Rate slump leaves schemes in derisking quandary

Those schemes that have set liability-driven investment triggers – where they would choose to hedge their inflation or interest rate risk at certain gilt or rate levels – have not reached targeted derisking levels as the market has deteriorated.

Lloyd's Superannuation Fund, a £382m multi-employer scheme serving employers in the insurance market, uses 20-year swap rates to set its derisking triggers, but it has not hit one since April 2011 as rates have hit rock bottom (see graph below, based on Bloomberg data).

"Yields have fallen so far we are nowhere near it at the moment," said Bob Clark, pension manager at the fund. "To try to lock in at the rates now would be foolish. We believe rates will improve."

The Lloyds scheme is aware that, as a closed fund, it has a fixed lifetime in which to derisk, but is confident in its employers’ support. "We are calling on our assets each month [to pay benefits to members], but we have a strong covenant," added Clark.

Eric Stobart, a trustee at a number of pension schemes including Lloyds, told PW at a National Association of Pension Funds conference last week that his schemes faced tough decisions over whether to change their derisking criteria.

"Moving to a different set of parameters is quite a major decision," he said. "[It] has cost implications."

Shell's derisking balance

Schemes that lock into derisking strategies, especially at prices they deem expensive, are also concerned that they will miss some of the upside if the market recovers.

Limiting return-seeking assets has led to questions on whether funding shortfalls can ever be put right. Clive Mather, chairman of the £12.4bn Shell defined benefit fund, said for most schemes "growth is the way from deficit to full funding," but they need to keep aware of the risks.

"We are constantly fine-tuning what is a very large fund to give us what we believe is the best protection on the downside but the best opportunity to ride the wave when it comes," he said.

Schemes should base decisions on their own specific requirements, for example by acting based on movements in their funding ratio, said Dan Mikulskis, director of asset-liability management and investment strategy at consultancy Redington.

"This should be done under an appropriate framework,” he said. “It should not be a decision based on trying to guess the fair value of swap rates."

The advantage of using triggers is they take some of the emotion out of the decision, said Robert McElvanney, senior investment consultant at Aon Hewitt.

"If you don’t do it that way, it gets to the numbers you would have chosen and you think, let’s just leave it and perhaps it will get cheaper."