The COVID crisis and the volatility of 2020 has revealed some lessons for the investment team at Coal Pension Trustees (CPT). It has taken a more top down view of managing its portfolio looking at economic themes, risk exposures, cashflows and its manager roster holistically. Amanda White talks to CIO Mark Walker about where it sees return opportunities, the prospect of manager consolidation and how it has embraced technology for better investment practices.
The two pension funds of the legacy coal industry in the UK are unique in many ways. Where most defined benefit funds in the UK are looking to match liabilities in their allocations, Coal is focussed on return-generating returns. They are probably the most mature defined benefit funds in the country – having not received any new money in 26 years since privatisation of the industry – but they take the most amount of risk, all in order to meet their obligations (and with a Government guarantee sat behind the liabilities).
The volatility of 2020, combined with the fund’s approach to risky assets meant there were cashflow challenges last year. But this is not all bad news, the experience prompted the fund to leverage a new relationship with a technology company in Silicon Valley to aggregate data for an improved top-down view for management of cashflows and allocations.
The main test in 2020 was on cashflow says the fund’s chief investment officer, Mark Walker. The 30 per cent drawdown in markets came at the same time as a 10 per cent depreciation in the pound sterling, which meant the funds were “looking for £1 billion pounds in cash quite quickly to fund obligations”.
“We didn’t want to sell equities and lock in losses,” Walker says. “We had some low risk assets to use to meet cashflows – TIPS, investment grade credit, government bonds – and were already focused on cashflows as an key part of our strategy.”
The funds were facing £600+ million of currency hedge payments and all the contingent capital managers were drawing down (albeit for good reasons – there were new opportunities to make outsized returns!). And the government announced rent holidays for real estate tenants who couldn’t pay, which came into effect just before the funds’ quarterly rents were due. This meant it faced an immediate 40-50 per cent reduction in income from its UK real estate holdings.
“For two to three months it was all about finding cash, and making sure we could meet commitments, manage currency hedge payments, and make sure we had cash to pay benefits – that was our starting point,” he says. “By June everything had started to turn positive: the Sterling was appreciating again, we had positive cashflows in July from private market assets, and in September we completed on a few property sales.”
One of the funds also had some equity hedges on which it monetised at the bottom of the market, delivering much needed cash.
“It was all about cash management, and making sure we were funding commitments and planning for a more conservative situation with less income.”
The new technology has meant CPT now has its own system to aggregate and manage data to see where it is at a point in time (and reduce the number of spreadsheets used to aid decision-making).
“We have a projection tool on cashflows and can look at a granular level on individual funds in private equity etc. if we need to” Walker says. “Not only that but we’ve had access to datasets to look at what we might expect in different circumstances from drawdowns and distributions from different types of private markets managers, and how that might vary if they are median or top quartile, that has been fascinating.”
By the end of the year Walker says the volatility looked like a blip. Overall the fund received distributions of £500 million from private equity managers and sold a few properties.
“Last year was a very unusual year. It was very testing from February to April, then markets recovered really quickly. Contingent capital managers that drew down in March were already giving back money a few months later so it didn’t last very long,” Walker says.
“We finished the year well, we paid £1.4 billion out of the schemes through the year, and still ended up with more money at the end.”
But in the middle of the year, when things had settled down a bit, Walker and the team started to look at how they were going to make money in future.
Another top down consideration has been a change in the way the funds describe their asset allocation which is now in “purpose” categories.
“This works well from a governance perspective, the Trustees understand why they have the allocations, and can align the capital allocation more directly with their objectives and risk tolerances.”
There is a small proportion of assets in lower risk assets such as government bonds and everything else is in growth assets aimed at delivering returns. The growth assets are split in three ways: core public markets predominately equities; real and income assets such as property, infrastructure, ships and private credit; and “high octane” which is targeting 10 per cent per annum and includes private equity and special situations debt. Across the two funds this category has an allocation of over £4 billion, which is a pretty significant allocation.
“When we are investigating new high octane investments we might also look at a property we already own and say if we invest some money in a re-development opportunity that could make it a high octane asset. Any kind of capital allocation that gives us a big potential return fits but we still have to plan how much future exposures will be and what distributions will be and then that comes back to cashflows again.”
