United Utilities scheme allocates to private debt after ‘positive’ valuation
The £2bn (€2.5bn) United Utilities Pension Scheme has allocated 7.5% to private debt after the fund’s triennial valuation revealed the scheme’s improved probability of reaching full funding by 2020.
Sponsored by the FTSE 100 water supplier, United Utilities, the defined benefit (DB) plan had as much as 60% in growth assets in 2011 before trimming back in a bid to reduce investment risk.
Aided by an internal inflation hedging mechanism, the scheme now holds 80% of its assets in a liability matching portfolios, which it told IPE would be diversified even further give the expected positive funding news.
However, the fund said despite also looking at real estate and infrastructure assets, it chose a pooled fund which allocates to real estate and infrastructure debt, alongside private loans.
Steven Robson, head of pensions at United Utilities, told IPE the £150m allocation to the debt vehicle was funded by cutting exposure to synthetic equities, corporate bonds and other alternatives.
“We see infrastructure and real estate debt as a better option to holding real assets because the debt fund is backed by collateral and felt it was better than the actual asset classes,” Robson said.
“It’s the ‘looking for slightly better returns for a similar level of risk’ argument.
“We haven’t gone to try and shoot the lights out, but a more certain return and aiming to capture the illiquidity premium.”
Robson also said given the fund’s performance from its reduced investment risk and 90% interest rate hedging, it had begun to reduce its reliance on an inflation hedging mechanism.
After its 2010 valuation, the scheme agreed an arrangement with its sponsors by which it increased its exposure to inflation risk in return for company contributions to fluctuate based on real inflation levels.
It set the fund’s inflation liability projections at an annual increase of 2.75%, well below the market rate of 3.8%.
This reduced the fund’s projected liabilities, which allowed the team to take advantage of lower required investment returns by decreasing investment risk and increasing interest rate hedging.
In return for the reduced risk in the fund, the sponsor agreed to make cash payments into the scheme to match real liability increases from inflation.
Water suppliers in the UK see their revenue increased by inflation each year as part of the agreement reached at privatisation, meaning United Utilities’ revenue would increase by the same proportion as scheme contributions.
However, Robson said the scheme was now increasing its inflation expectation to 3%, still below long-term expectations, but reduces the fund’s reliance on the company covenant.
In addition, Robson said given the performance of interest rate hedging, and reduced investment risk, the fund was now more likely to be fully funded on a technical basis by 2020.
“But that is not the true end game, Robson said. “The end game is fully-funded on a self sufficiency basis, and we are looking at putting a second trigger in place to see how we can get there by a slightly later date.”
“Nothing is off the table,” he added.