Electrocomponents scheme invests in bespoke pooled fund

The £504.6m scheme is following a trend in asset allocation strategy that is being witnessed across the UK, as more funds look to derisk their portfolios and move out of growth assets.

The average UK pension fund had a 45 per cent exposure to equities at the first quarter of 2016, according to UBS Asset Management, compared with 64 per cent in 2006.

For an awful lot of schemes, they can just get what they want from pooled funds

Ben Gold, XPS Pensions

The electronics distributor’s latest annual report details the rollout of a trustee-led investment strategy review that took place following consultation with the company, with the aim of derisking the pension scheme’s investments.

It has adopted a fixed income-driven strategy as it chases cash flow while seeking to mitigate interest rate and inflation risk. Central to this strategy is its use of a qualifying investor alternative investment fund, which sits in a matching asset portfolio.

The fund has since been moving away from equities and diversified growth funds. The company’s 2017 annual report indicated a drop in the scheme’s DGF exposure to 22.1 per cent from 41.9 per cent.

Its equity allocation decreased to 7.7 per cent from 17.9 per cent. Its credit fund allocation also ballooned to 49.6 per cent from 3.2 per cent.

QIAIFs give control over liability management

Experts predict an uptick in schemes pursuing cash flow-driven investment strategies featuring structures such as QIAIFs.

The QIAIF is a bespoke pooled fund product regulated by the Irish Central Bank that was introduced in July 2013 to meet the requirements of the Alternative Investment Fund Managers Directive.

QIAIFs were brought into the market to replace qualifying investor funds, which were phased out after the AIFMD came into force in 2011.

The structure offers schemes the ability to design their own mandates in order to meet set goals, experts say. The Electrocomponents scheme’s QIAIF is provided by Legal & General Investment Management.

The company’s 2017 annual report indicates the removal of the scheme’s directly held exposures to government and corporate bonds of 9.7 per cent and 12.4 per cent respectively.

These were moved into the QIAIF structure, according to Rod Tanner, head of group pensions at RS Components – the UK, European and Asia Pacific trading brand of Electrocomponents.

Uncertainty currently reigns over the long-term direction of gilt yields, with political risks such as Brexit threatening the slow path of increasing interest rates.

According to the company’s report, the scheme investment strategy is ready for gilt yields to head in either direction.

The trustee has defined a benchmark for total investment in bonds, government and corporate, interest rate swaps, inflation swaps, gilt repurchase agreements and cash as part of its matching asset portfolio.

“Under this strategy, if gilt yields fall, the value of the investments within the matching asset portfolio will rise to help match the increase in the valuation of the liabilities arising from a fall in the discount rate, which is derived from gilt yields,” the report reads.

“Similarly, if gilt yields rise, the value of the matching asset portfolio will fall, as will the valuation of the liabilities because of an increase in the discount rate,” it continues.

Gilt yields have recovered from a dramatic collapse in 2016 that followed the UK’s decision to leave the EU. At the time of writing, the UK 10-year gilt yield had grown by 32 per cent over the past 12 months.

The discount rate employed by the UK scheme is set at 2.7 per cent according to the report, up from 2.6 per cent in 2017.

According to the report, the scheme holds index-linked gilts, inflation swaps and repurchase agreements “to manage against inflation risk associated with pension liability increases”.

This represents a grand departure from just a few years ago. Tanner said that in March 2015, the scheme was holding approximately 70 per cent of its assets in growth assets.

Seeking more control over its liability management, it opted for the QIAIF, which “offers us a bit more flexibility, we can structure it how we want to”, he said, adding: “I think quite a few schemes are moving to that sort of approach.”

The scheme is currently 50 per cent hedged and is targeting a hedging position of 90 per cent, according to Tanner.

“That’s something that can be managed through the LDI structure, and LGIM can assist us with that,” he said.

Shifting responsibility to the fund manager

The QIAIF represents 44.9 per cent of the scheme’s assets, according to the distributor’s latest annual report.

Ben Gold, head of pension investment, Leeds at XPS Pensions, said QIAIFs offer a solution to schemes with specific objectives in mind.

Seeking LDI or synthetic equity exposures are common reasons for using QIAIFs, he said, describing the structure as sitting “halfway between a pooled fund and a segregated account”.

Synthetic equities have been viewed by schemes as another way of reducing investment risk. Last year, the pension scheme of housebuilder Taylor Wimpey converted its physical equity investments into a synthetic, volatility-dampening exposure.

It combined a volatility-targeting mechanism with downside protection delivered by put options to manage the scheme’s risk. The scheme has since reached full funding.

“By doing it in a QIAIF as opposed to an out-and-out segregated account, it means that the fund manager is effectively responsible for some of the operational aspects that would otherwise become the trustees’ responsibility under a segregated account,” Gold said.

He added, however, that schemes “have to be looking to achieve something you can’t achieve in a pooled fund”.

“For an awful lot of schemes, they can just get what they want from pooled funds, they don’t need to create something that’s specific to their circumstances,” he said.

Cash flow is becoming king

Described by some experts as “the younger sibling of LDI”, the search for cash flow has grown in importance as aggregate net contributions to UK private sector DB schemes continue to decline.

Last year, analysis by consultancy Spence Johnson predicted net DB contributions would drop to -£23bn by 2025.

Jignesh Sheth, investment consulting director at consultancy JLT Employee Benefits, said he expects more schemes to adopt cash flow-driven strategies.

“You can build a portfolio that is expected to pay all your benefits by combining corporate bonds along with gilts and some liability-driven investment techniques – you can see that you can take a lot less risk today and have a lot more certainty of meeting your pension benefit obligations,” he said.

“This is a strategy which… has been around for a while, but it’s only really picked up steam in terms of what schemes are considering more recently, and I think we’ll see a lot more of it,” Sheth predicted.

Electrocomponents prefers time-based approach over triggers

Subsequent to the Electrocomponents scheme’s 2016 actuarial valuation, which revealed a deficit of £60.8m, the sponsor agreed to make minimum yearly contributions between £4.3m and £7m plus inflation until February 28 2023, according to Tanner.

In the year to March 31 2019 the group anticipates contributing £10.4m to its UK scheme, including £7.5m of shortfall contribution payments.

The company is a member of the FTSE 250 index. Last week, new research found that FTSE 350 companies are now in the strongest position to support their defined benefit schemes since the 2007-2008 financial crisis.

Simon Cohen, head of investment consulting at Spence & Partners, said many schemes will have triggers in place that will prompt revisions in investment strategies, in response to improved funding levels.

These triggers are “very bespoke to a particular client,” he said, adding that they are commonly “based on funding levels [and] based on gilt yields”.

Tanner confirmed that the Electrocomponents scheme does not currently employ funding triggers, preferring a time-based derisking approach. He added that the scheme has no plans for imminent changes to its investment strategy

“We have looked at triggers, but haven’t put anything in place just at the moment, but we might do should we deem it necessary,” he said.