Santander focuses on rewarded risk

“I’ve had easier weeks,” says Antony Barker, managing director and chief pensions’ officer of the £9.7 billion ($12.8 billion) Santander UK Group Pension Scheme, the defined benefit scheme for employees of the UK arm of the Spanish-owned bank, speaking the week after Brexit. But there was no suggestion that Barker was anything but prepared and poised to benefit from the UK’s decision to leave the European Union.

“The immediate impact of Brexit on the asset portfolio has been largely positive – gilt yields have depressed dramatically, but fortunately we increased our hedge ratios significantly and synthetically during the preceding weeks. Equities have recovered most of their initial losses, and as many of our mandates are global, unconstrained approaches, active management and a weakening in Sterling will have enhanced returns. Our real estate portfolio is tilted away from prime office accommodation and the private markets exposure is largely US dollar denominated. The themes in the portfolio were global ones, so the referendum result changes very little.”

It’s a robust position and “can-do” attitude, grounded in reforms that Barker introduced four years ago, when the fund shook off the stigma of being “a legacy HR problem” to become “a key business division of the bank,” innovating, demonstrating value for money and good governance.

The conservative investment portfolio of passive equity, index-linked gilts, and other conventional bonds was swept away for a more diverse risk-on investment strategy, combined with a reduction in overall risk by hedging the fund’s liabilities.

“We see two types of risk: unrewarded and rewarded,” Barker says. “We divide the opportunity set into economic or rewarded risk, and duration risk, which includes longevity and inflation and which is unrewarded, so hedged out at the best possible price. We identify the underlying investment thesis and then establish the best rewarded asset class to gain the exposure. It’s true that you can’t get more return without taking risks, but simply taking more risk doesn’t guarantee greater returns.”

Last year physical assets such as property and alternative investments were the portfolio’s best performing, with the $1.5 billion property portfolio posting gains in excess of 20 per cent net of acquisition costs and duties.

And it’s private markets where Barker has brought most transformation. Here investments are driven by individual stock selection considerations rather than macro level economics, he says.

The portfolio comprises global growth investments that Barker expects to double, or more, in value over a five-to seven-year period, even if economies and markets are stagnant. He focusses on smaller to mid-market opportunities and avoids speculative, highly geared or structured investments.

All direct acquisitions in private markets are driven by a theme or the “next big idea.” It could be in technology and digitisation; the ageing world or urbanisation and new consumer classes emerging in developing markets.

That’s entertainment

The fund has explored an entertainment theme with the acquisition of the Manchester Arena and The Brewery; another entertainment venue in London.

Barker likes the African middle class story, where changing consumer habits and technology take-up are creating opportunities in food distribution and mobile. In addition an energy theme doesn’t just stop with renewable generation, but includes energy consumption and transmission investments.

“A number of the strategies that we have in South America are looking at distribution of US-generated shale gas over a wider sphere.” Cybersecurity and handling big data is another theme.

“We recently invested in the leading company tracking epidemic diseases such as Ebola, which sells on their research to governments and insurance companies,” he says

And Barker believes Santander has the edge over other investors when it comes to off-market acquisitions.

“The reputation of pension funds is very much one of jilting people at the altar; we talk a good game, we have lots of meetings, but then we fail to come up with the goods at the right time. In off-market transactions, people want deal certainty.”

It’s something Santander can offer with cash in the bank and an ability to execute deals quickly.

“We have a longer time horizon than most, and having worked out how much cash we need to pay benefits over the next few years we can take on more complex projects and find extra value in ‘hairy deals’ needing true active management to extract that value.”

And he is quite prepared to put the work in to transform assets into a finished product. In today’s low return environment, improving the assets and then selling them on is proving a winning strategy.

Commercial property – so hot right now

“As the commercial property sector has been seen as increasingly hot, we have taken the opportunity to sell lower quality holdings at a very full price through a pro-active sales strategy, reinvesting the proceeds in new assets with demonstrable embedded value.”

Barker is a strong advocate of collaboration and shared services, linking up with other pension schemes in a variety of operating models, designed to enhance governance and execution and allow mutual participation in the best ideas.

It’s a strategy illustrated in Santander’s stake in Hermes’ infrastructure vehicle seeded by the $36.5 billion BT Pension Scheme.

Under this partnership, the Hermes fund has developed a number of renewable energy investments, as well as acquiring port sites. Most recently, Santander’s segregated account program supported Hermes’ successful bids for Eurostar and AB Ports.

And Barker is equally happy to collaborate with managers. In both private equity and the hedge fund space, Santander takes stakes in the managers so that the fund gets returns, both from a pay-off on its own investments and also from the broader success of the manager’s business through the cycle.

“In return for our investment, we enjoy a share of revenues in both the underlying fund managers and the selection business, doubling our return on the market beta exposure alone,” he says.

In private equity, the fund has worked with managers to create a low-fee fund of co-investments and a fixed fee non-discretionary account, where the manager brings due diligence, specific research and execution to ideas generated by either Santander or third parties. He also encourages more collaboration across the manager roster; for example the real estate managers work with private equity managers.

“This has reaped dividends in making ideas better, investments more profitable and execution more feasible. While good advice is always worthwhile, money paid away in fees is money that could go to pay pensions,” he says.

“The experience of pension funds generally over the past 20 years has not been good, and yet the appetite for change and innovation has been curiously limited, constrained perhaps by consultant and asset manager vested interests. If you always do what you’ve always done you’ll always get the same result.”