United States equities and real estate were the strongest suits at the $26-billion Hartford-based State of Connecticut Retirement Plans and Trust Funds (CRPTF) out of an entire portfolio that posted 11.6 per cent in the fiscal year ending June 2013.

Now the manager of Connecticut’s six retirement plans and nine trust funds is developing opportunistic strategies across the portfolio, as well as its alternative asset allocation.

It’s an approach focused on seeking investments that generate cash flow and strategies to protect the fund from rising interest rates against a backdrop of underfunding, with the biggest plan in the CRPTF portfolio, the Teachers’ Retirement Fund, only 55 per cent funded.

“Given our funded ratio, we need to make up ground and keep pace with achieving our targeted returns,” says Lee Ann Palladino, chief investment officer at the CRPTF, who joined in February 2005.

Explaining the challenge ahead she says: “It is a question of looking in the rear view mirror in terms of the portfolio value lost as a result of the market declines associated with the recession, and looking ahead to muted returns in the short-to-medium term horizons.”

Reducing equities in favour of alternatives

Following a 2012 review of asset allocation, CRPTF now has a 48 per cent equity allocation, reduced from 52 per cent, and a 20 per cent allocation to fixed income, pared from 25 per cent and comprising core fixed income, inflation-linked bonds, high yield and emerging market debt.

Connecticut’s private equity allocation is unchanged at 11 per cent, but it has increased its real estate allocation to 7 per cent and has 8 per cent of the portfolio in alternatives, with the remainder in a liquidity fund.

“Over the course of the last fiscal year, we have been overweight equities and this has been positive,” says Palladino. “Our plan is to reduce equities in favour of our alternative investment portfolio, going forward.”

As well as reducing its fixed income allocation, Connecticut will reposition the allocation to better “protect the principle and earn cash flow”.

Palladino explains: “Cash flow generation is a key element of our strategy given our plan-participant demographics. We have reduced allocations from US fixed income and treasury bonds to high yield debt. We also seek strategies that have a high component of cash flow within private markets such as secondary private equity, mezzanine debt and credit opportunities.”

She says the fund will use less constrained bond funds and hedging strategies to help protect its US fixed income portfolio against rising rates.

Real and diverse

Real estate is a particular focus for the fund in its search for cash flows. The portfolio, which returned 10.2 per cent in the fiscal year 2012-2013, is benchmarked against the National Council of Real Estate Investment Fiduciaries Property Index (NCREIF Property Index) and is focused on every sector, from retail and industrial to hotels and real estate investment trusts, looking particularly at “beaten down and value add areas”.

Palladino says that although the portfolio only invests in the US, it is diversified with a split between a core portfolio, accounting for 40 to 60 per cent of the total allocation, a value-added portfolio, an opportunistic portfolio and a publicly traded portfolio. Investments encompass externally managed separate accounts to limited liability companies or limited partnerships with a focus on professionally managed commercial properties and land.

The fund’s boosted real asset allocation, sitting within its alternatives, global inflation-linked and real estate portfolios, will offer diversity away from equities and fixed income and hedge against inflation.

Here the emphasis is on energy, global inflation-linked bonds, commodities, agriculture, metals and timber, says Palladino. The alternatives portfolio also includes an allocation for opportunistic investments such as dislocated European credit.

“We are long-term investors and committed to our diversified asset allocation strategy,” says Palladino. “However, we strive to be more nimble in these ever-changing markets and have built in flexibility across all asset classes, and in public and private markets, to allow opportunistic mandates.”

These mandates will employ more flexible investment guidelines versus the benchmarks and allow for short and intermediate opportunistic positioning, she says.

Equities exposure

Connecticut’s domestic equity allocation, invested in its mutual equity fund and benchmarked against Russell 3000 Index, is primarily passive. Developed-market international stocks also hold “a meaningful passive allocation” as does the fund’s core US fixed income allocation.

All other public market allocations are active. “Our philosophy for active or passive management is based on efficiencies of the market, the ease of replicating the benchmark, cost and the ability of active managers to add value,” she says.

Developed-market equity exposure, via its $5.6-billion developed markets international stock fund, benchmarked against MSCI EAE IMI, is 65 per cent active and includes an overlay that hedges 50 per cent of the currency exposure.

“This is a sizeable portfolio and we were concerned about our exposure to short-term currency fluctuations,” says Palladino. “The strategy has added 240 basis points to overall returns given the rise in the US dollar.”

The overlay is currently managed by Insight Pareto Investment Management. In other portfolios, such as emerging markets, foreign securities remain unhedged because of the smaller allocations to these markets. The overlay can be managed passively or actively, depending on opportunities in the marketplace, she says.

Connecticut’s private equity portfolio returned 9.5 per cent between 2012 and 2013.

