PPF drops silo investment structure in favour of 'hybrid' assets
The Pension Protection Fund (PPF) has re-assessed its investment principles leading to a 12.5% allocation to “hybrid” assets that provide liability matching and outperformance.
Historically, the UK’s lifeboat fund allocated 70% of its assets towards cash and bonds to match liabilities, with 30% in risk assets aiming for a LIBOR plus 1.8% outperformance target.
However, in a re-jig of strategy, the fund will now invest in a wider range of assets previously deemed unsuitable for the silo nature of asset allocation.
As a result, cash and bonds will now account for 58%, alternatives 22.5%, equities 7% and hybrid 12.5%.
Meanwhile, the fund told IPE it has completed a £330m (€415m) real estate co-investment with insurer Prudential as its first significant hybrid asset allocation.
It has also begun awarding risk-factor mandates over asset class mandates, giving external managers greater flexibility on asset selection.
This includes private placements and loans as the fund completes the awarding of a mandate for direct lending.
It will also finalise an emerging market debt tender that gives the manager freedom to invest across different emerging economies and credit qualities, with the fund solely looking at the absolute return target.
Barry Kenneth, CIO at the lifeboat fund, said the previous silo allocation nature meant it could not use index-linked corporate bonds, as they would only fit in its risk-seeking portfolio, and not benefit from liability-matching characteristics.
He also said the new hybrid investments allowed the fund to overcome regulatory challenges for its large liability-driven investments and derivatives book.
The additional costs of continuing to run a large LDI strategy, underpinned by derivatives, is to increase substantially as the European Market Infrastructure Regulation (EMIR) takes hold, and Basel III decreases competition in the counterparty market.
“These regulations mean, if we wanted to change our asset allocation in five years’ time, it would be a lot more troublesome to do so,” Kenneth said. “We can now have less reliance on the over-the-counter derivatives market.”
The fund will now look at using new hybrid assets, such as corporate index-linked bonds, and allocate excess returns to the outperformance portfolio, and the liability characteristics to the LDI programme.
A long-term lease, for example, will shift from alternatives to hybrid.
“We’re not introducing new asset classes, but the assets by definition have more than one function,” Kenneth said.
“A lot of the assets we currently invest in, we are just looking at them differently.”
He said the PPF fit in somewhere between a pension fund and an insurance company, and that annuity providers often allocated to these assets.
“I do not care what the asset is called, but rather what it gives us,” he added.
With this, the PPF has awarded risk-factor mandates, which allows managers to invest across a range of assets but target illiquidity, excess return, inflation and duration.
“In this kind of space, it is very important we do not constrain ourselves to particular asset classes,” Kenneth said.
”This gives us the best chance to fill the 12.5% allocation, or around £3bn in three years.”
The first significant asset was completed last week when it co-invested £330m in two commercial properties in Manchester with insurer Prudential.
This provides the fund with a lease contract for 23.5 years, with an annual 3% uplift in rental income.
Kenneth said the fund would continue to co-invest with insurers in real estate to ensure it moved into a higher-valued market away from the competitive lower-valued.