Small schemes warming to derisking face challenges

Research from Legal & General Investment Management showed a third of respondents indicated an interest in liability-driven investment and trigger-based derisking.

Schemes sized between £20m and £100m represented the largest proportion of those interested – about half of those who expressed interest.

Robert McElvanney, investment consultant at Aon Hewitt, said he has seen an increase in interest for LDI among smaller schemes.

“With yields increasing over the past year or so they are seeing their funding levels improving. They are also therefore seeing it is more affordable to take some inflation or interest rate risk out,” he said.

LGIM’s research found schemes with assets of less than £50m could face challenges as there are often just a few trustees, a constrained budget and a lack of risk management tools.

“For the majority of medium-to-smaller pension schemes, most of whom are constrained by resources, it is much more difficult to identify how and when to derisk their schemes efficiently,” the report stated. “The cost of both investment advice and strategy implementation therefore remains a barrier for smaller schemes.”

One challenge facing smaller schemes is understanding how their asset allocation should change over time and the interaction with technical provisions.

“The trustee obviously wants to take out investment risk as and when they can, and the [company] will probably be interested to see how that impacts technical provisions, so that it doesn’t unexpectedly or unintentionally impact cash contributions,” McElvanney said.

The survey also found a “clear need for more education and training in smaller schemes”. Investment expertise was the first or second biggest challenge for 22 per cent of trustees. 

“One of the major factors putting off smaller schemes from the adoption of more advanced risk management products is the inevitable complication, accompanied by a dearth of knowledge,” LGIM’s report continued.  

Smaller schemes have many advantages over larger schemes when implementing LDI as pooled funds have proliferated, said Steve Barker, managing director at Barker Tatham Investment Consultants, which specialises in advising smaller schemes.

“It has meant that hedging interest rates and inflation has become as easy to use for small schemes as investing in equities, credit or any of the other asset classes,” he said.

Cost of implementation of such a strategy could also be a worry for small schemes. But Barker said due to the low number of liabilities that need to be hedged, fund managers are more likely to give a mid-range price.