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 emerging best practice.
Dan Mikulskis: Most schemes out there are dominated by interest rate and inflation risk, and the challenge is really trying to increase that basic level of hedging along the way.
The challenge of central clearing – of interest rate swaps, and possibly, in the future, inflation swaps – this year will be a big development. We are yet to see exactly what the effect of that is going to be.
Marian Elliott: An innovation that is perhaps still developing is the way in which LDI is talked about with clients and the place that it takes as part of the investment strategy. The ways trustees understand and use LDI and the options available to them need to be made a bit more straightforward and less technical.
Jonathan Crowther: In my experience, a lot of innovation comes from projects where the larger schemes seek input from a combination of banks, advisers and providers, who all view the issues through different lenses. Where these different views converge and focus, you tend to get new ideas and new opportunities. Eventually, you find the essence of many of these ideas is distilled and then trickles down to the smaller schemes.
One possible example will come from the introduction of central clearing, which may drive some initiatives. I do not know exactly what they will be at this point in time, but there will be some factors that come into play, such as efficient management of collateral or margin to reduce cash drag. Once again, I expect innovation will cascade down from the work done by larger schemes, and the techniques will filter down to the smaller schemes.
Laura Brown: The challenge providers take on is how to make those interesting, innovative strategies work for medium-sized and smaller clients, and how to make those strategies fit within the overall journey that our clients are on to derisking and buyout, or self-sufficiency in the long term.
Steve Barker: One of the most interesting changes is a move into defined contribution. Fifteen years or more ago you had LDI used for large segregated defined benefit schemes. Then we had pooled funds set up so that smaller schemes could use LDI. The smallest client we had using pooled LDI products was a £1m scheme. I think there is scope for using those same ideas for DC.
Richard Butcher: DC is an interesting one for me. I am not sure I have seen LDI yet in DC and the reason for that is very few people are actually recognising their liability. At the moment we focus on contributions and investment returns, rather than what we are trying to achieve with those contributions and investment returns. I think it will come, but I do not think we are there yet.
Elliott: Sooner or later that has to take hold, and there are enough people who think that way for there to be a general groundswell that we need to be communicating this in a much better, more sensible way to members and providing them with guidance about the likely outcomes in retirement. The problem around LDI in DC is who pays for it.
Barker: There are two main challenges – one is how you package it up so that it can be delivered in small enough parcels. The bigger issue is communication, because you have got to communicate to members that there is a liability. It is not about building up your pot as big as possible; it is about what you can afford to buy in terms of the annuity at the back end of it.
And if annuity prices fall through the floor, and their assets fall through the floor, how do you cope with disgruntled members of a scheme that, on the face of it, look like they have lost a lot of money?
Brown: In terms of solutions that are out there in the market already, if we think that the liability for DC ultimately is purchasing an annuity – which I suppose it is – some providers have pre-retirement funds which allow you to move towards an appropriate asset allocation that actually matches the annuity pricing of the top three annuity providers. So there are those kinds of products out there; I know there are not so many at the moment, and obviously continued innovation and competition will be useful.
Crowther: There are some technical challenges in delivering LDI in its current form for the DC space, simply because of both the daily pricing and dealing requirements. That facility is not readily available in the LDI space at this point in time.
Butcher: I accept there are technical difficulties but there is no reason why we have to have daily dealing in DC; it is a market-driven thing.
Crowther: There is no statutory requirement, but it is the market standard. The reason it is the market standard stems from the fact that across employers in general, payroll comes in on every day of the week and so there needs to be a facility to invest on a daily basis.
Butcher: That must be expensive.
Crowther: It can be. As providers, we have already established LDI funds for professional investors that tend to price and deal weekly, which might be adapted and could be worked upon. However, the suitability goes back to the advisory market and their appetite for what they will accept as DC products.
