On the go: The current economic malaise, and especially the impact on liability-driven investments now interest rates are rising, proves it is especially important that trustees continue to ask questions about their investment strategies, even if they seem “silly”, says Fred Berry, the Pensions Regulator’s lead investment consultant.

In a blog published on August 16, Berry said there was anecdotal evidence that some defined benefit schemes “may have been underprepared, after years of falling interest rates in which LDI funds were paying collateral back to schemes. But we know that advisers were making trustees aware of the risks, and our DB investment guidance covers it too”.

He wrote that TPR, which “can’t be everywhere at once”, relies on trustees as “a first line of defence”, making it important to ask ostensibly “silly” questions of them as they “lead to interesting conversations”.

“Perhaps the investment strategy is making the best of a difficult situation. The risks are well understood. They’re being monitored. Plan B can be implemented quickly and efficiently,” he said.

“Not every conversation goes like that, but it’s important not to generalise from those that don’t. They’re a biased sample. Many schemes are managing their risks well.”

Berry noted that conversations about strategy “have changed a bit in recent years”, marked by a greater focus on liquidity management in maturing schemes, and covering such things as income-generating assets, “liquidity waterfalls” (a theory that states funds will use their most-liquid assets first to meet redemptions), and the risks of forced disinvestment in depressed markets.

“We wrote about that in our DB investment guidance back in 2017, as well as in our first DB funding code consultation in March 2020. We’ll have more to say on it in our second consultation due later this year,” he said.

Berry explained why a focus on “operational risk” at this time is important, though he stressed that there are many other questions to be asked, such as “the implications of rising rates for investment strategy”, as well as whether schemes “should be reviewing their LDI strategies in light of recent events”.

“It almost goes without saying that we expect trustees to monitor their scheme’s investment, risk management and arrangements on an ongoing basis and take action as appropriate. As always, it’s important for trustees and advisers to work well together to manage scheme risks,” he said.

He added that the regulator’s view is that liability hedging is “a good thing” as, “if nothing else, most schemes will ultimately secure their benefits and hedging protects against a rise in the cost of doing so”. 

The same applied to leverage, which is “fine if not done to excess [and] the risks need to be understood and managed”, Berry continued.

“If the questions in this blog have set you thinking about operational risks as well as strategic ones, getting good advice and effective risk management, they’ll have done their job, silly or otherwise,” he concluded.

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