The largest allocation is to buyouts but investments include early, mid and late venture capital funds, acquisition and restructuring funds, mezzanine debt funds, turnaround and distressed funds. Target returns vary between a 400-to-800 basis-point premium net of fees above the 10-year average annualised return of the Standard & Poor 500.

Palladino says primary funds are the predominant investment vehicle, but Connecticut also invests via secondary funds, funds of funds and separate accounts. Investments are diversified according to their vintage, geography, industry and strategy, she says.

Palladino’s internal team is made up of seven investment professionals and all assets are externally managed. “We are not entertaining any move in house; we are happy with how it is working,” she says. For now the focus is on clawing back lost ground and meeting an 8 per cent state legislature-set rate of return. “It will keep us on our toes,” she says.

CalPERS has adopted 10 preliminary investment principles following a board offsite in July, but a number of topics, including the role of active management, are still under debate ahead of the September board meeting that is the deadline for the principles’ adoption.

The $266-billion Californian fund began the process for establishing investment principles in January and the workshops have been guided by Towers Watson.

While many of the draft investment beliefs could be described as more generic investment-related principles – such as CalPERS articulating its investment goals and performance measures and ensure clear accountability for their execution – the fund has also adopted a unique view of its fiduciary duty.

Anne Simpson, director of corporate governance at CalPERS, says it has wrapped a new framework of economy around the fund, including three forms of capital.

Specifically it states that “long-term value creation requires effective management of three forms of capital: financial, physical and human”.

“We have some old-fashioned economics to ground what we’re doing and why sustainability matters,” she says. “It is ground-breaking stuff this investment beliefs work. We want to be engaged owners. This is a transformation, it’s like the oil tanker turning around.”

Questioning duty

In the past CalPERS chief executive Ann Stausboll has also been vocal in questioning the fiduciary duty of pension funds.

At the Ceres conference in January 2012 she said the fiduciary duty of pension funds should extend to issues outside the parameters typically understood as being directly related to beneficiaries’ financial interests.

Stausboll said it is a fiduciary duty of investors not only to manage risk and look for opportunities associated with climate change, but also to push for business and government action to tackle environmental and sustainability issues.

“We’ve made enormous progress in just the past few years, but we need to keep up our continued engagement with companies and policymakers to help advance the transition to a sustainable global economy,” Stausboll said.

“As fiduciaries, it is our job to make sure investors, businesses and policymakers are responding aggressively and creatively to the risks and opportunities associated with climate change and other sustainability issues.”

This sentiment has now been reflected in one of the draft principles to come out of the July offsite: “CalPERS investment decisions may reflect wider stakeholder views, provided they are consistent with its fiduciary duty to members and beneficiaries”.

Woven right through

Simpson says the fund now has a goal of integration for sustainability, which is a long way from the “scattered initiatives” of a few years ago. “The thinking is woven right through,” she says. “We are thinking about future members and pensioners and encouraging managers to do the same.”

CalPERS will also be pushing its managers further on cost and disclosure issues.

Another principle is that “costs matter” and as part of this all costs should be transparent. But Simpson points out that this is difficult in the private asset classes. “In these asset classes there is no disclosure of carry. We are pushing the thinking on this.”

 

The July draft

The 10 investment beliefs, listed below, required a “super majority” or two thirds of the board votes, to move forward for consideration or adoption at the September investment committee, at which the fund’s investment beliefs will be finalised.

Since the April investment committee workshop, a number of topics have required additional discussion, that will continue until September. The issues for further discussion are: active management, investment performance targets and alignment of interests, the approach to integrating sustainability into investment decision making, and risk management and measurement.

The fund, which returned 12.5 per cent for the year to June 30, 2013, outperforming its benchmark by 1.5 percentage points, is also doing its triennial asset liability study.

Here are CalPERS’ draft investment beliefs asthey were in July 2013.

  1. Liabilities should influence the asset structure.
  2. A long time-investment horizon is a responsibility and an advantage.
  3. CalPERS investment decisions may reflect wider stakeholder views, provided they are consistent with its fiduciary duty to members and beneficiaries.
  4. Long-term value creation requires effective management of three forms of capital: financial, physical and human.
  5. CalPERS shall articulate its investment goals and performance measures and ensure clear accountability for their execution.
  6. Strategic asset allocation is the dominant determinant of portfolio risk and return.
  7. CalPERS will take risk only where we have a strong belief we will be rewarded for it.
  8. Costs matter and need to be effectively managed.
  9. Risk to CalPERS is multi-faceted and not fully captured through measures such as volatility or tracking error.
  10. Strong processes and teamwork and deep resources are needed to achieve CalPERS goals and objectives.

This policy memorandum from the Paulson Institute describes the current state of the Chinese pension system and offers some suggestions to address a range of issues.

