Derisking is a top priority for many schemes, particularly given the political uncertainty around Brexit and market volatility, reports pensions-expert.com.
Research conducted in 2016 by law firm Gowling WLG and independent trustee company PSIT found that 46 per cent of schemes have agreed a derisking strategy between the trustees and sponsor. Among those that had not agreed a risk reduction strategy, 91 per cent said it will be on the trustees’ agenda within the next three years.
Trustees of the Pearson defined benefit scheme appointed BlackRock Investment Management in September 2016 and Standard Life Investments in December 2016 to manage two new diversified growth funds.
The scheme’s £3.6bn DB section now has a 5 per cent strategic allocation to DGFs. Hedge funds, however, have disappeared from the strategy. In 2015, the scheme had a 2 per cent allocation to hedge funds.
A Pearson spokesperson said: “DGFs were implemented in the DB plan as a lower-risk, lower-cost alternative to hedge funds whilst still targeting a return larger than that of the matching portfolio.”
The spokesperson said the trustee and the company have agreed to accelerate the scheme funding, and expect it to become self-sufficient by the end of 2019.
“This is great news as the plan is very well funded and it also means that the trustee has been able to revise its investment strategy, so that there is now more focus on investments which match the plan’s DB liabilities, with less volatility and risk,” said the spokesperson.
DGFs have not delivered ‘equity-like’ returns
John Walbaum, head of investment consultancy at Hymans Robertson, pointed to the higher cost associated with hedge fund investment. “On that basis… we have seen some people cutting allocations a little bit, to try and reduce costs and moving into other areas where they feel the returns are perhaps more predictable,” he said.
With regard to DGFs, Walbaum said: “Our preference is generally for the ones… that are more granular and more active in the asset allocation.”
But Walbaum also reserved some criticism for DGFs. “The reality has been that they’ve not been that successful in many cases,” he said, partly due to the way DGFs have been marketed, Walbaum noted; while DGFs have delivered on low volatility, they have not generally kept the equity-like returns promise that helped sell them.
However, this could be a result of the way equity markets have moved, “and maybe, just maybe, these funds will get a chance to show their mettle if and when there’s an equity downturn”, he said.
Many DB schemes are attracted to the daily liquidity and relatively low cost nature of DGFs, according to Alice Lee, investment consultant at Willis Towers Watson.
Pearson scheme reaches full funding due to increased employer contributions
The defined benefit section of the Pearson Group Pension Plan has reached close to 100 per cent funding less than 18 months after agreeing a reduction in the length of its recovery plan.
However, she said this can sometimes be at the cost of diversification and long-term returns. “DB schemes often don’t need daily liquidity, and once they free themselves of this constraint... they are better able to capture a broader opportunity set including illiquid assets,” she said.
Lee noted that schemes “should consider the merits of an endowment-style approach to investing, with a focus on maximising return on capital by accessing genuine diversity — often via alternative investments — from the best providers they can find, including specialist managers”.
Can DGFs be a governance solution?
Paul Niven, head of multi-asset investment at BMO Global Asset Management, argued that “DGFs can provide a governance solution for DB schemes where the manager has flexibility to allocate across a broad range of investment opportunities in order to meet their performance objective”.
He also noted that DGFs tend to be outcome-focused and so, taking into account scheme liabilities, can deliver returns that are consistent with a DB scheme’s objectives.