Even for longterm investors 10 years is a longtime in the life of a pension fund. This is exactly how long ago the investment strategy of the £1.5bn (E2.4bn) Xerox pension fund in the UK was put in place. “We have just had our tenth anniversary of this and what we really pleases us is that we have interfered minimally with that strategy,” says Tony Phillips director of pensions at the fund, based in High Wycombe. “Obviously in that time, we have done a tweak here and there.”
The fund had come through the 1980s in good shape, having benefited not only by having high equity exposure, but also using the specialist manager approach, says Phillips. “We had a number of good performing managers, so everything was piled up nicely for us, with the fund in surplus.”
Despite this, or indeed because of it, the decision was taken to have a thorough review to lay the foundations for the new decade. Phillips took the novel step for that time of undertaking an asset liability management study, which done by the consultants. “What we ended up with was something that was not too different from the average of the time in terms of allocation, with 80% equities, 10% fixed income and 10% property.”
All that has changed during the 1990s is that equity is now down to 75% and fixed income up to 15%. “On the property side, as this had drifted down to 6%, we decided two years ago to bring this back up to 10%. And that was great market timing!”
At the time of doing the ALM, the fund had six external specialist managers, contrasting with the norm for the UK industry of one or two balanced managers. “One of our prime objectives once we were satisfied that the benefits were secure was to preserve the surplus the fund had built up.” The fund had assets of £600m then.
The best way to achieve this was to have a considerable portion of the fund passively managed. “This was to be the ‘bread and butter’ match for the liabilities, and to have the other managers around this for the extra returns. It was core and satellite before its time! We also decided to have a rebalancing mechanism, to bring it back to the strategic balance.” About 40% of the fund, including property was on an indexed basis. Bands of 5% for the equity and 10% for the fixed income components were set around the strategic asset allocation and once these were breached, rebalancing had to take place.
To operate the rebalancing, the three indexed funds, one for UK gilts, UK equities and overseas equities, were put in place with one manager. “The actual rebalancing was facilitated by our custodian, who monitored the positions and pointed out when the trades needed to be done. This has worked well as a system.”
Indexing at that time was definitely a new departure and few were doing it in the UK. “We were ahead of the curve in our thinking,” says Phillips. “Also, we knew what our people in the US were doing, which was probably why we had a global custodian before the rest of the market. But our reckoning was that it made sense for us.”
The rest were specialist equity managers having individual UK and overseas briefs and incorporating a diversity of styles. Each manager had its own individual benchmark. “We said we wanted outperformance of sufficient amount to cover fees and so on, but instead of setting a particular limit, we talked it through with the managers and give them in a qualitative and subjective way the sort of risk levels we were comfortable with. But we did not say ‘We want you to outperform by X% and tracking errors of no more than Y% and so on’.” It was more of a partnership approach were the fund would have as clear an understanding of the managers as it possibly could, says Phillips. “We were prepared to put a lot of work into that. That was our approach, which we developed into meeting and talking with them very regularly, so that we understood each other.”
The fund adopted the philosophy of being “broad brush” on sector allocation, which it has maintained. “So for the overseas managers, we did not segment the portfolios, saying the benchmark is the FTSE World ex UK. But we did know where the particular managers were likely to be investing. So we did not have a US or Asian brief.”
After the restructuring, all the managers came to a conference the fund organised, with a view to telling them what the thinking was and so that they could see how they dovetailed into the whole structure. “We got good feedback from this and the managers could see where they fitted into the whole. There was good debate as each manager wanted make as good a contribution as possible.”

So, having this ‘quantitative and qualitative’ structure in place, plus a close relationship with managers have helped keep the fund on track, he believes. “From the ongoing control aspects, we felt is essential to have a very clear process, with manager reports that we compare in our and not the managers’ formats. It took sometime to organise, but eventually it happened.” But in addition, Phillips makes a point of obtaining the individual managers’ reports to compare with the overall one that comes from State Street.
The investment committee plays a key role in this control aspect. It consists of Phillips, the financial controller of the fund, who looks after the investment accounting side and the fund’s operation’s manager. “We also use an outside consultant on the investment side.” Since 1994, the fund went the route of having an independent professional trustee firm and their representative sits on the investment committee. “The trustees of the fund are welcome to all the meetings of the investment committee, but generally they do not come, though recently this has been changing, which is a good thing,” he says.
“We take a day and half each quarter, with a rolling agenda,” Phillips explains. All the reports are considered here. “As part of that two or three managers come in rotation to discuss conditions. But in addition we would ask particular managers to come, if there was an issue needing attention.” Then one of the managers would be asked to come to make a presentation to the full trustee board meeting held some weeks later, which also receives detailed minutes of the investment committee meeting.
The process is straightforward but penetrating, Phillips feels. “You do get to know the managers very well and to pick-up any causes for concern that need to be nipped in the bud. It means that we have sorted out matters, where others could have parted company.” This means of course that to part with a manager would be a very major event, he acknowledges. “But we did part with two managers over the 10-year period. And on the bond side, an active fixed income brief was added some two years ago.”
So how did the 10-year strategy work? “We found that we had outperformed our benchmark on all the measured periods since inception, which is very satisfactory.”
In the past five years, the fund was in the sixth percentile of UK fund performers, which he reckons was not bad for a 40%-indexed fund. “Very satisfied that we managed to keep the take we had on the managers and the structure throughout, by maintaining and developing the relationships with the individual managers. There was real understanding of what they were doing. And we were content, with steady and reasonable outperformance. Such an approach over a 10-year period really delivers the goods. Softly, softly and slowly, it builds up, but all the time committed to the active and passive mix.” There is no conflict between active and passive, each has its place, he maintains. Ten years on and the fund is also in a surplus position – enabling the employer to take a contribution holiday. “The company has not had to pay a pension contribution for some years,” he points out.
The fund is now taking a hard look at the next 10 years, as it is maturing rapidly, with 6,500 pensioners and 5,000 deferreds, with 4,000 contributors – the same total as decade ago, but with a much lower proportion of actives. “The equity proportion is something we are taking a very close look at in our new ALM. It is not just maturity considerations but the changing bond equity returns scenario.” But the study’s results will be but the start of the discussion within Xerox. “It is certainly an interesting time. We would like to put in place a new plan for the next 10 years, but we know that we have to change. It is probably a bigger challenge now than ever.”
Phillips does not for one instant believe the debate about DC or DB is over. It has not come up as an issue within Xerox, though the fund has offered a DC option since 1989, the thinking being that there would always be some employees a DC scheme would suit better. But even over that period the assets in the DC plan are around £30m, but this could change. Originally, an employee could go into either scheme, but last year, new employees automatically go into the DC plan, which has matching contributions. “ On average, employees put in 4%, so with the Xerox matching 4% under age 40. Then we push additional voluntary contributions very strongly.” At age 40, they have a once off chance of transferring into the DB scheme and have the option of keeping the DC benefits or transferring them into the DB plan. “We give a reasonable choice of investment links in the DC plan,” says Phillips.
As with the active and passive debate, there are two styles of providing pensions, with one more appropriate than another in certain conditions and sometimes a mix is best, he adds. “DC is not a done deal – just don’t rush the decision.”
Being responsible for both the benefits and the investment side of the Xerox fund, gives Phillips a very rounded picture. “When you see someone who has been a good company person comes to retire or is struck down with an illness before then, it’s a matter of great satisfaction and comfort to know that the financial side is taken care of for that individual as a result of the fund. All the regulation and other burdens that are imposed are there to ensure that this happens satisfactorily.”