Lucy Barron, Partner, Aon
Since the beginning of time (in the pensions world), we have seen rapid growth - both in terms of liabilities accrued and in the range of assets used to back these liabilities.
As financial markets grew arms and legs, and new species of assets formed, the strategies to align the investments to match the liabilities and the objectives of trustee boards became more and more complex.
As with the pensions investment market in general, each individual scheme will have been living its own ode to Darwinism and on a journey to adapt to the maturing of their membership and reacting to external factors to prolong the survival of the scheme.
In the current climate, many schemes are very well evolved and have maximised the resources around them to reach a very stable and well hedged position, nearing buyout. However, for those still on the evolutionary journey, there are a few key stages we can observe:
Early in journey
At this point, your scheme may have a funding shortfall or have a membership profile with younger members than the average pension scheme (and potentially some members still accruing benefits), and as such, the focus will be on generating returns and diversifying your assets in order to reduce the risk. This will involve investing in a wide range of assets, including those that provide hedging to reduce funding level volatility from changes in yields and inflation. While the sponsor may still be paying ongoing or deficit reduction contributions, the investment strategy will be critical to protecting the funding level and avoiding the effects of market turmoil - and all while maintaining growth to narrow the funding gap.
Nearing buyout
As the evolution continues and your scheme gets closer to buyout, it will be time to consider the insurer pricing and moving to a portfolio which better matches the expected movement in price and with more liquid assets to pay the buyout premium. This will involve reducing the allocation to growth, such as equities, diversified growth funds (DGFs) and illiquids, and instead investing in an element of credit to mirror the investment strategies of the insurers. Additionally, it will mean reviewing your hedging strategy to ensure it remains appropriate for your buyout target.
Those of you with your ear to the ground on the pensions front will have heard much of the debate in recent months has been around the acceleration of funding levels. This has resulted in illiquids representing a higher proportion of assets in the portfolio than expected, as they had maintained their value. With this in mind, creating an exit strategy at this stage over an agreed time period will help to manage the butterfly effect and allow you to maximise the impact of the value of your illiquids without incurring large exit fees or reduction in sale price from being a forced seller. This will be extremely beneficial since the market for illiquids as part of an insurance transaction is still developing, although there have been fast paced developments in recent months as insurers help schemes find solutions.
Close to transaction
With a transaction planned in the short term, the investment strategy will now be focusing on position protection to ensure your assets are as closely aligned with the insurer pricing as possible and in a liquid form to fund the premium where possible. This means both you and the insurer can have more certainty a transaction will proceed. If you are yet to choose an insurer, it will be beneficial to understand the range of investment strategies insurers employ, since each do things differently. For example, insurers tend to invest in LDI and between 20-50 per cent investment grade credit within their portfolios. This is a reasonably wide variation, with a knock-on impact on the remaining portfolio. A dedicated risk settlement investment specialist understands the more nuanced differences between insurers in great detail and can support you with aligning your strategy and giving you the investment tools and flexibility to optimise the outcome for your scheme.
If instead, you have agreed to speak to one insurer on an exclusive basis and require some final rebalancing prior to transacting, your risk settlement investment specialist is best placed to advise on this, with the ultimate goal being to enter into a price lock using your actual assets. This will give peace of mind that, despite any market issues your assets may need to weather prior to signing on the dotted line, you can still exactly match your price lock and emerge insured.
If you would like to hear more about how to evolve your pension scheme investment strategy with a target of buy-in/buyout in mind, please feel free to contact me at [email protected].
This post is funded by Aon.
