Run affordable risk, say experts

Since the turn of the century the combined deficit of UK private sector defined benefit pension schemes has increased to around £900bn from £250bn, according to the latest figures from consultancy Hymans Robertson.

Over the past 15 years sponsors have paid more than £500bn into pension schemes but big positions in equities, interest rates and longevity adopted by schemes have driven a meteoric rise in deficits.

There is a very big party going on but you have to move next door to join the fun

Rupert Brindley, JPMAM

As schemes work with sponsors to tackle rising deficits, trustees must balance their matching and return-seeking portfolios in order to deliver the income required to pay pensions and ensure continued growth of assets.

Jon Hatchett, partner at Hymans Robertson, said that while a combined deficit of £900bn on a buyout basis was a “stark” figure, the long time horizon of many UK schemes means there is still opportunity to solve the problem.

He said: “The whole of the UK pensions industry is not looking to buyout today.

“For schemes in a reasonable position we think an income-based strategy is… a better risk-adjusted way of solving the problem.”

A more income-oriented investment focus would mean a sizeable risk reduction for many schemes.

“Schemes need to ensure they’re not running more risk than they can afford, which probably means running less risk than they have in the past and accepting that its going to take them some time to reach full funding,” said Hatchett.

Two camps

Ross Leach, head of investment advice at consultancy P-Solve, said investing in income-generating assets will become increasingly important for well-hedged schemes nearing the end of their recovery plan.

“The key is in the planning and being aware of when you get close to 100 per cent funded on technical provisions… [trustees] need to think beyond that to the impact of the company contributions coming to an end.”

Leach said risk management is crucial for schemes with a significant way to go on their recovery plan who continue to pursue a high level of return.

He said: “Those schemes who have got that gap [are] investing very much with a high-return target in mind and they’re probably going to have to run with a high level of return for quite a long time to achieve that.

“Their challenge is… diversification, interest rate and inflation hedging, structured equity – the use of those to be able to effectively maintain a substantial amount of assets on risk for longer.”

Putting assets to work

Schemes’ cash flow requirements could face increasing pressure if significant numbers of members take advantage of freedom and choice.

Nick Griggs, head of corporate consulting at consultancy Barnett Waddingham, said maturing schemes should view their investment strategy in the context of cash flow requirements.

“Different dynamics come into play when a scheme becomes cash flow negative – [they are] investing to deliver the income needed to pay pensions,” he said. 

“There are lots of things that people might say are looking expensive at the moment, it’s really looking at all the different asset classes and making sure you’re making them work as hard as possible,” he added.

Amid an expensive bond market with just £7bn net issuance of sterling corporate bonds in 2015, Rupert Brindley, managing director at JPMorgan Asset Management, says schemes need to become “less picky” about their matching assets.

“Investors have to get comfortable with currency hedged [corporate] bonds – that’s where the supply is coming,” said Brindley.

“If you look at the ratio of the amount of issuance that’s happening in the States relative to the amount that’s going on in the UK… It’s effectively saying as a bond investor there is a very big party going on but you have to move next door to join the fun,” he said.