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Impact Investing

IPE special report May 2018

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Do lifeboats hinder or help?

Defined benefit schemes in the UK are like drowning men encumbered with offers of help. The UK government has thrown them a lifebelt in an effort to buoy them up, but the fear is that this could weigh them down further.
The National Association of Pension Funds (NAPF) has warned that changes to the regulatory framework contained in the Finance Act and the Pensions Bill are likely to kill off future forms of DB occupational pensions
In an open letter, Christine Farnish, chief executive of the NAPF says: “Current changes to the regime, well intentioned in their own right, risk the perverse consequence of discouraging and disincentivising any future DB provision.”
This view is supported by leading UK pension schemes. Richard Barlow, managing director of Electricity Pensions Services which runs the £17bn (e25.1bn) Electricity Supply Pension Scheme, says: “Broadly speaking the ESPS would share the views of the NAPF. What has tended to happen with all pensions legislation since the 1980s is that it has not had the effect it was intended to have.
“Governments constantly think of ways that they can make pension schemes better. But whether the provisions of the Pensions Bill will actually make things better is a moot point.
“Confronted with a huge raft of Government proposals (a) you have to spend a lot of time understanding them (b) you have to spend a lot of time influencing them and (c) you have to spend a lot of time implementing them. And while you are doing all those things you are not actually running your pension scheme at all.
“On this current Bill we started off with proposals to make pensions simpler so that employers would be more likely to offer them. We’ve ended up with provisions for a Pensions Protection Fund that make pensions more complicated and employers less likely to offer them. So you don’t always get what you want, or what you expect or what was intended from government legislation.”
The recovery in equity markets in 2003 has only partly restored pension funds to their former health, he says. “Within my own scheme the value of assets at end-March 2004 is a considerable improvement on the position in 2003. But unfortunately that one good year was preceded by three years of adverse investment returns. So the overall position over four years is that we’re in a worse position than we were four years ago.”
Pension funds are likely to switch from equities into bonds and gilts in the future, he suggests. Yet this will be a gradual move rather than a step change.
“Asset allocations change all the time, and each scheme has a different position in regard to assets and liabilities. But as a generality one would expect to see a move away from equities toward bonds and you would expect that to be happening slowly.
“Pension fund trustees have been looking very carefully at their investment strategies having regard to the events of the last four years. The problem is that when you have a deficit it is not a particularly good time to adopt a strategy which matches your assets to your liabilities, because all you are doing is locking it in,” says Barlow.
“So although many trustees envisage a progressive shift from equities to bonds and gilts they envisage doing this in a phased way so that they implement the shift in tranches as equities rise to particular levels. They are trying to move in the direction of safety but not in such a way as to lock in deficits.”
UK pension funds are also looking more closely at liability-led investment strategies, largely because of greater longevity. Sandy Flight, principal treasury and investment officer with Dundee City Council Tayside Superannuation Funds (£787m) sees the principal challenge to pension funds as the impact of lower mortality rates on liability expectations.
“Our aim will be to try to get our assets to grow as quickly as our liabilities are growing,” he says.
This has meant focusing on the profile of the membership and moving the fund in the direction of a liability-driven investment strategy. “A year ago we moved the structure of the fund to a more specialised manager structure. As part of that we were able to introduce scheme-specific benchmarks for the first time.
“The idea was first to make a gradual move away from our previous balanced mandates and then a gradual move over time to try to align them more closely to our liability profile.
“Basically that means more fixed income at the first stage. The next stage which will probably take place in a year or two will be to consider alternative investments. Private equity is probably the most likely, although fund of hedge funds could be a further step after that.”
Further down the line, the pension fund may consider absolute return mandates. “We’re probably a few years away from that but I think that’s the way being driven just by circumstances and events,” says Flight.

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