Caterpillar trims active equities to fill LDI buffer fund

Defined benefit schemes are increasingly using trigger-based methods to decide when to increase their liability hedging.

The £1.1bn scheme hit its first trigger in December last year. At the time, it held 67 per cent of its assets in actively managed equities across six managers.

It reallocated one of its underperforming equity mandates, along with 2 percentage points from each of the other managers' holdings, to its swing portfolio which is invested in passive equities. This portfolio is used to fund its LDI strategy.

Jane Wilson, UK pensions manager at the heavy machinery manufacturer, said the scheme was addressing a mismatch between its equity holdings and its liabilities, as well as the coherence of having its equity exposure split into small pieces.

“As that comes down we have to look at small holdings and decide whether it makes sense to be holding numerous small pots,” said Wilson.

The scheme is currently at 88 per cent of its technical provisions and will hit its next trigger when it reaches 92 per cent, she added.

Caterpillar's approach

It now holds 50 per cent of its assets in equities across five managers, 17.5 per cent in its LDI portfolio and 8 per cent in its swing portfolio (see box for full asset allocation).

Caterpillar takes 2 per cent as a proportion of its portfolio out of each of its equity holdings as it hits a trigger so it can top up its swing portfolio.

Wilson said: “We set up a process that said when our funding level hits a certain point, we have got to have that money ready to move into that LDI portfolio."

The scheme also sold half of its 5 per cent allocation to property in May this year and is currently looking for a private buyer for the remaining proportion. This 2.5 per cent was also reallocated to the scheme’s swing portfolio.

Wilson said the scheme has a set closure date to future accrual of December 2019 so at that point will have to decide whether it wants any equity parts in its portfolio.

The scheme’s investment strategy will be determined by how quickly it is “charging down that derisking path”, she said.

“[We’re] partly trying match liabilities but partly trying to keep the equities in there to give us some outperformance because we’re underfunded,” Wilson said.

Robert McElvanney, partner at consultancy Aon Hewitt, said he has seen an increase in schemes using funding-based triggers.

If trustees have already agreed trigger points in advance it can take some of the emotion out of the debate, he said, but added schemes need to be ready to act speedily.

“You can find [that] if it’s due to equity markets going up then [they] can fall down quite quickly as well,” he said.

Simeon Willis, principal consultant at KPMG, said he has also seen a rise in the use of trigger-based asset allocation.

“The real challenges are around deciding what the triggers are going to be going forward and deciding what’s important to you,” he added.