The author, veteran academic and policy wonk Robert Pozen, discusses the key challenges facing the Chinese pension system, examines the causes of each of these challenges and puts forward proposals to address them. The paper focuses primarily on one of the four subsystems that constitute the sprawling Chinese pension system, the Urban Enterprise Pension System, which covers urban workers who are mainly employees of large private and state-owned enterprises.

The problems China faces in providing for its elderly are not entirely different from those in the developed world – ageing populations, increased life expectancy and insufficient funding. However, there are some doozies that have uniquely Chinese characteristics, such as the one-child policy, the mobility-hobbling household registration system and the pension system’s administrative and geographical fragmentation.

The refreshing take of this offering is that, unlike the noisy partisan nature of pension fund discourse in the real world, it comes up with sensible, well considered solutions to the extraordinarily complex issue of caring for our families. Take the time to read Tackling the Chinese pension system.

Oregon State Treasury, which runs $80 billion worth of state investments including the $62-billion Oregon Public Employees Retirement Fund, is preparing the portfolio for a new dawn.

John Skjervem, chief investment officer of the treasury’s investment division, sees the speed and extent of the recent sell-off in fixed income as “a shot across the bow” that the benign bond environment is coming to an end.

“The secular bull market in bonds, over three decades old now, is over,” says Skjervem, who joined Oregon last November from Northern Trust Group, the Chicago-based bank.

He’s just overseen an adjustment in asset allocation at the fund to better protect the portfolio against inflation and the anticipated lag in bond market returns.

Newly approved asset targets include a 20-per-cent allocation to fixed income, pared from 25 per cent, a 37.5-per-cent allocation to public equity, down 5.5 per cent, an increased 20-per-cent allocation to private equity, an increased 12.5-per-cent allocation to real estate and 2.5 per cent each to absolute/return, commodities, infrastructure and other real assets, to which money liberated from bonds will flow.

The tweaks to Oregon’s asset allocation also show the fund unwinding investments it put in place to capitalise on dislocations created during the global financial crisis. These adjustments better reflect today’s changing economic climate, explains Skjervem.

“As the 2008-2009 crisis unfolded, Oregon increased its exposure to credit-sensitive fixed income, which subsequently generated several consecutive years of strong returns. But financial markets in general and credit markets in particular have recovered, so we think now is a good time to unwind at least part of that bet.”

He applauds his predecessor’s initiative and perseverance since these credit-sensitive investments benefited greatly “when spreads compressed by over a 1000 basis points” after the financial crisis. Now he believes the strategy’s risk-return profile is “no longer as attractive” and the tactical element of the strategy has largely “played out”.

Eye on the ball

Although Oregon was hit hard by the financial crisis, Skjervem says it was these kinds of strategies that helped the fund recover well. The board and staff didn’t “blink and commit the ultimate sin” of selling risk assets into a bear market.

Instead, led by Skjervem’s predecessor Ronald Schmitz, who now serves as chief investment officer for the Virginia Retirement System, the fund made tactical credit investments, specifically in high yield bonds and bank loans.

“I think it probably took real courage to increase the fund’s credit-sensitive exposure and buy all the way through the bear market.”

Warming to his theme, Skjervem explains that Oregon showed the same fortitude with its private equity allocation. It got board approval to actually increase its commitment in one particular case by providing rescue financing. It was a strategy, he says, that has “been vindicated by the generous private equity returns we’ve recently enjoyed.”

The fund currently has a 22-per-cent exposure to private equity, overweight its increased 20-per-cent target allocation but in “a fast and furious” stream of realisations this will soon fall back to target. Oregon was the first investor in private equity manager Kohlberg Kravis Roberts in 1981.

Back then a seminal investment when the industry was still in its infancy via a leveraged buyout of a local retailer generated six times multiple. “This was the beginning of what is now a big and robust private equity portfolio,” says Skjervem.

It’s an expertise that now informs all the fund’s private market allocations, like its newly increased 12-per-cent real estate portfolio, what Skjervem describes as Oregon’s “other success story”. To ensure the corresponding returns exceed liquid public-market alternatives, Skjevem applies certain criteria.

“First, we need to see evidence of a return premium net of fees and transaction costs and second, we need confidence that this premium will persist over time. Finally, we need access to top managers in these markets to make sure we actually capture these persistent return premiums. Medium private-market returns are usually no better than the liquid public-market equivalents.”

Getting to the real

Money from the reduced bond portfolio will be portioned to real assets, including infrastructure. It’s an asset class where the fund only has “a toe in the water”, but will now make an area of emphasis, although Skjevem notes that there are few well known funds through which to invest.

He likes infrastructure for its inflation sensitivity and the way it matches the plan’s intermediate liabilities.

