Tesco chooses cash flow matching over strategic asset allocation

Speaking at the Financial Times' inaugural Investment Management Summit this week, Steven Daniels, chief investment officer at Tesco Pension Investment, said that the investment strategy was about trying to find assets the scheme wanted to hold into perpetuity.

It allows us, in effect, to throw out the window the strategic asset allocation

Théodore Economou, Cern

He said the scheme does have a strategic asset allocation due to the conventions of the industry, and that it makes it easier for sponsors and trustees to understand.

“But it is also a distraction from what we are trying to do, which is to make sure we can pay the pensions when they need to be paid, and the industry is starting to recognise that,” Daniels said. “Our trustee has definitely recognised that.”

As an example, he said they decided to move away from standard allocations to hedge funds, private equity, and infrastructure, and put in place a pot of money dedicated to alternatives.

“In what we would call the alternatives space, we buy what we want to own, for as long as we want to own them for,” he said. “And the key, in terms of strategic asset allocation, is about understanding every asset that you have and understanding the risks and returns you want to achieve." 

Speaking on the same panel, Théodore Economou, chief executive officer at Cern Pension Fund, said it has built a governance model where the only constraint is the overall risk budget, which “in practice translates into the risk appetite of the board”.

“Within that envelope, staff is free to allocate risk as it sees fit,” he said. “It allows us, in effect, to throw out the window the strategic asset allocation, which is not part of the process any more, and allows us to integrate dynamic asset allocation and adjust the asset pool to where we are in the long-term and short-term cycles.”

Cern is the European Organisation for Nuclear Research, and the organisation behind the Higgs boson particle physics research.

Economou, who is also chair of the Lombard Odier Pension Fund, said the scheme has adopted a risk-based approach that integrates five risk factors, which are tied different phases of the economic cycle. “The factors cut across asset classes,” he said.  

Lessons from the past

Daniels said the financial crisis in 2008 was very good at giving lessons in how to invest. “One of the clear things I took out of that was the need to understand exactly what we are investing for, and what are the liabilities are, and make sure any investments we make are going to help you manage your liabilities,” he said.

The Tesco scheme is a young fund, with positive cash flows for many years to come. “As a consequence of that, our need for liquidity is not huge,” Daniels said. “What is important to our trustees and members of the pension fund is to ensure that we can actually pay pensions at some distance in the future.”

The scheme is looking for a range of assets that will help them achieve this. He said: “The key thing we want to understand with any asset that we buy [is] what is the income that we expect to get in any particular year in the future and what do we believe are the risks of receiving that income.”

Daniels said by understanding those aspects the right asset mix can be created, and schemes can start to put in place some risk mitigation measures.