7 Reasons Pension Funds can Feel Good Post Crisis

AC-B1-RG-RedBlog-Banner-650x289.jpg

 

Part 1 of the Asset Class ‘Back to the Future’ series. Robert Gardner revisits seven strategies from the original Spring 2010 Asset Class and asks what has changed.


In order to help pension schemes achieve their goals, we believed asset classes could offer three things that could help fund deficits;

1. growth e.g. equities and private equities;
2. risk control e.g. Liability Driven Investment (LDI);
3. cashflow matching e.g. Investment Grade Credit (IGC)

We felt there were asset classes that offered all three benefits.

Captured in our table of investment ideas, we sorted these asset classes in order of ‘easiness’:

To what extent were they offering growth to fund the deficit?

To what extent were they hedging and reducing deficit volatility and therefore helping secure members?

What additional risks did they present?

How complex were they?

How accessible were they?

Investment-Ideas.png

Reviewing this table today, this looks close to a value for money framework for assessing whether asset classes are good value for money.

What’s happened in the time that’s passed?

LDI 2.0

What we said…

We wanted to take advantage of different investments and broaden the toolsets used. The LDI industry has evolved significantly since 2010.

…and what happened

LDI is primarily seen now, as then, about risk management.

It’s highly accessible, although there are additional risks and complexity. Its primary use is to manage and control the scheme’s funding level. That said, there remains the opportunity to enhance yields. Major LDI managers are continuing to develop thinking in this space, hedge ratios have continued to increase.

Secured Leases

What we said…

What if, instead of investing in property and getting returns as set by the IPD index, you invested using a fixed income and credit mindset?

The value was buying property with long-dated, inflation-linked leases. We first saw opportunities in this space in 2009. We then recommended to clients in 2010.

…and what happened

This asset class has developed hugely. There are several fund managers who offer Secured Lease funds, either direct or segregated. Many of our clients have successfully invested in this asset class.

Ground Rents

What happened…

In spite of the challenge in accessibility, several clients invested in this asset class through an Aviva Investors Realm Fund.

A challenge has been to marry investors with the supply of ground rents.

However, as a long-dated, inflation-linked, high quality asset class it remains attractive. I would love to see it become available in a retail format for DC investors.

Social Housing

What we said…

This was an asset class that was not well known or well understood by pension schemes. It was an asset class dominated by banks lending to them. Changes in the social housing world meant they needed to find new sources of finance. There was an opportunity to either provide them with debt or equity.

…and what happened

M&G did set up a social housing fund – unfortunately it was unable to deploy as much capital as necessary.

Some secured lease providers have social housing in their portfolios. As it turned out, people thought there would be an increase in inflation-linked debt, but actually focussed on issuing nominal debt. As a result, buy-in and buy-out providers often invest in Social Housing.

While the structure was different to what we were imagining in 2010, it has become a key asset for these providers.

Infrastructure

What we said…

This was a tale of two parts – infrastructure debt and unlevered infrastructure equity.

Infrastructure debt was attractive for a time. Clients who were able to invest quickly achieved much higher yields than are available today. Infrastructure debt is now much more widely understood by the pensions industry. There’s a good supply of fund managers offering infra debt. The issue is yields have fallen – the growth element is much reduced.

If you want long-term, better hedging characteristics, should not invest in equities that are leveraged, but rather invest, unlevered, in infrastructure.

…and what happened

Unlevered infra equity now has a number of fund managers. We’re currently seeing more growth and interest from clients.

Equity Release Mortgages (ERM)

What happened…

This has evolved into lifetime mortgages. At the time there was a debate over whether it would be eligible for insurance companies under the Solvency II legislation.

We have seen some interest and demand, but nowhere near the level we’d expected to see. Some clients are still considering this asset class. From a top-down perspective, it is extremely attractive.

However, it’s vital to understand and manage the additional risks. To what extent is the additional complexity worth the return and risk?

Insurance Linked Securities (ILS)

What we said…

It’s amazing to think that, in 2010, ILS were relatively unknown by pension schemes. Typically, people held a small proportion of their fund of hedge funds in ILS e.g. if someone had 5% in a fund of hedge funds, 2% of that would be held in ILS.

We said this was an attractive diversifier to corporate bonds, offering attractive yields and spreads. Many clients were able to start investing in 2010/11 and have benefitted from high levels of premiums and low losses over the years.

…and what happened

A challenge is that the ILS market has seen a huge inflow of capital. That has had the effect of suppressing the premiums as supply and demand of capital has changed. Also there have been no major pay outs. As a firm, we are currently not recommending ILS to clients. The risk and return is not attractive enough. Should premium levels rise again, we have recommended clients remain open to considering the opportunity again.

A highlight

The PPF hired us to help them develop a framework for investing in illiquid assets. They’ve subsequently invested in a lot of the assets talked about here. We’ve developed similar frameworks for several clients who are either towards the end of the middle game or the beginning of the end game.

Key takeaways

Don’t underestimate the power of understanding the context and long-term risk management. Taking new ideas and using a simple framework of growth, risk management and cashflow matching.

This paper identified the framework and process by which you should approach and assess these asset classes. It’s great to see, 7 years on, these asset classes have been considered, invested in and evolved.

For more on the power of a robust framework, you should read my blog on good governance.

Click to go back to Asset Class 2017

 

Author: Robert Gardner

Robert is Co-Founder and Non Executive Director at Redington Ltd. He started his career at Deutsche Bank before joining Merrill Lynch in 2003, working as Director in their Insurance and Pensions Solutions Group. In 2008, Robert also co-founded Mallowstreet, the online pensions community which continues to grow with presence and support from the industry. Robert is passionate about the impact of social media on business believing that education, collaboration and contributions are the best way to tackle pension challenges. In January 2019, Robert joined St. James's Place Wealth Management as Director of Investments.