Interview – BT Pension Scheme

Generally, we take a corridor approach where there is a central path to de-risking with boundaries around it. That means we move in a general direction, but we can adjust the pace at which we move along that central path. But yes, it is dic- tated by the maturity of the scheme rather than by a specific view on assets.

So, you now have a higher exposure to fixed income? Yes. Over the past five years we have gone from 60/40 matching to 40/60. That path is continuing. As part of that, our strategy targets cashflow-aware investments, like secure income, corpo- rate bonds…it is looking at our liability profile. As the scheme matures, those lia- bilities become more predictable.

How do alternatives fit into that strategy? It depends on what alternatives you are looking at. Our focus is on private credit. We also run exposure to private markets in general and have some private equity and infrastructure in our portfolio. Our real focus is on morphing some of our

existing exposures away from

property, for example, where there has always been capital appreciation. We are working with our managers to target income streams that fit our cashflow matching approach and our cashflow cov- erage ratios. It is transitionary.

You are a relatively mature scheme, so is liquidity playing a bigger role for you now? It has been prominent for us for a while. We spent some time looking at our liquid- ity profile about five years ago when we first started our hedging programme. Liquidity means different things over dif- ferent time periods. We are always think- ing about short-term liquidity to generate our pension payments when they fall due. But it is important that we are doing so in an orderly manner. We do not want to sell assets to fund pension payments, so we are trying to build natural liquidity in the portfolio to meet those payments.

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Which asset classes are internally man- aged and which are outsourced? Our starting position is that we outsource. There are instances where we believe we can do something more cost effectively or with a better outcome than doing it inter- nally. The main area for that is around lia- bility-driven investment (LDI). We only run our £17bn gilts portfolio in-house, in conjunction with our overlays. The markets team manages the LDI port- folio and is able to increase or decrease exposure across the five main market risk factors to which the scheme is exposed: rates, inflation, equity risk, credit risk and currency risk.

Bringing the gilts in-house was a decision we took because of the size of the expo- sure. We needed to better control how that was implemented. We took the view that if we brought it in-house and moved away from a benchmark approach, we could use liquidity pockets in the market and work with certain banks to pace the speed of the hedge. That has worked well. One of the things that worked for us is that coming out of 2009, regulation changed for the banks and not many of them were warehousing much of their risk. There were a handful of banks that realised that if they worked with us, we could take risk down on one side, while they were able to line up transactions on the other, throwing off inflation and some interest rate exposure. It meant that we developed strong relationships with banks that knew we could hold prices and take down the risks over that period. It was rare that we would line up, say, three banks and ask for the best price. We knew we needed to be smarter in how we accessed that market. It meant we were not your standard pension fund price taker. We were able to trade at more opti- mum levels.

When we spoke in May last year, you were planning to reduce the overall number of actively managed mandates. How is that working out?

When the mood music starts changing, it will be interesting to see how markets are

going to respond.

This is something we have been doing for about five years now. Back then we proba- bly had more than 40 relationships with managers. Over time, we have brought it down to between 20 and 25. The reason was twofold. One was that by having so many mandates, we felt we were washing out a lot of the active management in them. We felt we could drive a harder negotiating bargain with larger and fewer mandates and that has worked well. The second angle was that we wanted to develop deeper relationships with some of those managers, which has also worked well. We have replaced some of our passive exposures to more active exposures. This goes back to designing defensive portfolios. The one thing we try to avoid are aggressive sell-offs – that is where we want to outperform. We do not mind giv- ing up some return on the upside, but it is the sell-offs that hurt the scheme, particu- larly if our liabilities are suffering from lower rates, which tends to be the way it works out. In working with more active managers, we have been better able to

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