Barker Tatham's Steve Barker, PTL's Richard Butcher, Spence's Marian Elliott, Legal & General Investment Management's Laura Brown, Axa Investment Managers' Jonathan Crowther and Redington's Dan Mikulskis discuss schemes' first steps in the market.
Dan Mikulskis: The fundamental reasoning for implementing liability-driven investment within most schemes is to ‘right-size’ the risks being run by addressing interest rate and inflation risk. You tend to often meet with misconceptions saying, ‘Rates are low, surely they can only go up and surely I am only going to lose money in this approach.’
There are responses to that - LDI is not focusing on short-term rates. We are looking at longer-term rates which are currently building in significant interest rate rises. People are quite surprised when you explain how steep the interest rate curve is and also the extent to which carry and roll-down affects their liabilities as well.
The fundamental way it is approached has really remained exactly the same as always although the challenges evolve, given the market environment that we are in.
Marian Elliott: There can be a temptation to try to call the market and say, ‘Oh well, rates will increase,’ or, ‘Equity markets are going up, we should be part of that,’ – and that is not necessarily a trustee’s job. It is very difficult when that is the start of a conversation, to convince someone that the best thing that they can do is to hedge risk.
When you move the conversation around to, ‘What are you trying to achieve here? What are the risks that you are really trying to mitigate? What are the real-world risks? What would happen if your contributions went up to this level and what impact would that have on the sponsor?’
When you start looking at it in much more of a ‘probability of achieving your objectives’ way then that is a much more constructive conversation and can lead to a better decision being taken in terms of the investment.
Laura Brown: With schemes that do not currently have a specific LDI strategy as such, but hold some kind of bonds or gilts, we are seeing a sense that LDI is the next step on a journey to using those gilts in a more efficient way to reduce more of the risk.
So there is quite a simple story around that; you already have 25 per cent of your assets in gilts, which provide some hedging, so we can restructure those in a sensible way that actually gives you more hedging for the same amount of cash by using derivatives. That seems to be a good way of communicating it to people who might be a little bit unsure about the dynamics.
Steve Barker: Something that has surprised me is how open-minded trustees are about LDI, particularly the smaller schemes that I deal with. Eight or nine years ago when pooled LDI funds became available – which made LDI a discussion that was worth bringing up for small schemes – I thought, ‘Brilliant, this is a solution that really works well and it should be a no-brainer,’ but I was a
bit sceptical about how easy it would be to explain how they work.
But I have only had two clients that we have ended up recommending using pooled LDI funds [that] have decided not to because they were scared off.
Jonathan Crowther: If you were setting up a pension scheme you would never start from where we are today.
However, despite the complexities of how we got to our current starting point, pension schemes are working hard to develop a much better idea about where they ultimately want to end up.
Once you know your desired destination, LDI is simply how you look at your assets and liabilities together, in order to plot the best route to this destination, bearing in mind the time you have available and the extent to which you can tolerate veering off course in pursuit of a possible shortcut.
We have found that talking with schemes about these issues is the best way for them to get comfortable with LDI.
Richard Butcher: I am the consumer, but we do have to bring on board the employer, and you should not underestimate the need to be able to carry them along with the trustees on this. We firmly believe the delivery of a pension scheme’s objective is a team effort – the employer, trustees and service providers – everyone is going in the same direction.
Quite often the barrier is not the trustee – I think trustees are willing to take advice. It is the employer, the finance director in particular, who says, ‘Well, I read the FT every day so I know the interest rates are going to go up and I think the stock market is going to fall.’
Barker: A lot of finance directors, even in small schemes, are used to interest rate swaps, and they are used to the idea of, ‘If we have got an exposure to our company, that is an unrewarded one and we want to get rid of it, we will use derivatives to get rid of that risk.’
Applying that same thought process to pensions comes naturally to a lot of finance directors. I have often found finance directors of companies have been very supportive and actually helpful.