The funds are trying to evolve the connection between top-down strategy and the bottom-up implementation.
“Our overall view is it should be done differently than in the past,” he says.
“One of my bug bears is sometimes we’re too within asset class, trying to fit the allocations to a target and not very top down. That’s not the right starting point. Our starting point also has to integrate key themes that we believe will present return opportunities like climate, technology and Asia. More connection between the top-down strategy and bottom-up implementation is what we are trying to do. This includes being more directive and selective in where we want to take risk exposures, and then maybe more flexibility in adapting to the opportunities that come along.”
This also requires a mindset shift and an eye on the team culture in order to resist working in silos.
“We look at how we work together and understand the importance of the different inputs and how we share information and communicate, we have to be able to do that to get this working,” Walker says. “Technology is an enabler especially for us where we have such high return targets, cashflows and private asset allocations. Understanding the variables, the cashflows at a granular level and expected return scenarios has been invaluable.
“We still have a long time horizon but assets will gradually decline and being able to plan illiquid assets, which you can’t change quickly, over a long time horizon is becoming even more important to us. Technology gives us the starting point: if want to achieve x in 10 years then how much do we need to commit now, model strategy first then we can look at the granularity like individual fund selection.”
The use of technology has been a great enabler for the fund, but it hasn’t been easy to set up.
“The big thing it that it is about data to begin with, knowing where you are but you have to have the systems to manage and data organised in the right way. When we started working with the technology company we spent a lot of time organising our data. One of the pieces of cashflow data for example is the “known unknowns”, for example if a property manager says we might get some sale proceeds in a month, it’s a might, that’s not a fixed cashflow, but a known unknown, there is still some uncertainty. We have lot of those, and we need to make sure we incorporate them, so we don’t sell £50 million in equities to pay pensions when 5 days later you have proceeds from other asset sales.”
Cost and complexity
Another consideration for the funds is to examine costs and complexity.
“If you have a look at most people’s forward looking return estimates then not much looks like good value right now. One way to lose money is costs, if you pay less costs then net returns should go up, all else being equal.”
Walker and the team are examining areas where they can “think and work more smartly”.
One of those is in the manager roster where he concedes there are too many external managers.
“We need to consolidate that list and are in the process of thinking about how to do that,” Walker says. This includes asking existing managers questions about relationships and how they would manage being on a shorter list of core or strategic relationships.
“There is a lot of commonality between the two individual pension schemes but we have 225 individual accounts or direct investment positions in each, that’s far too many.”
In addition, there are 33 managers across the two funds which manage over £100 million in assets but then a whole tail of managers with less than that including another 35, typically private market managers that have mandates of £25-100 million.
There are around 170 funds and co-investments in private equity and special situations and it can be difficult to get on the roster because there is such a legacy.
“What we look for is something differentiated – if something is new that we don’t have access to it but it fits our strategies or is a niche part of the market. We are a risk taking organisation, we need to take risk to generate returns. We can’t look at everything because we are a small organisation, but if we see something that looks interesting and we haven’t already seen it there’s more chance of us taking a look.
“Hopefully with some external managers we will have a more strategic relationship in future, not just about assets under management but sharing ideas, training and a connection between the organisations to work on new things. And hopefully being able to see things in development. We also want to work with people who give us access to investments that fit our themes such as climate, Asia and technology.”
Coal has been investing in onshore China A shares since 2019 and its public equities allocation is already quite balanced between Asia and the US.
“It’s quite different to the market cap, its already more aligned towards Asia and that will stay. We also need to think more broadly around other assets beyond equities and Asia.”
The use of technology has highlighted the importance of data management and being able to coordinate it and everyone being aligned.
“We have had teething problems, but we are doing pretty well and are now thinking more about risk and position sizing at the fund level rather than mandate or asset class level. Add to that less managers and lower costs and we are moving to have more conviction and sizable positions,” he says. “It’s exciting – what a time to be an investor. I’m thinking how do we make money to meet future cashflows, that’s an exciting place, a little bit scary because the world is changing rapidly, but there will be a lot of opportunity. We have to get more right than wrong and ensure we have some good winners. The investment industry makes the job more complex than perhaps it needs to be, our job is simply to create wealth and not lose it again!”