The Shipbuilding Industries Pension Scheme has committed £220m to a liability-driven investment mandate run by Legal & General Investment Management, as it seeks to derisk and hedge against interest rate rises.
LDI has been the subject of ongoing debate in recent years as those optimistic about rate rises struggle to justify paying for something they believe will get cheaper, but experts recommend having a derisking plan in place regardless.
As we move into the current environment where returns are more difficult [to achieve], in order to get the same level of return you might have to keep more in growth assets
Alan Collins, Spence & Partners
Roger Buttery, managing director of Hadrian Trustees and a trustee of the Shipbuilding Industries scheme, said the scheme entered the mandate in July last year.
He said the scheme aimed to derisk through the investment, adding: “We wanted some coverage on interest [rate] and inflation hedging.”
Matching assets make up 35 per cent of the scheme’s overall asset allocation, comprising a mixture of bonds, gilts, LDI and cash.
Buttery added the funding level had improved, but that the funding-based derisking trigger points combined with the investment environment in recent years meant the scheme “had to be patient” in seeking improvements in the funding level.
Buttery did not provide information on the levels of triggers used by the scheme.
Stiff triggers
Persistently low gilt yields and the attendant impact on funding levels has long been a challenge for schemes using derisking triggers, as the levels such triggers require have become more and more unattainable.
Simeon Willis, head of investment strategy at consultancy KPMG, said unexpected falls in market rates had been a persistent problem for schemes using derisking triggers and LDI since around 2010.
“Then we had another step down [of rates] in 2014 and so the levels we had before began to look absurd,” he said.
“Where we are now is, we’re at record low yields again. People who had triggers set 20-30 basis points above the market level will have triggered, but a lot of schemes who had triggers didn’t have them that low.”
Willis advocated the use of a multi-dimensional series of triggers, combining funding level, market level and time-based triggers to ensure schemes derisk even when the market is unaccommodating.
“At least have a backup plan that you do some hedging over time if things don’t improve,” he said. “It’s a much more robust approach to increasing the level of hedging… irrespective of how you got there you lock in that level of benefit. The key is having a time-based bit underneath.”
LDI for growth
Alan Collins, head of trustee advisory services at consultancy Spence & Partners, said low rates and high triggers were leading schemes to consider leveraged LDI as a way of keeping a large allocation to growth assets.
“Expected returns across the board are lower and have remained lower,” he said.
“The general outlook for investment returns has been lower. As we move into the current environment where returns are more difficult [to achieve], in order to get the same level of return you might have to keep more in growth assets.”
He added: “If you use leveraged LDI you can get £10 of coverage from £3 of assets. You get the same level of coverage with less resource. You free up the £7 to invest in growth when growth is more difficult.”
However, he said the challenge is often getting trustees to be comfortable with this concept, especially if they expect interest rates to begin rising again soon.
Collins said: “There is a mindset among a lot of trustees that interest rates are at a low point and they’re definitely going to get higher. We’re not seeing a lot of evidence.”
