our clients. And the US dollar is your classic safe haven asset so investors tend to flock to it in times of stress, meaning it generally appreciates in those periods. That is exactly what we saw last year.
What do you think have been the key challenges from a governance perspective during the gilts crisis and indeed beyond?
Pavan Bhardwaj: Focusing on the gilts crisis specifically, most of the challenges stemmed from the fact pension schemes are just not set up, and nor should they be set up, to take really rapid-fire decisions in a very compressed amount of time. So, in normal market conditions, the focus and priority of trustees would be investing over the long term, looking through the business cycle, and not being overly reactive to day-to-day mark-to-market shifts in the funding position.
But the problem was that over September/October, the circumstances required almost the opposite approach. That caused some really practical challenges - speed of execution, speed of response, and things like convening meetings at very short notice. Just the amount of collateral calls that were coming through and being sure you were actually taking decisions on the basis of advice because often there just wasn't the time to go through those normal steps - this meant it was a dislocated period in financial markets, so it needed a different sort of response.
Calum Mackenzie: There's been a huge rebalancing going on. You could almost describe it as seeing many years of derisking happening in an incredibly short period of time. If you imagine many pension plans have got what's known as a journey plan and as their funding levels improve, they gradually want to take risk down, down, down, and then they'll get to a very smooth landing hopefully.
But the yield movement was so extreme that suddenly if you think about all these triggers, they all got blown through incredibly quickly. If anything, many pension plan managers are now looking at their portfolios, and saying 'wow, I was expecting it to give me cash plus 2.5% last year - now I've got a portfolio that may give me cash plus 1%'. Then they realise they're five years closer to buyout, their ultimate goal, and they only need cash plus 1.25% to get there.
Before we end, what are everyone's key takeaways from our discussion?
Calum Mackenzie: First, re-evaluate your endpoint. How long is it going to take you to get to your endpoint, and how much risk can you take? The second part is repositioning. How are you going to reposition your portfolio and get ready for this new environment? Using that ‘get busy, get simple, or get help' framework can be powerful when you're going through the sort of self-reflection that I know many corporate sponsors and pension fund trustees are right now.
Pavan Bhardwaj: One thought that is helpful to keep in mind is quite often after events like this, there is a tendency to over-compensate at an industry level and actually respond in a very specific way to the most recent crisis. We know there will be other crises down the road, but we can be virtually certain these will be something nobody today has contemplated. History shows that's usually the case.
Philippa Allen: We believe re-evaluating your investment toolkit and making sure it's set up for a range of different environments is important. As part of that, true diversifiers, assets like gold and currencies we spoke about earlier, can be beneficial, as well as those all-weather type strategies.
This webinar was held on 30 March 2023 in association with Aon. Listen to the discussion in full here.
