Determining a pre-defined strategy and committing to it is the key to dynamic de-risking, according to executives at Mercer in Canada, who are seeing a lot of interest in the strategy, but hesitancy in implementation.
The initiation of any big change begins the minute the decision to do it is made. This is true, also of the decision by pension plans to de-risk. Further, the decision comes with a commitment which is essential to the successful implementation of the strategy, according to Robert Stapleford, principal and leader of Mercer’s investment consulting business in central Canada.
“If you don’t have upfront commitment, then there is no buy-in of the philosophy of derisking,” he says, and this has implications for the implementation of the policy.
As with many plans Stapleford says it is a clear two step process: long-term policy setting; and implementation.
“There is lots of discussion at the policy level, but not as much activity on the execution side,” he says. “If the policy issue is to de-risk then dynamic de-risking is one of the approaches. There are still a lot of funds addicted to the equity risk premium so there is still a struggle there, a hurdle to get over.”
If a fund does decide to use dynamic de-risking as a strategy, then partner and leader of Mercer Canada’s retirement, risk and finance professional group Scott Clausen (pictured) says a commitment up front to the idea is essential.
“The strategy requires almost daily valuations of those triggers – you need to capitalise quickly and can’t miss the opportunity, which you will if you have to go to the board with decisions,” he says. “There needs to be a plan set in place with the board. It is a big change so you want commitment up front.”
The idea of dynamic de-risking is it provides plan sponsors with a framework to help define and target an endgame, but also to provide them with a roadmap to get there. In particular many funds may want to de-risk, and even terminate their plans, once they reach full funding.
To achieve this, plan sponsors can execute a “glide path” investment strategy to capitalise on risk reduction or risk transfer opportunities as they arise.
Typically the de-risking of the investments of a plan occur with pre-determined events, such as funding levels, the investment environment or time, acting as triggers which dictate changes in asset allocation.
While setting and sticking to the strategy is a key first step, the plan of some funds falls down as they lack the implementation expertise.
Mercer argues it is in a unique position when it comes to dynamic de-risking as it can bring in liability management, specialised actuarial expertise, as well as the ability to execute the glide path trades because it has investment management capabilities.
Heather Cooke joined Mercer in November as business leader implemented consulting and dynamic de-risking and she says the firm marries all the aspects of pension management in its service.
“It’s about looking at taking a glide path over time and integrating more equity allocation to fixed income, using market gains to fund that shift, and marrying asset and liability sides,” she says.
The fund needs to pre-define a trigger, which may be a certain funding level, which sets a change in the asset allocation. For example she says at a 70 per cent funded level the asset allocation may be 60:40 but the long-term aim is to get to 20:80 as the funding level increases.
“It might take 10 years but the aim is to better match liabilities. Instead of doing it in one shot which has a point in time risk, this is gradual. It’s like a lifecycle fund for an individual on a plan level,” she says.
“From an automation and execution level Mercer looks at those triggers daily. The pre-defined rules of engagement and pre-coded strategic work are done up front. If you do that, you understand your strategy and what you want.”
Clausen says there is no real advantage to accessing the equity risk premium if a fund is fully funded.
“Funds are paying more attention to it. They used to do asset and liability matching every three years, now they are looking at their funding status quarterly.”