TPT assists banks with risk capital investment

Following the financial crisis in the late 2000s, strict capital requirements were imposed on banks in an attempt to safeguard the financial system. The Basel Committee on Banking Supervision released the first version of Basel III, which outlines these regulatory capital demands, in late 2009.

TPT is seeking to capitalise, loaning money to institutions that fall under this regulation and need a higher capital backing, in return for regular premiums. It has allocated to two separate managers running regulatory capital strategies.

If there are factors which drive equity returns, it’s also reasonable to suppose that there are factors which drive returns on other asset classes

Cliff Speed, TPT

TPT, which looks after about £9bn and 250,000 members, will provide risk capital alongside banks for their loan books.

“We’re not replacing the bank. The bank must still have an expression of interest in these loans, but we’re providing some of the capital, and that allows them to have a regulatory capital release,” chief investment officer Cliff Speed said.

“Simply, it means that they can afford to pay us a premium for putting our capital at risk, and because of the capital requirements that premium can be quite attractive in a risk-reward and a risk-adjusted returns space,” he added.

Strategy could benefit from market competition

Basel III requirements on banks, which govern capital buffers, will need to be fully adopted by 2019. But Bill Coen, secretary general of the Basel Committee on Banking Supervision, said in a speech in May that the implementation period for the reforms may take until 2025 to complete.

Daniel Fox, senior investment associate at consultancy P-Solve, has observed growth in regulatory capital investment, and expects this to continue. It does nonetheless remain a “niche” area, according to Fox.

“With the Basel III rules coming into play in 2019… typically the European banks still have need to improve capital adequacy ratios, which will continue into their coming years,” he said.

By proceeding with investment in regulatory capital, TPT is putting its money into a market with relatively few operators.

“Given the complexity of these transactions, there are quite high barriers to entry for the managers,” Fox said.

Sophisticated means of finding returns

TPT is also in the process of selecting a manager for alternative risk premium strategies. These give schemes the ability to apply non-traditional risk factors normally used for equities, such as value and momentum, to other asset classes.

“We’ve seen lots of people employ factor investment for equities, so rather than just thinking about the equity risk premia, you then begin to research to delve a little bit deeper as to what actually drives returns,” said Speed.

He added that it would be “reasonable” to think that factors also drive asset classes other than equities.

“If there are certain factors it’s often worthwhile being able to go long and short of underlying securities and make sure you can optimise your exposure to these different factors,” he added.

Alternative risk premia carry less risk than equities

John MacDonald, senior manager research consultant at Hymans Robertson, said that alternative risk premiums had previously only been accessible via costly hedge fund strategies.

“It’s become a more affordable way of getting these diversifiers into the portfolio – so it does make sense from a pension fund perspective,” he said. “It’s probably [been] on an upward trend in recent years,” he added.

“The risk is not any more than equities. If anything, with some of them it might be less,” he said.

As with regulatory capital strategies, the market has room for growth and is currently occupied by a handful of providers, according to MacDonald.

He added that trustee understanding of alternative risk premiums has some way to go, and although the strategy will be examined by investment consultants, it would not currently feature on the radar of the majority of trustees.