Defined benefit schemes in the United Kingdom have put aside much larger collateral buffers since the LDI crisis last year with implications for how they invest. Pension funds typically stress tested their portfolios around a 3 per cent increase in gilt yields, but after last year’s gilt crisis, many funds now scenario-plan for an 8 per cent increase in yields.
“Since the gilt crisis last year, my role has focused particularly on making pension fund portfolios more resilient,” says Tegs Harding, professional trustee with Independent Governance Group.
“DB funds have put in place more prudent collateral buffers than what they had during the crisis. We haven’t been sat on our hands. We’ve got much better collateral defaults in place and we can deal with yield increases.”
Harding is chair of the investment committee at £20 billion ($25.3 billion) Legal & General DC Mastertrust and also looks after a book of seven other pension schemes including the £5 billion Diageo Pension Scheme, where she is also chair. The Mastertrust provides pensions for around 200 employers from around the UK and has around 1.9 million members.
The large yield increases in gilts last year had a huge impact on DB and DC funds in the UK. DB funds with large LDI exposure and an illiquid book had large and rapid calls for capital and needed to implement contingency plans quickly. To shore up collateral, they divested some assets and organized loans from sponsors to ensure they could maintain their hedge.
Investment strategies revisited
Harding says her role includes working with pension funds to revisit their investment strategies.
“Some DB schemes with, say, a 15 per cent allocation to illiquid investments going into the crisis, will now find themselves with a much bigger allocation (up to 30-40 per cent) to alternatives because of changes in the valuations in their portfolio,” she says.
“We work with them on how to change this.”
UK DC funds have larger collateral pools in place and are much better able to deal with yield increases that DB funds, says Harding.
However, DC funds are still navigating the impact of last year’s correlation between equities and bonds.
“On the DC side, we are focused on making sure funds have invested enough in illiquid assets,” Harding says.
“Investing in alternatives through the growth stage of a DC fund leads to better member outcomes. We look closely at Australia’s DC model where assets are made to work harder with more investment in illiquids and the local economy,” she says.
Harding says governance is getting more complex as regulation comes thick and fast, with trustees required to respond to it.
“Much of a trustee’s job is around policy setting and setting the overall ambition and objectives of a pension fund. And geopolitical risk is increasingly impacting the investment climate,” she says.
“My role is to help pension funds deal with these challenges and keep up with the big systematic risks that need managing.”
A growing element of her role involves working with pension funds on how to integrate biodiversity. She notes many pension funds began to integrate ESG with a focus on climate and TCFD reporting, but this is evolving. “Now there is a realisation that we can’t just focus on climate in the transition,” she says.
“Many companies won’t do well if we don’t tackle biodiversity too, and we must look at things holistically.”
“Professional trustees are more diversified than member-nominated trustees,” she says. “Pension funds take diversity seriously and want trustees from different backgrounds.”
“My primary role is to make sure that people get the benefits they are entitled to. I provide support on how to invest the assets and value the liabilities; check they are administered correctly and make sure employers are contributing the right amount. We also advise on investment and cyber and operational risk.”