After a big drop in the value of defined benefit pension scheme assets last year, employers and trustees may consider reviewing their long-term investment strategies, says Katrina McKeever
Last year's global financial meltdown sparked a rollercoaster ride for defined benefit (DB) pension plans. The UK's 200 biggest privately sponsored pension schemes recorded their largest-ever year-on-year fall in asset value, an 18% drop overall during the year, according to figures from Aon Consulting. Some accounting systems may have masked the full extent of the crash to some degree, but in a continuing period of economic uncertainty, employers and trustees may want to look carefully at schemes' long-term investment strategies to ensure they are fit to meet liabilities. Andrew Dyson, head of institutional business at Blackrock, says employers may find the true cost of operating a DB plan is not apparent on their company's balance sheet. For example, measuring risk on AA bond benchmarking for pension scheme liabilities may make the fund appear healthier than it is.
Some employers and trustees may previously have been considering a buyout option to offload their scheme's liabilities, but may now be forced to look for an alternative solution in light of the economic turmoil. "Interest in buyouts will continue, but less business will be done for several reasons," says Dyson. "The pricing earlier this year was unusually attractive, so, unsurprisingly, trustees responded to that. It is now normalising, however. Also, most funds are less well funded than they were, so are less able to afford a buyout."
Employers that are unable to afford a buyout may have to ensure their scheme's investment strategy is managed more tightly. But Chris Martin, managing director of Independent Trustee Services, says investment decisions should not be rushed. "Trustees should have a long-term strategy and there is no reason why they shouldn't continue to execute that."
Instead, trustees should be left to decide whether they want to make changes to investment strategy, how profound any changes should be, and then judge who is best placed to advise them. If they then want to make changes to the scheme's statement of investment principles, they have a statutory duty to consult the sponsoring employer. It is also wise, although not required, to talk with other interested parties, such as pension managers and consultants. Employers could also work with trustees to decide on a strategy. Stephen Barker, head of investment at JLT Benefit Solutions, says: "Employers can be proactive and seek investment advice themselves, not on the details, but on the most important aspects of the investment strategy, primarily asset allocation, and then talk to trustees about seeking a more efficient investment strategy."
Tactical decisions, such as predicting how the market may change, should be left to fund managers, says Barker. "Trustees should decide how much they should have in equities, how much in bonds and then what types of equity and what types of bond. Set the benchmark in the strategy and give the fund manager responsibility to implement it, but also give them some discretion to move away from that benchmark to try to add value."
Where the balance of equities in fund portfolios has dropped by a large margin because of the falling markets, Dyson advises redressing that balance quickly while equities are cheap. "Equity prices have fallen a long way and have priced a lot of disappointment into the future earnings or a lot of distress into the price," he says. "If you are a long-term investor, now is a much more attractive time to be holding or buying those assets."
On a more strategic level, volatility in equity markets and regulatory changes may be driving a trend away from traditional equity-based investment towards asset allocation strategies or diversification as a long-term option. But before changing an investment strategy, trustees should consider what returns are required from the pension fund. "If you move from equities to bonds, you tend to reduce the risk but you reduce the expected returns, so whether that is a good thing or a bad thing depends on scheme objectives," says Barker.
A possible solution is liability-driven investment, which involves a framework for controlling DB liabilities to address previously unrewarded risks, such as interest rate changes and inflation, says Barker. "Companies should concentrate on getting their strategy right rather than trying to second-guess the market [and] making sure they are taking the right level of risk" he says
If you read nothing else, read this...
- The economic climate may prompt employers and trustees to review their defined benefit pension's investment strategy.
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