Trustees of the Manchester University Superannuation Scheme have adopted a new liability-driven investment strategy, while dropping a UK equity mandate in favour of global equities.
Total UK pension fund exposure to LDI grew to £741bn from £658bn between 2014 and 2015, according to KPMG’s 2016 LDI survey. But given that this derisking has concurred with falling bond yields, schemes are also focusing on how to generate income.
What they’re looking for is more diversification and potentially greater returns
Vassos Vassou, Dalriada Trustees
A newsletter to members of the university's £494.3m superannuation fund states that “in July last year, the scheme was in the process of introducing its liability-driven investment strategy”.
It explained that “this aims to match 40-50 per cent of the scheme’s liabilities against movements in interest rates and inflation”.
During the year, the scheme also invested £162.8m in a new global equities allocation, having removed its £149.8m exposure to UK equities.
Heather Mawson, head of pensions, said the scheme “started investing in LDI as part of a programme to reduce risk”.
The move to global equities was made “to remove the UK bias, increase the diversification of the equity holding and thus also to reduce risk”.
Why schemes go global
Many schemes have been making the move from UK equities to global equities as part of an ongoing trend over the past 10 to 15 years, said Colin Cartwright, partner at consultancy Aon Hewitt.
Given that the UK index is dominated by a number of very large global companies, “there isn’t a great deal of diversification”, he explained.
Investing only in UK equities means “you’re missing out on a number of industries that are underrepresented in the UK”, including large technology companies such as Google, Netflix and Amazon.
Moving to global equities allows schemes to compare companies with others in their industry, regardless of their geographical listing, he said.
Similarly, Vassos Vassou, senior trustee representative at Dalriada Trustees, said that when a scheme switches from UK to global equities, this “implies to me that what they’re looking for is more diversification” and “potentially greater returns”.
He said that holding LDI to more closely match liabilities, “frees up the rest of your portfolio to seek extra returns”, by investing in equities, for example.
Coping with rising yields
While Vassou said he considered LDI a good strategy, “it is there to lose you money when your liabilities go down, so there will be cash calls potentially in future that those trustees will need to meet by selling other assets”, he explained.
However, “that aspect of it isn’t something that’s [at] the forefront of the mind of a lot of trustees at the moment, because of the way gilt yields have moved… but at some point it has to go the other way”, he added.
Simon Bentley, head of LDI client portfolio management at BMO Global Asset Management, said that while yield increases could cause collateral problems for schemes, “there’s an increasing popularity in packaging growth strategies with LDI to just completely eliminate that governance burden” when producing cash to top up the LDI assets.
Source: Manchester University Superannuation Scheme
For example, “you can invest £100 in your LDI portfolio and hedge £300 worth of liabilities, which means that you’ve got £200 left to invest somewhere else in growth assets”.
However, “what that does create is the risk that we have to top up that £100 collateral pool”, Bentley explained.
Leicester Uni scheme cuts risk with higher hedge
Following closure to future benefit accrual, trustees at the University of Leicester Pension and Assurance Scheme have decided to double its hedge, as experts emphasise the importance of keeping an eye on triggers and cash flow.
He said trustees are usually more concerned about this from a governance perspective. “They understand that it’s an essential and useful part of the strategy, but [they] are just a little bit concerned about having to sort out paperwork and move money around at short notice”.
One of the reasons why some schemes have been dissuaded from investing in LDI is the possibility of yields rising.
Rob Scammell, senior LDI portfolio manager at fiduciary manager Kempen Capital Management, said: “If you were to allocate to LDI currently, and yields were to go up, you would make a loss on the assets within the LDI portfolio.”
However, “it’s also worth bearing in mind that the value of the liabilities would also go down, and this is the point of a hedged portfolio… it’s supposed to mirror the liability stream”, said Scammell.
