The Houses of Parliament and Cambridge University are two venerable British institutions. But the differences in how they run their pension arrangements illustrate the contrast between the UK-style pooled liability-driven investment (LDI) and a more traditional form of pension investing, no longer as popular in the UK but still common elsewhere.
At first glance, the Parliamentary Contribution Pension Fund (PCPF) and the Cambridge Colleges’ Federated Pension Scheme seem to have similar asset allocation. The politicians’ retirement fund has a strategic allocation to UK Gilts and bonds of 15%, while Cambridge has 18.9% in LDI (typically Gilts, Gilt derivatives and cash), as at end-March 2022.
The rest of the Parliamentary fund is in equity, liquid and illiquid bonds and property. The Cambridge fund also has lots of growth investments. One big difference is that it also has 17% allocation to absolute-return bonds, listed next to LDI.
Then we come to synthetics. The trustees of the Cambridge fund are explicit about the use of derivatives: “The scheme’s current LDI strategy is to hedge to the value of 93.5% of the scheme’s assets.”
They believe derivatives minimise the proportion of the scheme invested in these matching assets, thereby maximising the capital available to invest in growth assets to improve the funding level.
This implies leveraging, borne out by the March 2022’s report that 93.5% of assets were hedged with only 18.9% of assets. Such leveraging was the golden key to LDI’s success during years of miserable returns on sovereign bonds. But the question raised by last autumn’s crisis on the London bond markets was how a pooled leveraged LDI strategy accommodates greater capital calls when Gilt yields go through the roof.
For Cambridge, the absolute-return bonds are one ready source of liquidity. But the Cambridge fund also has one overarching investment manager, Schroders, that can also sell at speed units in the return-seeking strategies such as public equity when necessary. We can call this joined-up LDI.
One of the revelations of the UK crisis last year was how slow some of the governance processes for buying and selling were. Some schemes, consultants and managers were set up to complete switches over weeks, not days. Much has been improved since, but the investment industry does not like to publicly admit its weaknesses, so more revelations may emerge only via litigation.
No such troubles affected the Parliamentary fund, which reported at the end of 2022 that it did not use LDI strategies. So while there might be some hedging value in assets such as corporate bonds, the PCPF is accepting a greater mismatch than Cambridge and the majority of UK pension schemes in the expectation that ‘riskier’ assets will meet liability obligations over the long term.
The politicians’ fund was 80% funded at the end of last March. This is well below average for UK defined benefit schemes and might be of concern to regulators. However, all becomes clearer, including the disregard for LDI, when one learns that the scheme sponsor is none other than His Majesty’s Exchequer. This is not an institution subject to the accounting standards that first inspired LDI. And venerable as they are, even the Cambridge Colleges cannot match the Exchequer as financial backer.
Brendan Maton is a freelance journalist