What your scheme could learn from the PPF's approach

The PPF's results come amid a backdrop of deteriorating funding ratios for many DB schemes.

Data from consultancy JLT Employee Benefits last month showed the collective pension deficit of FTSE 250 schemes stood at £12bn at the end of 2014, up £5bn on the previous year.

The PPF’s funding level improved to 115.1 per cent at March 31 2015, from 112.5 per cent in 2014.

Source: PPF

Returns delivered £4.5bn to the fund over the year, as well as £1.1bn from new schemes entering the PPF and £0.6bn from levy collection. However, it attributed the improvement primarily to its investment strategy. 

They do think of themselves much more like an insurance company in how they look at risk and asset categories

Paul Kitson, PwC

Adapted risk approach

The PPF has recently hired a chief risk officer and restructured its risk functions to more closely resemble those in the banking and insurance industries.

Paul Kitson, partner at consultancy PwC, said: “They do think of themselves much more like an insurance company in how they look at risk and asset categories, buffers against risk and managing risk.”

Calum Cooper, partner at consultancy Hymans Robertson, said many schemes work on a more conventional approach to risk and could benefit from adopting the PPF's approach.

"Many schemes are still working on an old-school growth and matching asset-type approach," he said. "The insurance company portfolio typically wouldn't hold any growth assets, they would have income assets and protection assets."

Cooper said an asset allocation of 20 per cent government bonds and 80 per cent income-generating assets could expect an annual return of gilts plus 1 per cent – the equivalent of the expected return from a portfolio of 40 per cent equities and 60 per cent bonds.

He said 20 per cent in "physical protection assets", or gilts, could be used to buy 100 per cent balance sheet protection against changes in interest rates and inflation using a liability-driven investment strategy.

They hedge all their liability risk 100 per cent. The average scheme won’t have hedged as much so they will have taken a loss on their liability

Gavin Orpin, LCP

"An average UK scheme could invest like an insurer today," he added.

Gavin Orpin, partner at consultancy LCP, said high levels of hedging were key to the PPF's success.

“They hedge all their liability risk 100 per cent," he said. “The average scheme won’t have hedged as much so they will have taken a loss on their liability. All [the PPF] have to do is outperform cash.”

Hybrid strategy

Last year, the lifeboat fund updated its statement of investment principles and announced a move towards a “hybrid asset allocation strategy”, in which it would allocate more capital to less-liquid assets that provide excess return and liability-matching properties.

The first of these investments was made last year with the purchase and leasing of a large office building in Central Manchester.

Writing in the fund’s most recent annual report, chief investment officer Barry Kenneth, said: “Overall positive returns have been seen from most of our strategies without being strongly driven by a single asset class,” with return-seeking assets generating 7 per cent during the year.

The report cited global government and corporate bonds, public and private equity and real estate as strong performers.

In the statement, Andy McKinnon, chief financial officer at the PPF, said: “The greatest impact on our financial position has been the increase in the value of our liabilities caused by falling interest rates...

"The matching effect of our investment programme has acted to mitigate this and contributed a further £1bn to the surplus.”

However, McKinnon added: “The external environment and universe of schemes we protect continue to present challenges”, which was reflected by a change in the fund’s probability of success to 88 per cent in March 2015, down slightly from 90 per cent the year before.