Royal Mail Pension Plan – Interview
Anything over 0.5 is phenomenal, any- thing over 1 is dreamland. A Sharpe ratio of more than 2 means that you are in fantasy world. To achieve a Sharpe ratio of 3 was like nothing I had ever seen. Our Sharpe ratio is currently around 2, and that is stag- geringly good. We are very pleased with how the programme has gone. That is why it has been so successful. We had a great hedging strategy and a gold dust portfolio that just kept giving as it has evolved over the past eight years. It is also important to remember that markets were forgiving and whatever asset you were in went up, to varying degrees. But to man- age that out-turn in such a risk-controlled way is something I am proud of. Remember the scale: Royal Mail’s market capitalisation is today just over £3bn and since its flotation its profits each year have been a few hundred million pounds. We oversee pension assets for the group of the order of £14bn. If we had put that all into shares which then dropped by their standard deviation of 18% you would almost have lost the market value of the entire business.
We would not be getting any Christmas parcels next year…
Quite. That is why risk management is such a crucial part of a scheme like ours, which is much larger in scale than its sponsoring business.
How has your broader asset allocation strategy played into the performance? As mentioned earlier, for the old Royal Mail section more than 80% of the assets are in the hedging portfolio, which includes gilts and collateral backing the hedge. The rest is in this cash-plus return seeking portfolio. As it is, because we are effectively fully funded, we do not neces- sarily need massive amounts of return in future. Of course, being fully funded also means that we can afford to take a modest level of risk to get better returns for our members, but we remain on a de-risking journey.
There are two options when you get to that. You can do what the Post Office did and say we have such a healthy surplus that we will seek an insurance deal that gets rid of not just the interest rate and inflation risks but also the mortality risk. But there is always a cost attached to pur- suing this option and for the Royal Mail section these costs could be high as it is an immature scheme, which only stopped accruing in 2018. Most defined benefit schemes only have pensioners to buyout, which are relatively cheaper. In the case of deferred members, such as those in the old Royal Mail section, you are talking about double the insurance costs. The alternative is to manage the assets on a self-sufficiency basis like an insurer would and keep that premium for your- self. What then also happens is that the basis on which insurers price this deferred maturing pension liability reduces over time. So, for us it may be cheaper to wait. However, such ultimate de-risking deci- sions are considered frequently by our trustee board with input from the sponsor. To be concerned about insurance pricing is quite a luxurious position to be in. For the 12 months to June, our hedging assets for the Royal Mail section increased by 21%, that is £10bn-plus two. Our return seeking assets over that period were pretty much flat, slightly down even. Overall, af- ter fees, assets grew by 17% to the end of June. That was driven entirely by the reduction in the real yield from -2.1 to -2.5, so it is simply the noise of the interest hedge going up and down. We can go plus and minus £1bn in short order, with the assets going up, but so do the liabilities and therefore the funding position is largely immune to the movements in long-dated interest rates. But the return seeking is what makes the difference to your real surplus or deficit. Since 2012, our return seeking portfolio has achieved 6% per annum [time weighted] on 2.9% volatility. As we de-risked significantly during 2019, the money-weighted return achieved would be greater than this.
How was your portfolio positioned going into this year? The Royal Mail’s DB section has been largely de-risked. We took all the equity ex- posure out last year, turning a third (£1bn) of it into cash. So, on a money-weighted basis it has done tremendously well. We went into the year holding quite a lot of absolute return funds [e.g. macro hedge funds], very short duration on cred- it, private debt and property. We also have some pseudo-hedging assets
in infra-
structure debt, but they sit somewhere in between the return seeking and hedging element of the portfolio. So, we were effectively long cash and macro funds, which included some of our best perform- ing portfolios, two places where you wanted to be and underweight on the place where you didn’t want to be in the first quarter: the liquid stock market. Sim- ilarly, when listed equity markets started picking up we did not get any of that, but bonds and the absolute return assets per- formed well too in that period, so it has been a decent year. We are restructuring our portfolio and over the next few years will be moving further towards self-sufficiency.
The new DBCBS section, which manages around £1bn, is much more ambitious in terms of seeking returns. Its purpose is to generate these lump sums, which it tries to increase each year. For its first 12 months it gave the inflation-plus increase. But the DBCBS section of the portfolio has a higher equity exposure, bearing in mind that this is a big risk, there is a cap on the amount of risk we can take, and the target return is set out in its trust deed.
That sounds different from a DC scheme. It is. DBCBS is totally different to the DC scheme in that the pension lump sum which scheme members accrue each year is guaranteed. If we achieved an inflation- plus increase, which we did this year, then they will also get that increase to the lump sum they receive upon retirement. The design of it is clever, a bit like a with-prof-
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