Archive for November 2017

Brendan McLean

Autumn for me represents two things: colder, darker days, and a new budget. I wait excitedly for the budget in the hope of fewer taxes, but it seldom happens – however this year, something else exciting happened. Philip Hammond, Chancellor of the Exchequer, declared the Government wants to see pension funds invest in patient capital as a way of financing growth in innovative firms as part of his mission to unlock over £20bn of new investment over the next 10 years, ensuring the UK economy is fit for the future.

This move follows a government consultation that closed in September 2017 which discussed lowering barriers to patient capital investment, such as long-term illiquid investments in start-up companies, for defined benefit (DB) and defined contribution (DC) schemes.

This change won’t take place overnight – The Pensions Regulator will still need to provide guidance on how trustees can increase patient capital investment, which both the regulator and HM Treasury has not yet provided a timescale on. However the Treasury has said they will establish a working group consisting of institutional investors and fund managers with the goal of increasing access to patient capital for innovative firms, and removing barriers to investment for DC members.


In this current low yielding environment with various asset classes valued at record highs the thought of allocating to alternative long-term investments such infrastructure and venture capital which are less correlated to traditional asset classes offers a hope of a higher level of future returns for DB schemes. This could help decrease funding deficits. I believe over time illiquid long-term assets which are currently more accessible for larger schemes will become available for smaller schemes, as previously occurred for LDI.

Investment in long-term patient capital represents an opportunity to encourage younger DC members to get involved with investing in their pension.  As they are unlikely to retire for decades the benefits of long-term patient capital will be more visible to them. However most DC pensions’ assets are currently daily priced and normally offer daily liquidity. These two factors make it extremely difficult to make illiquid assets available to DC investors.  On a technical point, DC funds are offered in life assurance wrappers and the rules around those wrappers typically prohibit investment in illiquid asset classes.

Removing barriers to entry can only be a positive thing as it will help investors allocate capital more appropriately. These new changes will benefit DC members as they currently have a greater challenge accessing long-term illiquid investments. DB schemes will also benefit as they will have a greater opportunity to allocate to diversified less correlated assets.

For more information or to discuss the content of the blog please get in touch.

Brendan McLean
t:/ 020 3794 0193

Alan Collins

I read an interesting comment piece by Peter Smith in the ever-reliable FTfm section of yesterday’s Financial Times.  It concerned a possible upcoming change in the investment strategy of the Bank of England’s own defined benefit pension scheme.

So, what have they been doing and what might be next?

Around 2007, the fund switched investment strategy from one with a mix of gilts and equities to a “portfolio exclusively focussed on index linked-gilts”.  Having checked the most recent fund report and accounts (as at 28 February 2017), the actual split is around 60% index-linked gilts, 30% index-linked corporate debt (issued by the likes of Network Rail) and 10% fixed-interest gilts.   The point being is that the scheme has been wholly invested in debt-based securities for over ten years.  This has served the scheme very well over many years, with the funding level now reported to be 101%, an improvement from 96% in 2011.  I would take issue with the contention from Marc Ostwald of ADM investors who rather uncharitably suggested that the scheme has “been an OK performer more through luck than judgement”.  Many schemes will look back and wish they had achieved the same “luck” over the last ten years.

The really interesting bit is what might come next.

According to recent meeting minutes, the Scheme’s Chair of Trustees (John Footman) has stated that the Scheme was considering “alternative approaches” and “taking more investment risk”.  This is being taken as a sign that gilts are “relatively less attractive” and that “defined benefit pensions are not necessarily best served by gilts”.

Gilts may not be hugely attractive, but they remain an important tool (perhaps the most important tool) in a trustee’s armoury for tackling the biggest pension scheme risks of interest rates and inflation.  While many of our clients are rightly seeking higher yield where they can get it (through multi-asset credit, illiquid assets and other growth assets), gilts (and instruments such as Liability Driven Investments) will remain core to a scheme’s investment strategy.

In my view, this potential change in tack may actually be more about dampening the expected cost of future benefits than managing the risk of benefits built up to date.  With ongoing accrual costs at an eye-watering 50%+ of pensionable salary, perhaps it has been decided that more investment growth is needed to mitigate this (broadly speaking, the more investment growth that is assumed, the lower level of contributions are expected to be needed to pay for future benefits).

There is no suggestion that wholesale change is on the horizon.  I would expect the vast majority of the £4 billion plus fund to remain invested along current lines.

