Interview – National Grid
other an almost 5% allocation to that asset class. That is simply a reflection of where the scheme is in its journey. It also means that the weighting to LDI-type assets, whether that’s gilts, buy-and-maintain credit or buy-in transactions, is clearly a huge part of the overall asset allocation.
You might not have been too affected on the equity side by the volatility we saw in March, but being invested in equities still comes with challenges, doesn’t it? As discussed, we changed the composi- tion of the equity portfolio about a year ago. In terms of risk management, there are a few levers you can pull. One is how much you invest in equities and the other is the structure of your equity portfolio. We felt that an approach which is a com- bination of quality and low volatility would make sense. In times of crisis, this could mean that we would fall slightly less than a traditional market cap bench- marked portfolio would. That will, hope- fully, enable us a smoother journey in terms of de-risking. That worked, but if markets recover quickly, we will most likely be lagging compared to where the market is.
You also mentioned active independent thinking. Does your equity portfolio have a high active share compared to market cap- based benchmark indices?
There is a lot of expertise available in the market, but, in the end, you need to make up your own mind on what will work for the trustees. If you just follow what is in vogue you will run from one strategy to another and that is something we try to avoid.
Informed, independent thinking to me also means keeping our eyes open and having a dialogue with these experts. We then establish to what extent it makes sense for us and for our trustees to use that expertise. At the same time, if you do things differ- ently to the market then you need to be
20 | portfolio institutional October 2020 | issue 97
transparent with your trustees and, pref- erably, the sponsor as well. They need to understand why our way of doing things is differentfrom common practice. To give you an example, we pay a lot of attention to what we call dynamic asset liability management, where we regularly update our expectations for the market and reflect that in the scheme’s asset allocation. With that approach we do not have a benchmark, so it’s not like we have a set strategic asset allocation. What we do have is a set of approved assets that we can invest in and a set of approved ranges within which we can allocate along with other risk tolerance limits. Within that framework it is up to us to set the asset allocation, which is not measured against a traditional benchmark but to gilts+ ‘something’. Secondly, we try to determine all the pos- sible asset allocations one could establish within those ranges and risk limits, and how we performed against these other potential asset allocations. That is not an approach which is used a lot in the UK but is something the trustees were happy to accept.
Has this dynamic asset liability manage- ment approach been formed due to the maturity of the scheme? Not necessarily. It is probably something that is more common in the Netherlands than the UK. We have this asset liability management focus, but it is also about being aware of the limitations of such an approach, where you try to be nimble and not to overestimate what you do. Most schemes would do an asset liability man- agement study every three years, but it requires a lot of ‘forecasting’ expertise to set a fixed strategic benchmark for the next three to five years and not update it in the meantime.
Our approach is a bit like a satnav where you update a journey when you hit a traf- fic jam. We have our target destination and then we update our journey to reflect
where the market is in terms of risk and expected returns.
What are the limitations of a more conven- tional approach?
When you set out to do an asset liability study every three years it requires a lot of comfort with your assumptions and, as we know, markets change all the time. So, you assume that you know more than you can know whilst an approach like ours means being aware that you cannot know everything. If you travel from London to Paris, Madrid, Germany, the Netherlands or wherever, you set out your expected journey and the satnav provides you with the ability to adjust your journey as you go along. You might be stuck at Dover because of traffic jams. That is why this approach where we update our assump- tions more regularly in a structured man- ner hopefully will increase the probability that we reach our destination on time.
Recalculating the route, so to speak? Exactly. That is one aspect, but we also have a more traditional investment risk analysis which is like a motor manage- ment system. Whilst you are driving, you need to be aware of if you have enough petrol or are low on oil. The two in combi- nation should hopefully mean that you arrive at your destination safely.
This approach might be more suited to highly volatile markets?
Risk is such an intriguing topic. While we care about risk but less about the volatility risk which you can recoup from, we are mostly concerned with what’s outside those ranges. Where there is a risk that you will not be able to recover, the risk of ruin, is what we also try to establish.
In what scenarios would you not be able to recover?
This could be in an asset liability context where something might happen to our assets. If that has a mirror effect on our liabilities, then we would prefer it not to
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