Baptist scheme pulls DGF for global infrastructure

The pension scheme also plans to offer defined contribution members an ethically invested default strategy.

The introduction of an allocation to global infrastructure within the DB fund’s portfolio was driven by a desire to boost diversification and access long-term returns.

Funds that have used that relative-value approach as a large component of their return have really struggled

Simeon Willis, XPS Pensions

The decision to remove a DGF manager was due to performance issues.

Changes during the year were not limited to the DB plan. Following discussions with advisers and lawyers, the trustees have decided to offer an ethically invested DC default fund.

Real assets, which include infrastructure and real estate, remain one of the most popular forms of alternative assets among European pensions, according to Mercer’s 2018 European Asset Allocation Survey.

However, multi-asset strategies, including DGFs, are seeing by far the largest average allocations. The survey shows that the average allocation to these strategies was 19 per cent, compared with 8 per cent for real assets.

Between 2006 and 2016, DGF managers mostly performed in line with a typical yearly objective of Libor plus 3 per cent, but failed to keep up with global equities, according to consultancy KPMG.

Alan Pickering, chair of professional trustee company Bestrustees, said: “A number of trustees are feeling a bit bruised at the moment, since some diversified funds have provided downside protection, but they haven’t provided the equity-like outperformance that the label suggested we might expect.”

According to the multi-employer scheme’s 2018 newsletter to churches and other participating employers, “over the course of 2017, changes have been made to the scheme’s investment strategy in order to further improve the scheme’s balance of risk and potential reward”.

The main step taken was to introduce an allocation to global infrastructure, “to increase the diversification of the scheme’s investments and access assets offering an attractive long-term return”.

This investment was made by reducing the scheme’s exposure to DGFs and corporate bond investments, given that the overall bond allocation had increased above target.

“During 2017, and over a five-year period, the overall return on our assets has been slightly behind the average of the managers’ targets,” added the newsletter.

It said the main areas of relative underperformance were liability-driven investment funds and DGFs, partly offset by strong performance from the corporate bond manager.

The investment committee “has decided to remove one struggling diversified growth manager”.

DGF performance could see improvement

Simeon Willis, chief investment officer at XPS Pensions, said: “A lot of schemes are looking at what their DGFs have done and asking, ‘Have they been invested in the right place?’”

In theory, Willis said, “if the equity market goes south, then you’re expecting that the complementing assets that are in the fund as well will protect you in that situation so you won’t be hit on the downside”.

DGF managers tend to pursue one of two different strategies. Some allocate across a variety of different asset classes with a view that diversification will ultimately provide the benefit that is needed, and remain exposed to the ups and downs of markets.

Other managers take a relative-value approach, minimising the impact of market movements and rewarding manager skill.

“What we’ve seen is that the funds that have used that relative-value approach as a large component of their return have really struggled,” Willis said, explaining that they have missed out on the upswing of equities.

Ultimately, it is not that DGFs have failed. In the context of around a nine-year equity bull run, “you wouldn’t expect DGFs to have kept pace with equities… but it has highlighted some of the issues with expecting performance to be generated without taking that equity exposure as well”, Willis noted.

Adam Porter, investment research associate consultant at Hymans Robertson, agreed. He said DGF performance relative to equities should improve over the coming years if there are periods of sustained market volatility, especially where equities suffer significant sell-offs and volatility is closer to long-term historical averages.

“Investors, particularly defined benefit pension schemes, looking for attractive returns that offer significant diversification benefits alongside equities, now have a wider range of potential asset classes to invest in, so the relative attractiveness of DGFs has fallen,” he said.

He added that infrastructure is one asset class that has benefited from the struggles of DGFs through increased allocations.

The Baptist Pension Scheme has followed this trend with its decision to invest in global infrastructure.

According to Porter, pension funds seeking high levels of return over stable income should look to higher-returning types of investment, such as value-add or opportunistic strategies. However, he noted that this comes with higher expected levels of risk.

“Pension schemes with an income requirement should consider safer, more core infrastructure allocations where the income return dominates the total return. Some core infrastructure strategies also make smaller allocations to value-add and opportunistic infrastructure investments,” Porter added.

Ethical default for Baptist scheme DC members

The Baptist Pension Scheme trustees have also decided on a significant investment change to the DC plan.

The employer newsletter states: “The scheme’s investment advisers and lawyers confirmed that the scheme could offer an ethically invested default investment strategy for members of the DC plan.”

Up to this point, ethical investment strategies have only been available to those members who select them.

“These have proved a popular choice so the trustee is now working with [its] advisers to design a new default strategy on this basis,” the newsletter stated.

It added that these changes to the default strategy may not be introduced until later in the year or early 2019.

Jon Parker, director of DC and financial wellbeing consulting at Redington, said ethical investing “is driven by the beliefs – really the non-financial beliefs – of either a trustee board or a particular group of members within a pension scheme”.

He said: “Trustees of DC schemes can absolutely base their investment strategy on the beliefs of the membership.”

However, particularly with regard to the default strategy, “there has to be some strong evidence that that belief set is held by the majority of the members within that scheme”, Parker noted.

Concerns over low employer response rate

The Baptist Pension Scheme has more than 1,200 participating employers.

In 2016, the Baptist Union of Great Britain announced that it had established an employer group to develop a strategy for plugging the scheme’s deficit.

This employer group and the trustee of the DB scheme have submitted their recently agreed 10-year recovery plan to the Pensions Regulator and have been notified that no action is necessary to revisit the plan from the regulator’s perspective.

The group is currently reviewing the financial data supplied by many of the employers to help it establish the strength or otherwise of the employers’ covenant.

However, it has raised concerns over certain employers failing to submit the information.

“At the last request for information, only 75 per cent of churches and related organisations had submitted the information requested, even after reminders were sent out,” the employer newsletter stated.

It added that, while supplying information to the trustees is not a direct responsibility of the employer group, the group has expressed concern about the response rate.

“Any lack of information supplied weakens the employer covenant and could weaken any negotiations with tPR in the future,” it warned, urging employers to provide the information sought when the pension trustee next asks for it.

David Davison, director and owner of Spence & Partners, said this problem is quite common.

“What you’re trying to do with a multi-employer scheme, is you’re obviously trying to come up with a covenant for the scheme as a whole, effectively, which is the amalgam of the financial strength of all the organisations that are in there,” he said.

Once this is identified, the trustees can then assess what level of risk can be taken, and what discount rate can be used. Employers who do not respond are likely to be the smaller ones with a potentially weaker covenant.

“They probably have to make an assumption, which will probably pull the overall covenant assessment down, which obviously then has an impact in terms of contributions for everybody,” Davison noted.

If the covenant strength of those employers that had not submitted information was stronger than that assumption, it would mean that the discount rate could have been higher and contributions might have been lower, with a better funding position.

The way information is gathered is important, and a lot depends on what information is being asked for, and how easy it is for organisations to comply, Davison noted.