Cover story
Schemes’ ability to respond to the crisis also depends a lot on their maturity. For local government pool LPP, which unlike many defined benefit (DB) schemes is still open, the recent vol- atility could offer buying opportunities. Chief investment officer Tomlinson stresses that with liabilities in excess of 20 years, the scheme has the opportunity to take a long term-view on the crisis and invest. Nevertheless, he remains cautious, arguing that the dip might not have reached its trough yet. For PPF chief investment officer Barry Kenneth, holding a cash buffer has become a key element of downside protection. The scheme has been overweight on cash for more than a year. With relatively high funding levels prior to the crisis, the scheme could afford the expense of holding cash, which it then put to use by buying investment grade-debt at high-yield spreads throughout March, Kenneth says. BT’s Francis also increasingly sees a merit in holding cash. “I have been talking about this internally for a while, the option- ality of holding cash has been is now quite attractive. With as- set classes yielding so little anyway, the cost is also not that high. Having cash has allows allowed us to invest in corporate bonds at much more favorable rates,” he says. While holding cash and investing in falling markets has played out well for some schemes, it can play a role in offsetting some of the systemic factors that have contributed to a decline in liquidity and increased volatility, says LGIM’s John Roe. “You could just say schemes are buying cheap assets but what this is really about is providing access to cash at a time when every- body wants cash,” Roe says. He adds that his team increased the credit holdings in some of its portfolios by 7% to 8% throughout March. There is, of course, an element of danger to such interventions as default and liquidity risks are rising. Roe argues that spreads between credit default swaps and cash instruments can pro- vide an indication of the liquidity premium. “They both pro-
vide access to the same credit name but one of them you need liquidity for because you need to pay for the bond, the other one, credit default swaps, is an unfunded instrument, so you don’t need liquidity to access it,” Roe says. “When you see the spreads between the two widening, that is an indication of the liquidity premium.”
While markets appear to have reverted to relative normality, investors harbor no illusions, volatility is likely to become a recurrent challenge for institutional investors. Many pension schemes have already factored this into their portfolio strate- gies, either by reducing equity exposure, implementing hedges or holding additional cash reserves.
Whatever decisions individual schemes take to manage their volatility, they will have to strike a careful balance between the best interest of their members, and how their investments impact overall levels of volatility.
In the high yield space, we will be looking at defaults. That’s not something we have been used to in the last few years.” Stuart Trow, European Bank for Reconstruction and Development
Issue 93 | May 2020 | portfolio institutional | 25
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