So, what can we learn from the Scheme’s approach:

  • It is important to regularly review your Scheme’s investment strategy – a strategy that is right today won’t be right forever;
  • Diversification (and here I agree with Mr Ostwald) should be an important consideration for scheme trustees –even the smallest of funds should be considering how different asset classes can add to overall performance and reduce risk;
  • The nature of defined benefit pensions means that the ongoing build up of benefits is hugely expensive if the investment strategy is wholly gilt based.  To sustain benefit accrual (where the risk can be sustained), growth-seeking assets are likely to be a necessary part of the portfolio; and
  • The search for yield in the current environment may point towards alternatives to government bonds.

For more information or to discuss the content of the blog please get in touch.

Alan Collins
t:/ 0141 331 9970

Quick Summary

Andrew Kerrin

The first three quarters of 2017 truly flew by, with only two thirds of 2017’s last quarter left to go too.  We never do things by halves, and we have kept a close eye throughout the whole of the last quarter, to bring you the hottest topics in the pensions industry, divided up into bite size pieces.

Read more »

David Davison

An Unwelcome Inheritance

Mostly when people are told they have an inheritance it’s good news. A long lost relative or friend has bequeathed some money to you which opens up the opportunity to do all (or at least some) of those expensive items on the bucket list. Unfortunately an inheritance in an Local Government Pension Scheme (LGPS) is usually every bit as much of a surprise and shock, but far from as welcome for the recipient.

Many organisations, having become a participant in the LGPS were blindly unaware that to do so meant that they automatically inherited all the past liabilities for any staff transferring to or continuing with the organisation. Frequently this can mean that charities inherit hundreds of thousands of pounds of liabilities and in some cases many millions.

This anomaly arises because LGPS is unable to identify and allocate past service liabilities between employers, apparently only being able to allocate all of the liabilities to the latest employer. This is undoubtedly incredibly unfair as it means local authorities can deftly transfer the funding risk to an unsuspecting charity. Even where guarantees are provided tend only to protect charities on insolvency and not on voluntary exit or on increases in contributions.

The approach used by the Fund (in most but not all cases) notionally assesses the liabilities as being fully funded at outset so even if the funding level is only 90%, for example, it is assumed to be 100%. However this is far from a perfect solution for a number of reasons:-

    • The value of these liabilities will vary over time. If a further shortfall arises the funding costs for this will have to be picked up the new employer in full even though they did not employ these individuals at the time they accrued the benefits.
    • Where liabilities should have been notionally uprated frequently this has not been actually carried out or the exact terms have been lost ‘in the mists of time”.
    • Even if the benefits were fully funded this would have been on an on-going basis and not on a cessation basis. This means that on an ultimate exit the latest employer would pay a cessation debt on all these previously accrued benefits.
    • Should members benefits be subject to strain costs such as on redundancy or ill health early retirement these additional costs would have to be met in full by the latest employer.

These issues can come in to sharp focus where the latest employer has been admitted as part of an out-sourcing exercise. Procurers can inherit past service liabilities which dwarf any future service benefit which can be accrued over the term of the contract and become responsible for variations in the value of these liabilities over the contract duration and at the contract end date. Attempting to deal with these issues, usually very imperfectly, is achieved via contract negotiation and terms which again adds unnecessary complexity, inconsistency and frustration. A worked example showing the issues is available here.

Funds should really be dealing with this issue properly by segregating liabilities, as is the case in most other large multi-employer schemes. The costs related to past service liabilities would be fairly retained with the employer who accrued them with future service only being the responsibility of the new employer.

Frustratingly many Funds continue to deny the issue of inherited liabilities. It is totally inequitable to expect a small charity to pick up a cessation liability for benefits they previously inherited from a public sector body on an on-going basis, or even in many cases a funding basis well below this. I’m surprised more fuss hasn’t been made of this!!

Some Funds however have sensibly identified this and looked to deal with it fairly and I can only hope that all others will follow. Indeed these liabilities should just be re-allocated to public sector ownership, which is totally possible, and would mean that the Fund has them guaranteed with no cessation debt requiring to be paid. I can only think the reason for not doing this is the LA’s know they’ve dodged these liabilities and don’t want them back!!

The recent ICAS report made recommendations how this issue could and should be addressed. I would recommend that any charity that have witnessed significant contribution increases or have been provided with a cessation debt consider this issue and have it properly investigated as it could have a material impact and it seems an issue which when outlined would not be easy for funds to reject.


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