Coronavirus crisis shines the spotlight on fiduciary management

Back then, the fiduciary market was in its infancy, with fewer than 100 UK pension schemes delegating to managers and with less than £20bn worth of assets.

Today, there are about 1,000 pension schemes using fiduciary solutions, representing roughly £200bn worth of assets. The coronavirus pandemic has therefore been the first major test for fiduciary managers — so how have they navigated their portfolios through this major market drawdown? 

Both equity and credit markets registered serious losses during the first quarter of 2020. While equities do now seem to be following the V-shaped recovery many economists predicted early on, credit market performance has been more divergent, with investment grade recovering more strongly than high yield.

Putting a pre-made emergency plan into action during the height of chaos is far easier than trying to form a plan when everything starts spinning

Illiquid assets have not provided much relief either, as strict lockdown measures have prevented managers from going out to value properties, for example. With trading suspended in some funds, there has been a considerable level of stale pricing within these markets.

Meanwhile, interest rates — a key determinant for pension scheme funding levels — are down, meaning liabilities are up. 

These gloomy market conditions were not good news for defined benefit funding levels. The pandemic bulldozed its way into nearly every asset class, meaning there has been little room for portfolio diversification to lower risk and preserve capital. 

Nobody escapes a crisis completely

It is important to point out that no one was immune from this crisis. Nobody had a crystal ball advising them to entirely derisk their portfolios before the markets plummeted.

During the first quarter of 2020, there was a heightened level of activity from FMs. A report by XPS Pensions showed that 75 per cent of FMs had made short-term “tactical” asset allocation decisions during the period, either to take advantage of opportunities in the market, or protect assets from further depreciation.

A common theme was the purchase of investment-grade credit at the end of the quarter, capitalising on favourable yields following credit rating downgrades.

Performance in the first quarter varied between different FMs, with an average difference of 10 percentage points between the highest and lowest returning portfolio. However, in the round, FMs have hedged more of the liability risks coming into the year and have fared better as a result. 

Keep calm and allocate on 

While the full impact of the pandemic on portfolio performance will not be known for some time yet, this strange period has importantly highlighted FMs’ ability to be nimble, to get together virtually and make strategic decisions quickly.

For example, we reduced our weight to equities in February, before the significant market correction that followed, and added back exposure selectively in March in anticipation of a potential market recovery supported by unprecedented central bank action and fiscal easing. 

The crisis has therefore stressed the importance of using times of relative market ‘peace’ to plan for possible turbulence.

Trustees all have different return expectations, constraints, risk appetites and are at different stages of their journey; however, decisions on investment strategy, hedging and asset allocation need to be much more dynamically managed.

Managers have taken the disappearance of the physical office space in their stride and kept up communication, ‘meeting’ throughout the day if needed to discuss news flow updates and make measured changes to tilt portfolios accordingly. 

Furthermore, having predetermined funding triggers has shown to be an effective risk mitigation strategy. FMs can monitor funding levels daily and implement swift changes to asset allocation to protect schemes from severe bouts of market volatility.

Ultimately, putting a pre-made emergency plan into action during the height of chaos is far easier than trying to form a plan when everything starts spinning, ultimately leading to better decision-making.

Current market views and positioning

The policy of containing the virus may have reached its limits. Second waves have led to lockdowns being reimposed or easing delayed in the US, the UK, Spain and France. Several emerging market countries are suffering badly.

Despite the second waves, the US economy in particular has been doing well. Europe, which once looked set to speed past the US, has slowed a little.

But the general picture is of a global economy that is recovering well, and that feeds through into corporate earnings, where the once-bleak outlook is now brightening.

Against this background, we retain a small overweight in equities and investment-grade credit.  

Within equities, our greatest preference is for US equities, which has been a persistent theme for some months due to technology leadership and policy support. We are more cautious on UK equities due to ongoing concerns regarding dividend cuts.

Within fixed income, a preference for investment-grade credit is the key view — driven by policy support for the asset class — with a less constructive view on government bonds.  

Next steps for trustees

The global political landscape, trade wars and monetary policy are all still factors driving asset allocation but it is probably no surprise that the virus will be the main signpost for asset allocation going forward.

There is plenty more news flow to come in the way of possible second waves and a vaccine, and how these could affect a return to more normal levels of consumption.

Now more than ever, trustees should try to understand their portfolio’s strategy. Aiming to improve the funding level may be the ultimate objective, but there is real value in getting to know the FM behind the portfolio and understanding their philosophy.

By doing this, trustees are better able to engage with their FM on decisions and ensure that their manager and underlying strategy remain the right choice for them.

Christy Jesudasan is director for UK institutional fiduciary solutions sales at BMO Global Asset Management