Barclays steps up 'return-seeking'
Mark Hyde-Harrison, the pension fund investment director at the UK-based Barclays banking group, is responsible for not just one but five retirement schemes.
This multiplicity of schemes reflects developments in the UK's company pensions schemes over the past 10 years, notably the closure of many defined benefit (DB) schemes to new members, the move from DB to defined contribution (DC) schemes, and attempts by the designers of pension plan to share risk more equitably between employers and employees.
The five schemes, or sections, under the umbrella of the £15.5bn (€23bn) Barclays UK Retirement Fund currently comprise a DB scheme now closed to new members, a DC scheme, a career average scheme and an innovative hybrid scheme called Afterwork which combines features of cash balance and voluntary defined contribution schemes and is the principal scheme for new members.
Such a diversity of schemes could pose problems for an investment director. Yet Hyde-Harrison has tried to keep the investment approach simple. In this he has been helped by the structure of the fund's liabilities.
"We look at all the liabilities to define the best investment strategy and at the moment that is still dominated by our DB scheme. Whichever measure you use, liabilities in the DB scheme are in the teens of billions while liabilities of the Afterwork scheme would still be in the low hundreds of millions. The liabilities of the hybrid scheme represent a very small percentage of the total fund and aren't particularly significant at this stage in driving the investment strategy.
"From the DB asset side we take the view that to gain economies of scale we won't run separate assets against each scheme. We run one pool of assets and have different liability structures, which in the end need to be paid for by the performance of those assets over time."
This approach still takes account of the investment choice offered by the DC schemes. "We run the fund as a DB pool of assets with a DC selection of investment options. So whichever scheme members are in, they have the same investment options," he says.
The Barclays UK retirement fund's investment strategy has undergone a radical restructuring since Hyde-Harrison took over as the fund's investment director in 2002.
Until then, the strategy had followed the standard pattern of corporate DB schemes in the UK, with a high allocation to equities, particularly domestic equities. In January 2002, 44% of the portfolio was invested in UK equities, 29% in overseas equities, 10% in fixed interest securities, 9% in index-linked securities and 8% in real estate.
Since then the strategy has been to reduce the risk, principally by reducing the allocation to equities, says Hyde-Harrison. "We moved the investment strategy in 2002 to significantly reduce the equity content. This was largely done before the market fall in equities in mid 2002, although we were still caught by a few ripples towards the end as we were doing it. So I wouldn't want to say we had moved entirely, but we got most done in time."
In the current investment strategy, the strategic asset allocation is divided between ‘matching assets' and ‘return-seeking assets'. The matching assets portfolio is made up of a 37% allocation to bonds - up from 19% in the 2002 portfolio - which is divided equally between fixed interest bonds and index linked bonds.
"That is the risk reduction side of the fund where we try to minimise the unrewarded risks in that portfolio against the liabilities, by using whatever instruments we feel are appropriate between physicals, futures and derivates," says Hyde-Harrison.
The return-seeking assets comprise ‘developed equities' and alternative investments, together these account for 63% of the portfolio compared with 81% in 2002.
The total allocation to equities has been more than halved since 2002 from 73% to 35.5%. Much of this is due to the sharp reduction in the UK equities allocation, down from 44% to 10%. In contrast, allocations to international equities have increased in importance if not in size, with 12% to North America, 7% to Europe excluding the UK, 4% to Japan 4% and 2.5% to Pacific Rim excluding Japan.
"There has been a significant reduction of our equity portfolio and a greater internationalisation, says Hyde-Harrison.
The fund's strategic allocation to alternatives, the other segment of return-seeking assets, is currently 27.5% and now represents a significant part of the fund, he says. "We've probably gone further than most in diversifying our return-seeking assets in the alternative space. A lot of that is property, which has gone up from 8% to 10%. But we also now have quite a large range of different strategies."
There is a 4% allocation to private
equity, 3% to global tactical asset
allocation, 2% to commodities, 4% to high alpha bonds - unconstrained bond mandates - and 2% to a diversified hedge fund portfolio. There is also a 2.5% allocation to emerging markets, divided equally between equities and debt. "We treat emerging market equities differently from developed equities in being more alpha generating and a slightly different play, he says.
The aim of this diversification within the alternative investment portfolio is to improve the fund's risk-adjusted return. "The purpose, broadly, was that, having reduced the risk by increasing the matching assets from about 19% to 37%, diversification was aiming to maintain the return expectations but
lower the risk - that is, improve the risk-adjusted returns of our returns-seeking assets.
"This is really the measure that matters, and what is important to us whether we are spending this risk budget effectively and maximising the returns on the budget."
