From the blog: A lot of schemes use funding level triggers as part of a derisking journey.
Once a certain funding level is met you derisk by disinvesting from growth assets to add to the matching assets.
This reduces the level of risk of the investment strategy but also reduces the expected returns.
At first glance, this can feel like a sensible governance solution, but there is one major flaw: using funding level triggers means schemes are employing backward-looking metrics. It is looking out the rear-view mirror.
Explicitly framing the derisking journey around the end destination makes the most sense
On a car journey, would you only consider how far along the road you are, rather than considering what lies ahead for the rest of the journey?
How far along we are does tell us how much distance is left to travel, but it doesn’t help us to consider whether we are on track to get to our destination on time, achieving the funding objective. Whether there are open roads or traffic jams ahead will make a big difference in the remaining journey.
If a derisking framework is in place solely as a means of reducing the amount of growth assets then it does do that.
However, it is fair to say that what most schemes really want to achieve is not reducing the growth assets per se, it’s what doing so allows them to achieve. In short, it is about achieving the funding objective with more certainty as less variability is coming from the growth assets.
Indeed, while funding levels may be a focus for schemes, they ultimately need to be aware of what has driven any funding level improvement, and then be able to separate the decisions on the amount of growth assets and levels of liability hedging. This is a more sensible approach than automated derisking.
Explicitly framing the derisking journey around the end destination therefore makes the most sense. The best way to do this is to consider a forward-looking metric, specifically looking at the return required to achieve the funding objective.
After all, while schemes need to check the rear-view mirror from time to time, trustees need to ‘drive’ their schemes by looking out in front to ensure they make it to the destination on time.
Matt Simms is director, solutions at consultancy P-Solve
