13
Irish Pensions Magazine Spring 2014
Advertorial
Analysis
With schemes typically holding highly-concentrated,
equity-dominated
growth
portfolios,
further
diversification would clearly be in the interests of
many. With an array of alternative growth asset classes
available, such a move need not harm the expected
return too much; at the same time, the benefits of lower
risk brought by diversification can be captured.
Liability matching
Our survey also asked respondents to provide details
of their plans around liability matching. Around 37%
of schemes surveyed had plans to increase the asset
allocation to bonds, and a further 14% of schemes said
that this was currently under discussion. In addition,
around 44% of schemes have considered or are using
financial instruments (e.g. interest rate or inflation
swaps, and derivatives) to manage risk, with 16% of
schemes already using them as part of their strategies.
So progress is being made in toning down key risks,
such as exposure to nominal interest rates and inflation.
One interesting finding was the large growth in the
use of “dynamic de-risking” approaches, whereby the
re-allocation of return-seeking assets to bonds takes
place when pre-defined trigger points (e.g. often based
on funding level) are hit. Whilst these techniques can
allow schemes to take advantage of favourable market
conditions along their de-risking journey, the challenge
for trustees and companies in using these approaches
is in ensuring their governance arrangements are
robust (most of these strategies require some level of
delegation of investment duties), and in making sure
they are getting good value for money from these
services.
A further challenge for trustees and companies is in
ensuring that their liability matching portfolios are
well-hedged. The lack of availability of long term,
high quality fixed interest instruments is a challenge
for schemes. It means that for many, their matching
portfolios have a shorter duration than the liabilities
they seek to cover. This finding is supported by a
separate survey on investments published by the IAPF
in 2013. Whilst this mismatch leaves many schemes well
placed to benefit from an up-tick in interest rates, there
is always the possibility of a further fall in rates, and the
challenge of achieving a better matched position in the
future remains.
The current environment
Recent regulatory changes, such as the Funding
Risk Reserve, have increased the focus on having an
integrated funding and investment strategy. We expect
this drive towards a more joined-up view of funding
and investment risk to continue. The outcome of the
Element 6 case may also lead more trustees to start
building in assessments of the employer’s financial
strength into their decision making processes, and this
should include decisions on the level of investment
risk the scheme is prepared to take, and the modelling
of “worst-case scenarios” if things do not turn out as
planned.
Trustees will continue to feel the pressure of an ever
complex pensions landscape, with increasing demands
on both their time and expertise. Getting the right
advice will be important to good decision making. New
governance solutions in the investment space, built
around intelligent delegation of investment duties,
can help trustees focus more of their time on the
key risk areas, leaving the less important decisions to
specialists. For schemes wishing to go down this route,
the challenge will be in understanding the solutions
available, monitoring performance, and getting value
for money.
Final thoughts
Wherever schemes are on their journey to investment
de-risking, there are clear challenges ahead.
Underfunded schemes relying on asset outperformance
to fund deficits should carefully consider their asset mix,
in particular diversification within the growth portfolio,
to help optimise their quest for higher returns. Equally
important for schemes with large matching portfolios
is ensuring the robustness of the hedges they have in
place, and ensuring that these arrangements stand up
against changes in the economic outlook.
Having a realistic, well-considered investment strategy
in place is key to good risk management. A shift in
the Zeitgeist, spurred on by regulatory pressure and
changes to the funding standard, has meant that steps
are being taken to improve investment strategies.
More consideration is now being given to the potential
impact of these strategies on members and sponsoring
companies alike, but there is an opportunity to take this
further. With the direction of regulation a little clearer
than before, but with uncertainty and volatility in the
investment markets looking set to continue, now, more
than ever, it’s time to grasp the nettle.
The full results of our Pensions Risk Survey can be found
on the IAPF website
For further information please email us at:
or
Christopher Bown on +353 1 221 2498.
Article Author
40%
37%
14%
9%
Yes, already implemented Yes, planning to implement
Under discussion
No
Christopher Bown
Director
EY
Figure 2: Plans to increase bond allocation
