How schemes can navigate the post-Covid recovery

Speaking at a webinar as part of the consultancy’s Investment Conference 2021, principal and senior investment consultant Jude Bennett told attendees that although markets have to a large degree bounced back from the nadir of March 2020, lessons would need to be learned to secure DB schemes through the coming year.

Many DB schemes ended the year with flat or even improved funding positions due to effective government responses to the pandemic, as well as central bank stimulus and latterly confidence-boosting news about vaccines, Mr Bennett said.

2020 could, and in our view should, be taken as a good learning opportunity

Jude Bennet, Barnett Waddingham

“Clearly, there have been winners and losers depending on your particular investment strategy, but things are almost certainly brighter than they looked in March,” he said.

“2020 could, and in our view should, be taken as a good learning opportunity,” he continued, listing a range of best practices that would have helped — and in some cases did help — schemes weather the worst of the pandemic-inspired volatility.

These include hedging against interest rate risk, derisking away from growth assets, and emphasising capital preservation in growth strategies.

“You would also have slept better if you were making progress along the derisking journey, and had already taken action to constrain volatility in your funding position,” Mr Bennett said.

“Portfolios set up with an emphasis on capital preservation would have performed better in the worst part of the crisis than those relying on conventional diversification.”

While diversification would have shielded schemes against the worst Covid symptoms, it did not leave them well-placed to capitalise on the subsequent recovery, he explained.

“If you were a cynic, you might say the message from this is to hold equities and to hold your nerve. But clearly the appropriateness of different approaches depends on your ability as a scheme to tolerate risk, and to live with the ‘might-have-beens’ if the recovery hadn’t come through in practice.”

In light of the recovery since March, Mr Bennett argued that now was the time for schemes to review their risk positions and governance issues, asking how effective integrated risk management approaches were during the pandemic.

“Crises often throw up opportunities, and there were opportunities around in the worst parts of February and March,” he said. 

“The question is: did you have a framework in place to be able to take advantage of these?”

LDI of the tiger

The pandemic posed a number of liquidity challenges for DB schemes and their sponsors, and the aftereffects of the crisis are presenting a number of trends that impact on schemes’ liability-driven investment strategies.

Danielle Markham, associate and senior investment consultant at Barnett Waddingham, explained that the Bank of England’s prolonged consideration of negative interest rates ought to concern DB schemes because of its impact on gilt yields.

“The lower gilt yields go, the larger the value placed on scheme liabilities,” she said. “It doesn’t stop at zero; the value of the liabilities will keep increasing as interest rates fall further.”

Schemes pursuing LDI should be assured that their strategies will continue to work if interest rates go negative, not least because negative real interest rates have been the norm for a while, and the market has already priced in the outcome of a formal move by the BoE to take rates below zero, Ms Markham continued.

“In this environment, LDI can continue to operate and deliver the risk reduction that we need it to,” she said.

For UK pension schemes, some opportunities may emerge on the back of such a move, such as “greater dispersion in insurer buyout prices for schemes”, Ms Markham said. LDI assets were expected to behave in the same way as liabilities, “therefore we could see an increase in the value of those”.

“That means that schemes that have that greater level of hedging in place will be better off than those without,” she added.

Look long term

Rounding off the webinar, Barnett Waddingham investment consultant Chris Pritchard argued that DB schemes’ long-term objectives have never been more important, and should reflect the lessons learned during the pandemic.

“All schemes should have a plan for how they would get to their endgame target... and as well as having an idea of how you get to your endgame, you should also plan for what happens if things do not go as expected,” he said

Following the events of 2020, schemes in general, and trustees in particular, should think carefully about their diversification strategies, drivers of return within investment strategies, governance structures and processes, liquidity risk, and hedging in light of the long-term decline in yields.

Moreover, doing all of this now and putting processes in place to respond to unforeseen stresses would leave schemes in the best possible position to survive any future Covid-like events, Mr Pritchard said.