TfL Pension Fund – Interview
Actually, we have increased our hedging by a significant margin to lock in the ben- efits we have seen on our liability side, and it seems that we are again going against the crowd. We didn’t hedge when others were happy to do it at almost any price, and now that the price is right, we have upped our hedging ratio when oth- ers are trimming or are unsure. In those past 10 years, when real rates were down and falling, it is not that we forgot about hedging but that we focused more on proxy LDI assets such as infra- structure, UK PFI
investments and
renewables to some extent. We bought these proxy LDI assets at attrac- tive levels to build our hedges, but since September shifted our focus to classic LDI hedging using traditional LDI instru- ments. In a nutshell: we have ended up in a much better position post the LDI crisis.
Is this ambition to lock in the gains also based on an assumption that interest rates may have peaked?
Who can predict rates? Where they are today are not too far from the triggers we established years ago. Depending on which duration one wants to choose, rates are fairly well priced and consistent with our long-term assumption, so it makes sense for us to increase the hedge ratio.
By how much? We were in single digits but now we are in material double digits. We are also quite mindful of liquidity risks and are main- taining healthy collateral buffers. We don’t know where the rates might go from here, so have to be prepared for all eventualities.
Timing the market is always a dangerous game, isn’t it? Exactly. We only wanted to time it the moment it aligned with our long-term return requirements and real rate assumptions. We are not trying to time it tactically but it was getting quite difficult when real rates kept falling.
But increasing your hedges at this time is quite bold? I wouldn’t call it bold; I would call it pru- dent risk management which is consist- ent with our long-term beliefs.
You have ambitious interim targets to reduce the carbon in your portfolio. How is that going? We have definitely been bold here. Our target includes a 55% reduction by no later than 2030 and 100% no later than 2045. This applies to our entire portfolio, including
alternatives, which are the
trickiest assets to decarbonise. These are early days for our equity and bond portfolios where the carbon foot- print is down by 35% and 33%, respectively, compared to our 2016 baseline, improve- ments that are well ahead of the reduc- tions seen in our benchmark. So more is required, but things are going in the right direction. Generally, our green investments are up from nearly nothing to close to £250m. Again,
it’s not just about what you
shouldn’t own, but about what you should proactively own. My trustees strongly believe that it is as much about investing in the opportunities in the transition space as it is about risk managing climate exposed positions.
If I look at our fossil fuel exposure, the trend is down but last year it was up on the back of a strong price rally, so there is some way to go here, but in a considered and responsible way.
One thing I keep thinking about, and it applies to all pension funds, is that 10% to 15% of our holdings contribute 80% to 90% of our carbon exposure. These are energy-intensive sectors. We know where the problem is and that is where the opportunity for engage- ment is. We don’t want to sell the assets and see them falling into less responsi- ble hands. We are trying to achieve two things: one is to reduce our allocation to companies that are not willing to change. The other is to
increase allocation to companies and
asset classes which are part of the solu- tion. For both, engagement and collabora- tion are an important part of our toolkit, but they can only be deployed if you stay invested.
Finally, what do you expect to see in the markets during the remainder of 2023? Clearly 2022 was a huge challenge. Infla- tion surprise was the real villain, crushing almost every asset class. We have definitely reached peak inflation, but what I’m not sure of is that we are anywhere close to what the central banks would love to have, which is inflation at 2%. Markets have priced in that rates will tail off and then fall, but the economy and earnings would remain okay. There is this struggle in getting the right balance between rate hikes and inflation without killing growth. That will be the main problem for this year and some of the market expectations on rates, inflation and growth are premature and over optimistic. Some investors are starting their celebra- tions a bit too early. I hope I’m wrong and they are right, but we have to be mindful that the risks remain quite real.
What does this mean for pension funds? We tend to think in decades. And the past 10 years were exceptional in terms of returns. It ranked right at the top invest- ment decile on any metrics. But the next 10 years will not be anything like that. The world is different with geopolitics and supply chains a lot more disconnected, and many secular tailwinds risk becom- ing headwinds. That means we must be even more mindful of diversification and risk management.
The good news is that many schemes and endowments are in a good funding posi- tion, so at least we are starting the next 10 difficult years on a strong footing and therefore don’t need to take as much risk as we would have taken in the past decade and be handsomely rewarded for it.
Issue 124 June 2023 | portfolio institutional | 15
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