Mike Weston of Daily Mail & General Trust Pension Scheme tells Nina Röhrbein about his fund’s forward-looking approach to investment decision making
The UK’s Daily Mail newspaper is famous for its eye-catching headlines. But its pension fund also makes for exciting reading.
While many European pension funds err on the side of conservatism, the same cannot be said of the Daily Mail & General Trust (DMGT) Pension Fund.
It has a DB scheme, which closed to new entrants in 2009 and whose future accruals have shifted to a career average revalued earnings (CARE) basis, but it also manages a DC scheme.
The employer contributes 15% of a member’s salary to the DB scheme, and the employee pays in 6%.
With only 2,700 active members remaining, the scheme is expected to mature relatively quickly. Peak cash outflows are expected to take place between 2030 and 2035.
Due to a funding level of around 80%, a deficit recovery programme is in place, which means the scheme will be cashflow positive for the next few years.
“We are using the period between now and 2035 to maintain our allocation to return-seeking assets and take on some more illiquid assets to capture a risk premium to help close the deficit and ensure that the funding is in place to meet peak cash outflows,” says Mike Weston, head of investment at the DMGT pension fund. “We can maintain our reasonably aggressive asset allocation of 72% return-seeking and 28% liability-matching assets because we have a long-established corporate sponsor with a strong covenant who is prepared to effectively underwrite that risk. There is a degree of self-confidence in the group, which cascades down into the pension scheme, that just because everybody else is doing something does not make it right for us. Our philosophy is that every sponsor is different and every pension scheme is individual with its own particular pressures, which is why generally there is no one-size-fits-all answer.”
DMGT believes it is essential for the pension fund to have the expertise in-house to relate on a level playing field with its investment managers and professional advisers.
“We use the Pensions First PFaroe system internally to look at our assets, liabilities and scheme risk,” says Weston. “This allows us to forecast cashflows for our liabilities and the cashflows generated from our assets out into the future, enabling us to do a match and see where any gaps are. The model shows that we can afford to invest, for example, in 20-year infrastructure partnerships at the moment because we know that when we need the money we will have realised those illiquid investments.” The fund is about 67% liquid and 33% illiquid at present, with deficit recovery cash contributions providing positive cashflows for the next few years.
Until three years ago, the pension fund had a backward-looking, micro perspective - it focused, for example, on how investment managers had performed in the last quarter.
“My approach is based more on forward-looking, macro, taking into account what is happening in global markets and what that means for future asset class returns,” says Weston. “When our investment committee meets, it looks at the bigger, strategic picture.”
An actuarial and ALM review in 2007 recommended a strategic asset allocation of 40% global equities, 30% fixed income, 10% property and 20% alternatives for the pension fund. This was confirmed by the subsequent review of 2010, despite the fact that the scheme’s high equity and return seeking asset exposure led to technical underfunding in the wake of the financial crisis.
“Over the last three years, we have exceeded our liability benchmark by over 4% and outperformed our asset-derived benchmark by half a percentage point per annum,” says Weston. “This means we are back on track to pay our liabilities when they fall due, which is all that matters to us.”
For liability-matching assets, the pension fund only holds UK government bonds, primarily index linked Gilts. “If we started including global bonds we would be introducing additional risk elements into the portfolio such as currency risk,” says Weston. “But local versus global is a spectrum that requires attention across all of our asset classes. For example, our current property portfolio only holds UK assets. All the properties are directly owned by the pension fund across the mix of sectors from commercial to industrial and office to forestry. Property is the only asset class the pension fund manages in-house - the rest of the management is outsourced. A global property portfolio would require different skill sets, probably an external manager, a different thought process and, ultimately, the returns would have to compensate us for the extra risks.”
Of the remaining fixed income exposure, 10% is investment-grade corporate bonds, while the other 5% is made up of alternative credit such as asset-backed securities (ABS), leveraged loans and distressed credit. The pension fund entered ABS and leveraged loans in the aftermath of the credit crunch in spring 2009 when they offered exceptional value. Distressed credit followed in 2010.
“Over the last 18 months, we have been consciously increasing our global equity weightings to the maximum limit of 50% permitted in our statement of investment principles,” says Weston. “The capital to do this has been taken out of the government bond market.”
The alternatives allocation - equally split between hedge funds, private equity and infrastructure - also fits the heavy return-seeking bias of the scheme.
“Core infrastructure is increasingly viewed as a bond substitute,” says Weston. “We seek to invest in long-term, contractual, inflation-linked infrastructure cashflows although we also hold some opportunistic infrastructure, which is more akin to private equity. The hedge fund allocation has been implemented through a global fund of funds for the last five or six years but we are currently in the process of reviewing whether this remains the best way for the future. A key part of the decision will be whether we really want an equity substitute with lower volatility or an absolute return fund.”
Its direct private equity programme, which is run with Towers Watson as the scheme’s adviser, participates in 33 funds. It is global and cross-sector, holding venture capital, secondaries and specialist fund of funds as well as US, European and global buy-outs.
The next actuarial review is due in 2013, and as the scheme matures, over time it will inevitably move to a liability-matching asset allocation.
“For the last six months, I have been working on designing and implementing a de-risking strategy for the scheme,” says Weston. “It looks at where we want the scheme to go en-route to the expected peak of cash outflows and where the trustees’ and sponsor’s tolerance limits to the funding ratio are over time. It will also provide a coherent framework for our investment committee to look at new asset classes and investment opportunities.”
Together with one company and one employee trustee, Weston makes up the triggered assets switching committee (TASC). If any funding ratio triggers are hit, TASC will convene and make a decision immediately on how to change the asset mix and capitalise on any market opportunities. In the meantime, the scheme will hold on to its return-embracing asset mix and if no triggers are hit the TASC will not meet.
A move out of equities is unlikely for now. “We do not think there is any value in bond markets at the moment,” says Weston. “In fact, the bond markets carry more risk than equity markets at current levels. If we did hit a de-risking trigger tomorrow that required us to move out of equities, we would prefer to move into liability-matching alpha assets which have long-term contractual cashflows and provide better yields than government bonds, such as social housing, ground rents or infrastructure. But equally there is also an internal self-confidence to maintain existing asset allocations on the basis that we believe that bond yields will inevitably tick back up over time and eventually significantly improve our funding position.”
One of the by-products of having the de-risking strategy in place is a large amount of asset valuation data. This data will support future investment committee strategy development and decision-making. “We will be able to use the flexibility within the ranges of the strategic asset allocation to capture shorter-term tactical opportunities,” says Weston.
As the scheme matures and de-risks, it will become more passive. Currently, the pension fund has a 60/40 split in favour of active investments, with a more even split in the equities space.
“It is easier to de-risk and switch assets around if they are passively managed because we would be able to deploy derivatives,” says Weston.
He expects an active/passive split of 30/70 or 20/80 in the future, with a more active, higher return-seeking element of the portfolio combined with the larger passive core. “The liability match will be done through the passive assets, while the return-seeking part will be more performance focused,” says Weston.
“Another issue we are dealing with is the proportion of real as opposed to derivative assets. The problem is the cost of the derivatives. If you have to roll a derivative contract every three to five years you never know what the pricing is going to be at the next roll. So while in theory it would be easy enough to sell our equities, buy some index futures to maintain the equity exposure and use the cash realised to buy index-linked gilts, it has some practical drawbacks. But the right proportion of derivative based assets will help with any future changes in asset allocation.”
More imminent changes are of an operational nature. The five-strong in-house investment and finance team, together with their administration and IT colleagues, are moving from their Covent Garden office to DMGT’s headquarters in Kensington in July.