The post 2002 investment strategy has meant a growth in the number of external managers used by the Barclays fund. The fund uses Barclays Global Investors (BGI) to manage its bond and developed equities portfolios. "We've always had a long standing relationship with BGI and that continues. It is an arm's length relationship and we review and assess them regularly. But they have been very successful as a manager so they have retained our confidence," says Hyde-Harrison.
The pension fund can draw on the banking group's resources in other ways, for example by using the services of Barclays Capital as well as BGI. Yet the decision to use these services is for the trustees rather than the sponsor, says Hyde-Harrison.
"Partly as a result of the Pensions Act, we have now separated the pension fund from the bank to remove any conflicts of interest. We are now quite conscious that we wish to be independent, and that the trustees need to make their decisions independently of the bank with appropriate advice. But equally we understand that there is a working relationship with the bank and that we can access their resources,"
Where the Barclays fund has widened its use of managers is in the alternatives portfolio. "The belief set that we have had is that in seeking greater alpha returns, which is a function of diversification, the lower hanging fruit most probably has been in the alternative space until now," Hyde-Harrison says. "These are the less efficient markets, the markets where not every participant is necessarily a return maximiser. Therefore we have put our efforts into increasing our manager skill in those markets."
The portfolio's shape, with its lower allocation to equities, has remained unchanged despite the recovery in the equity markets. Hyde-Harrison says this is as it should be. "We do not try to time the markets. It
is a long-term strategic allocation, largely based around tolerance to risk, and to simply say that we
will take more risk on our balance sheet is not something that naturally fits.
"One of the really important concepts that has become embedded is that risk in a pension fund is not free, and the bank allocates capital against the risk in the pension fund. Therefore, it would feel a real effect if it were to decide to increase the equity content.
"Increasing the equity content of the portfolio isn't a cost-free decision, and you'd have to ask whether
you could spend that capital more efficiently somewhere else in the business. That introduces a discipline that militates against short-term market timing and helps the long term perspective."
The Barclays fund can afford to take a long-term view, he says. "We're not in a difficult place, a
Mexican stand-off, or anything like that. We're in a position where we can take a long-term view of what we believe is right for the pension fund and work with our sponsor for a long term solution which balances the desire for return-seeking assets to reduce costs with being very aware of the potential risks. Where
we do take risk we have to ensure that we earn the highest possible risk-adjusted return."
The investment strategy has delivered the returns expected of it, Hyde-Harrison says. "In the long term, with the rebound that has happened, I'd say broadly the strategy has done what was expected," he says.
"If you take a five-year view, the fund performance has been 6% per year over the last five years to the end of June, against our benchmark of 5.6%. So there has been a slight outperformance. Against our liabilities we have slightly underperformed - our liabilities have increased by about 6.8% per annum.
"If you move to a shorter time frame, so stripping
out the difficult market period at the start of this
century, our three-year performance improves to 13.9% pa for the fund as a whole. The benchmark returned 13% so there was 0.9% outperformance. This shows us that our manager skill over a three-year period is delivering and we're getting strong information ratios as a result as well."
"Over that period, liabilities only increased by about 4.4% per year, so we've got a 9.5% outperformance. This inevitably helps to improve funding levels.
"So even when we take the very worst periods into account in our performance we are broadly delivering what we expected. We also have the strength of Barclays covenant in terms of contributions if they are needed, so we are not entirely dependent on investment performance." While many UK corporate pension funds are faced with substantial deficits, the Barclays fund is in a relatively healthy state. In June, the pension fund was 109% funded on a funding valuation basis and 91% funded on an accounting valuation basis.
The scheme also stands up well in terms of the solvency measure applied by the UK's new Pensions Protection Fund (PPF). The PPF solvency ratio represents the funds assets as a percentage of pension liabilities. In June this year the ratio of the Barclays UK Retirement Fund was estimated to be 116%.
"We are not at the top of the pack since there are a number of UK companies which do not have accounting deficits, but we are well funded compared to the FTSE 100 and are in the top quartile," says Hyde-Harrison.
The Barclays fund also has the advantage of a financially strong sponsor. "We are very comfortable with our corporate sponsors and their ability to make good the deficit, despite the size of the fund," he says.
The relationship with the sponsor is critical to the well-being of the pension fund, he says, and ideally the objectives of both pension fund and corporate sponsor should be in alignment. They should agree, before anything else, on an acceptable level of pension fund risk.
"One of the challenges is to be very clear with our sponsoring employer about the level of risk that they wish to have in the pension scheme now that the pension scheme is more closely aligned to corporate balance sheet, and the corporate is committed far more strongly to the pension scheme by law than was the case in the past," says Hyde-Harrison.
"Therefore, there's been a very strong dialogue to ensure that, in setting the investment strategy, the corporate understands the consequences on funding, and the potential contributions scenarios which may arise in adverse situations, and that they are comfortable to take that risk on their balance sheet if it were to occur."