De-risking – Cover story


“Last month interest rates changed by 30 basis points in just one day,” he adds. “Those are the sort of things that lead you to believe that if you want to get anywhere near a buyout, you want to fully hedge your interest rate and inflation exposures. “Realistically, for schemes that are not fully hedged, buyout has moved a bit further away, unless you have a benign sponsor who is prepared to put more money in. I do not see many sponsors doing that in the current environment,” Wesbroom says. Another way to cover the shortfall might be by increasing the investment return targets in the liability-driven investing (LDI) portfolio, Pickering says. “Schemes that are a little further away from a buyout may be reviewing their asset allocation and looking at the leverage within that LDI portfolio to decide whether there are other near cash assets that might provide a little extra return and could get them even closer to their destination more quickly.” Pickering believes that there are now opportunities to move from the cash element within the LDI portfolio to credit or near cash with varying degrees of longevity. Obviously, you have to avoid an expensive round trip. “You would not want certain asset classes that you could not get in and out of within a few months because of costs. But these are opportunities to bring forward the time when you can affect a risk transfer,” Pickering adds. In Pickering’s experience, schemes looking to position their port- folio for a buyout would not necessarily have to mirror the portfo- lio of the insurer. “It is rare for schemes these days to transfer in specie. You might want to mirror what the insurer will be doing, but there is no guarantee that the insurer will take your assets in specie,” he says, adding that liquidity and avoiding high entry and exit costs should be the key priority.


“The aim is to get the sweet spot between the premium from going slightly away from cash without increasing the round trip,” Pickering says. For Visavadia, a key problem with planning a buy- out deal is the opaqueness of pricing. “My biggest concern is that I can understand what markets are doing and where my invest- ments are going but I just do not understand the pricing mecha- nisms insurance companies have. It is a dark world and there is no transparency around it,” he says.


“It is not clear whether I need to hold 100% or 110% of my techni- cal provisions because the price changes almost every week and we cannot track it in any meaningful way,” Visavadia adds. “Another problem is that as schemes are better funded, the sup- ply-demand equation changes, and as demand for buyouts goes up, the price goes up and that might mean that none of us can afford it. The opaqueness of the pricing of buyout deals is really uncomfortable,” he adds.


Packed lunch But a buyout is by no means the only option on the cards, and it is the most expensive way to deal with outstanding liabilities, as most trustees are well aware. They have to target the most pru- dent funding level, factoring in the insurance premium they would have to pay for disposing of their liabilities. And trustees, by nature, have to be frugal. Their priority has to be the financial interest of scheme members, rather than that of the sponsor or insurance company. This means that on the journey towards the endgame, the home-made sandwich, also known as self-sufficiency, still trumps the slightly more expensive pre- packed meal deal, also known as buyouts. Almost half (44%) of pension schemes are planning for self-sufficiency, compared to 34% for a buyout meal deal, according to Mercer. Perhaps more importantly, the share of those planning to pick up their lunch along the way, also known as technical provisions, has dropped to 22% from 34% in three years, according to Mercer’s latest de-risking survey.


One explanation for slowing growth is the emergence of pension consolidators such as The Pension Superfund, Clara and, more recently, the master trust jointly launched by Abrdn and XPS Pensions. Visavadia, Wesbroom and Pickering admit that this pooled lunch, to stick with the sandwich metaphor, is now an option on their cli- ents’ agenda. “We need to start thinking about the endgame dif- ferently,” Visavadia says. “As trustees, there are choices available to us and consolidators are one possible option. Not everybody is going to aim for a buyout. We need to keep an open mind, espe- cially when employers are seeing buyouts as quite an expensive proposition.”


It is rare for schemes these days to transfer in specie. Alan Pickering, BESTrustees


Fast forward Regardless of which de-risking option trustees choose, the defin- ing factor remains that the current market environment might bring the end of the DB scheme era forward, Pickering predicts. “DB schemes that are already closed to further accrual will want to transfer as quickly as possible, particularly those with overseas parents,” he says. “At one time, US employers did not like the idea of journey planning, they just wanted their assets to sweat. Whereas now, they increasingly find that by hanging onto a closed DB scheme, they are carrying an unrewarded risk.”


Issue 112 | April 2022 | portfolio institutional | 19


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