Shell drills for liquidity and slashes return-seeking assets post valuation

Last year, the trustees of the circa £16.4bn SCPF revealed that the scheme was 108 per cent funded on a technical provisions basis as at December 31 2017, up from 104 per cent three years earlier.

We decided then to take the risk off in respect of some equities and high-yield bonds

Clive Hopkins, Shell Contributory Pension Fund

Following this actuarial valuation, the trustees decided to review the defined benefit scheme’s investment strategy.

The SCPF’s latest annual newsletter to members notes that as the plan matures the investment committee expects to increase the proportion of assets that match liabilities, such as index-linked government bonds.

Trustees add that this also has the effect of reducing the scheme’s reliance on the employer covenant. 

This strategic asset-allocation review has now been completed, according to a video update published earlier this year. As a result, the trustees have overhauled the fund’s investment strategy.

Trustees introduce new liquidity tranche

Following the review, the target allocation for liability-matching assets has been increased to 33 per cent from 31 per cent.

The trustees have also introduced a new liquidity and investment-grade assets section – with a strategic asset allocation of 18 per cent for this part of the portfolio.

“These comprise shorter-dated government bonds and other similar investments,” says chair of the investment committee Clive Hopkins in the SCPF video.

“[They are] very secure, they yield better than cash, and they give us liquidity which we might need, and also they are there if we want to take advantage of any particular opportunities,” he adds.

The scheme has reduced the strategic asset allocation for return-seeking assets by 20 percentage points – to 49 per cent from 69 per cent. The allocation comprises assets such as equities, private equity, hedge funds, property and high-yield bonds.

“These are all assets which, over time, we would expect to yield rather more than the defensive assets, but of course that carries a risk with it and that’s something we have to weight,” Mr Hopkins says.

Scheme slashes return-seeking assets

Reducing the strategic asset allocation to return-seeking assets “was one of the fruits of doing the valuation – we could see that we could do that”, points out chairman of the trustee board Tim Morrison in the video.

Mr Hopkins adds that following the valuation results, in August 2018 the board decided to “take the risk off in respect of some equities and high-yield bonds”. He highlights the healthy surplus, adding “we had a reasonable cushion, which we’re pleased about”.

As funding levels improve, DB pension funds have looked to lock in gains and avoid any future volatility by moving into bonds.

Over the 12 months to June 30 2018, FTSE 100 pension funds’ allocation to bonds increased to 66 per cent, up from 63 per cent a year earlier, according to research published in January by JLT Employee Benefits.

It showed that in just 10 years, schemes’ investment strategies have transitioned from equity-dominant to bond-dominant portfolios.

A decade ago, pension funds’ average fixed income allocation was 35 per cent. Sixty-eight FTSE 100 companies now have more than half of portfolio assets allocated to bonds, according to JLT.

Overall, following the strategic asset-allocation changes, the SCPF now has 49 per cent of its portfolio invested in return-seeking assets, with the other 51 per cent invested in secure defensive assets.

Locking in gains

Investment derisking can be driven by a number of factors, but is most commonly a reaction to an increase in the proportion of pensioner members as schemes mature, or a move to lock in improvements in funding, according to Hugh Nolan, director and actuary at Spence & Partners.

They’re in a lovely position whereby the funding position justifies a less-risky investment strategy without having to ask the company for more cash

Hugh Nolan, Spence & Partners

“In the Shell situation, it seems to be more of a reaction to the funding position, which is increasingly common these days,” says Mr Nolan.

If a scheme has a strong employer, trustees can take a more long-term view on investment strategy in the hope of capturing a better return. If these calculated risks pay off, lower contributions are needed from the employer.

“What Shell has been doing here has obviously got to the point of being 108 per cent funded, and they’re looking at that and saying, ‘We can take less risk and still expect to pay our members in full without having to ask the employer for more money’,” Mr Nolan notes.

“They’re in a lovely position whereby the funding position justifies a less-risky investment strategy without having to ask the company for more cash," he adds.

Those trustees facing down less-rosy funding figures may not be able to afford the same low-risk strategy, however. A deficit can only be filled by investment returns or "by asking the employer for more money", Mr Nolan says.

A ‘milestone’ for schemes

Simeon Willis, chief investment officer at XPS Pensions, says: “Most pension schemes aren’t where they want to be – they want to get to a level where they’ve got better funding and can run less risk”.

Becoming fully funded on a technical provisions basis “is a huge milestone for a scheme”, Mr Willis notes.

Once funds reach technical provisions, “there isn’t an immediate requirement for the sponsor to put more cash in to provide the scheme with more immediate security, and that’s a really nice place to get to”.

Mr Willis says this usually “leads to a different outlook on the level of risk that is required”, as the incentive to run risk to reduce contributions is reduced.

However, schemes and sponsors may now have to plan further ahead.

In its 2019 DB annual funding statement, the Pensions Regulator made it clear that it expects schemes to set a long-term funding target consistent with how the employers and trustees expect to deliver the fund’s ultimate objective.

They should then be prepared to give evidence that their shorter-term investment and funding strategies are consistent with this goal.

Mr Willis says scheme progress against technical provisions can usually be linked back to their acceptance of the need to hedge interest rate exposure. Around 49 per cent of UK liabilities are hedged using liability-driven investing, according to XPS Pensions’ 2018 LDI survey.

“Where schemes have had a low level of hedging, that performance hasn’t been too good – some still find themselves a long way off,” he adds.

New opportunities

In the SCPF video, Mr Hopkins notes that the new liquidity and investment-grade assets section is designed to allow the scheme to take advantage of “any particular opportunities”.

“Having sufficient liquidity is an important feature of any well-managed scheme,” Mr Willis says, adding that liquidity can be used to give schemes flexibility.

For example, he notes: “If you’ve got flexibility on your assets you can do transfer values or liability-management exercises that might involve an upfront cash cost, but overall save the scheme money.”

However, it does mean that schemes forgo potential illiquidity premiums. “It’s a balance you want to get right,” Mr Willis says.

He notes that too much illiquidity can cause major problems, whereas if schemes have too much liquidity – which he is the case for many pension funds – the only problem is that they miss out on some potential risk reduction or returns.

The SCPF pays £40m a month in pensions, according to its recent video update.

More liquidity will help meet these demands, says Mr Nolan. He adds that if political turmoil results in market volatility, trustees will benefit from "having some liquid assets that you don’t need to worry about selling in that situation”.