The chief executive of the UK’s Pension Protection Fund (PPF) has said he is disappointed with the take-up of liability-driven investments (LDI) by UK pension funds over the last 10 years.
The PPF, which acts as a lifeboat fund to UK defined benefit (DB) schemes stranded through sponsor insolvency, operates a lower risk tolerance level to most, with an investment strategy focused on matching liabilities.
The £16.3bn (€19.7bn) fund has around 70% of its assets in bonds and cash, making heavy use of derivatives in its LDI portfolio as it aims to outperform increases in liabilities and a LIBOR + 1.6% target.
PPF chief executive Alan Rubenstein said that, while he did not encourage other UK schemes to mimic its strategy, as the PPF must remain contrarian, he was disappointed with the number of schemes failing to hedge liabilities.
Speaking at the London conference, The Investment Agenda, Rubenstein told delegates in 2005 that, when the PPF was formed, UK pension schemes had an average deficit recovery plan length of 8.1 years with 75% within 10 years.
“You would hope that, 10 years on, there would only be one-quarter of schemes in deficit,” he said.
“But, in fact, the [average recovery length] is now 8.5 years, and you have to go up to 11 years to capture 75% of schemes.
“In that sense, it does not feel like we have made a lot of progress. I am disappointed by the rate of uptake of LDI by pension schemes.”
He accepted that LDI strategies meant expecting a lower investment return, but he added that schemes with strong sponsors should accept this.
“There is no doubt, if you are going to do [LDI] over the long term and you can cope with the volatility, then you should probably accept [lower investment returns],” he said.
“If you are a typical pension fund with a sponsor that is comfortable with that, then, frankly, I have no difficulty with it whatsoever.”
Rubenstein defended the stance that the PPF’s lower risk tolerance and returns meant levy payers had to contribute larger amounts to complement its strategy.
The PPF charges an annual levy on UK DB schemes, which potentially could require cover, and uses this to fund its strategy and pay benefits.
“We have to strike a balance between protection for members, who have already lost part of their pension by being in the PPF, and understand that this has to be paid for,” he said.
“We think of the levy as the balancing item between benefits and the returns we get on the assets.
“It is right we run a relatively low-risk approach, and that does have consequences, but the alternative of putting it all on red would lead us into pretty big trouble pretty quickly.”
The PPF recently lowered its estimates of levy collection by 10% as the level of risk posed by sponsor failure decreased.
Given the scheme’s significant LDI portfolio, net investment returns were negative 0.7% in its last financial year.
However, its assets increased by 9%, with levy collections and new schemes entering the fund.
It did beat its liability benchmark by 2.9%, with Rubenstein highlighting a 19.5% return in its small equity portfolio as key.
According to research from consultancy KPGM, the UK LDI market was at £517bn as of the end of 2013, from more than 800 mandates and accounting for more than one-third of DB assets.