As global stock markets crash, Pippa Stephens looks at how some schemes have derisked through dramatic moves out of equities and into bonds
Centrica and Standard Life have both moved more than 15% of assets out of equities into bonds over the past year, as both schemes considered the changing demographic profile of their membership.
Shifting investments into fixed income is growing in popularity, two recent reports have shown, but should be combined with other strategies to effectively derisk, scheme management teams have been warned.
Asset allocation decisions should also be based on funding levels, rather than solely on the state of the equity markets.
Analysis by sister title Pensions Week found UK defined benefit (DB) schemes would have lost more than £34bn – or 4% of their total assets – as a result of the crashing global stock markets last week.
But since the market turmoil of 2008, schemes have been increasingly turning their backs on equities in favour of less volatile forms of fixed income to safeguard their assets.
A new report by LCP assessed the options for schemes looking to derisk in light of DB closure to new members and the anticipated “cost and administrative complexity of auto-enrolment”.
LCP noted the average proportion of assets invested in equities decreased from 45% to 42% during 2010, for schemes with December 31 accounting end dates.
The Investment Management Association’s annual report noted a decrease in total invested in equities from 47% in 2009 to this year’s figure of 43% – which, it revealed, represented 38% of the UK domestic market’s capitalisation.
Centrica's experience
David Byrne, pensions manager at Centrica, explained the company wanted to remove some of the risk and volatility from the funding of the scheme, as the demographics had changed since the last valuation.
“The investment policy in place prior to the derisking was based on fewer pensioners and deferred members than we have now – so some form of derisking is appropriate to match assets and liabilities,” he said.
He agreed it was a big switch for Centrica, as the company was effectively stating it expected less return from equities. He added its future service contributions would have to increase.
“We’re looking at a whole range of alternative investments to diversify risk as well. We do a lot of swaps to hedge against inflation and interest rate changes,” he revealed.
Byrne advised other scheme managers to discuss clearly with their sponsor any intentions to derisk as it was a case not of simply deciding whether to or not to, but working out whether the employer had the appetite to have higher ongoing costs in return for less volatility.
Amit Popat, partner at Mercer, stressed switching from equities to bonds should only be a part of a larger derisking strategy and was dependent on the funding level of a company. He said Mercer was encouraging schemes to derisk at the moment, but added schemes able to were in a privileged position.
Other derisking options
Assessing the scheme structure, closing it to future accrual and considering enhanced transfer value exercises are all other forms of derisking which should be considered alongside switching from equities to bonds.
But Popat said schemes should consider any asset allocation decisions based on the impact on their funding level, rather than solely the valuation of the equity markets.
This would include any changes to gilt and corporate bond yields, which are used to calculate scheme liabilities.
Assets should also be monitored more regularly than on a quarterly basis, Popat stressed.
A second round of quantitative easing (QE) could discourage pension schemes from derisking due to the potentially negative effect on gilt yields, although Byrne said QE was “not the issue”.
“It is more to do with trying to take out some of the uncertainties in scheme funding,” he added.
The survey by LCP also looked at several notable risk transfers during 2010 – such as British Airways, IMI and GlaxoSmithKline – which all purchased buy-in bulk annuity policies, designed to insure against the investment, inflation and longevity risks for a group of their pensioners.
It predicted similar activity during 2011 due to improved funding levels and current insurer pricing, which made it more likely a transaction could take place without the need for a cash injection from the company.