“In these shorter time periods, inflation can be really corrosive to traditional equity returns,” he says. Last January the fund, which seeks high single-digit returns in the asset, committed $100 million to Stone Peak Infrastructure Fund, focused on US utilities, energy and transport.

Skjervem says Oregon is also exploring infrastructure investment collaborations with neighbouring states.

Domestic equity investments include a passive allocation to various domestic and international benchmarks as well as a set of “judiciously selected” active managers running quantitative strategies that are focused less on stock picking and more on exploiting return anomalies associated with risk factors such as size and value.

Elsewhere in the public equity allocation, a developed-markets portfolio is split between a passive MSCI World Ex-US IMI Index fund and active Europe, Australia and Far East mandates. An emerging market allocation is invested in an MSCI Emerging Markets Index fund.

Although Oregon has a 2.5-per-cent target allocation to absolute return strategies, Skjervem says he shares his staff’s and governing board’s hedge fund scepticism.

“If you apply empirical tests to hedge fund-return histories, you often find high correlations with common market betas that you could otherwise replicate with various ETFs or index funds for 20 basis points instead of paying the traditional two-and-20 fee structure. I think there are other, usually more cost-effective ways of building these types of return streams. It’s good to apply this level of rigour because it also helps you identify those hedge fund managers that are doing something truly unique and accretive.” He doesn’t believe hedge funds have an edge when it comes to market timing either.

“If they could do this consistently, fine, but I haven’t seen it.”

Lean and mean investment team

Along with the Retirement Fund, Oregon State Treasury oversees assets for the Oregon Short Term Fund, the Common School Fund, the State Accident Insurance Fund and the Intermediate Term Pool.

There are no plans yet to build a bigger internal team – for now a “lean and mean” staff include 12 investment professionals and five administrative assistants, with the team divided between offices in Tiger, which deals with the risk allocations, and Salem, where fixed income and cash allocations are managed.

“Ultimately we’d like to bring everyone together,” says Skjervem.

The fund, which is 84 per cent funded, has an assumed earnings rate fixed at 8 per cent since 1989. The latest adjustments will leave Oregon more reliant on private markets, private equity and real estate, as well as real assets such as infrastructure, to meet that goal. “Our strong brand, ability to write big cheques and continuity of staff and governing board make us a sought-after partner,” says Skjervem.

Reels of financial data and analysis coupled with the occasional piece of market gossip or personal hunch are the time-honoured tools investors rely on in building an active portfolio. More recently, an element of sustainability or corporate governance analysis has tried to muscle into the process. Soon there will be another revolutionary option complementing financial and non-financial data – if an ambitious project being launched in Germany has its way.

Murat Unal, head of the consultancy Funds@Work, is an aspiring Mark Zuckerberg of institutional investment – on a mission to shake up established norms by unleashing the power of social networks. He sees the interconnectedness of individuals to be a missing link in portfolio analysis, and an element that can be vital to the performance of investments. “People across the world are social beings embedded in social networks that can constrain or promote their assets,” he explains.

Unal draws on a long tradition of economic thought that takes social network capital to be a key driver of economic success. In any society there are probably those who get ahead thanks to an influential relative, a former colleague or university friend.

Such ties can be problematic, Unal reasons. “Say, for example, you have an independent director who is actually closely connected to the rest of the board. Their efforts to maintain independence might be compromised by having been recommended to the board by an executive director with prior social ties or sharing the same mindset – these kind of ties could be disastrous if they are unable to see a problem in time.” Merger and acquisition deals can also have distorted prices when key executives at the two parties are connected, he adds. Chief executives at big banking groups with divided retail and investment activities can likewise pay greater attention to the area in which they rose up through the ranks. That can be to the detriment of other less familiar spheres of their businesses.

While Unal feels financial data will always remain the essential component of financial analysis (and that environmental, social and governance data will become mainstream), he and his team reckon that social network analysis will be vital in helping sophisticated investors’ most difficult task – attempting to predict the future. “Financial data is like looking in the rear view mirror, but a social network analysis can actually project a company’s next moves,” he contends. As much as investors should know how a company has got where it is today, their assessment of future prospects is arguably the most vital factor in determining whether an investment succeeds.

Quantifying social network capital

You don’t have to be a believer in an evil elite to acknowledge the core tenets of the social network capital idea – that there is a definite interconnectedness between successful businesspeople and their social circles the world over. Determining how that all impacts the performance of investments is the tricky part. The pushes and pulls of vast social networks that everyone is a part of can, after all, hardly be written as neatly as a cash-flow figure or a price-earnings ratio.

Unal and his team are determined to give unpicking complex executive networks their best shot though. He says they are prepared to invest substantial resources and are convinced that they have a track record that can help. They want to “make social capital more tangible, moving investors and decision makers beyond financial and non-financial data, and see how social networks affect investment returns and risk profiles”.

SONEAN and yet so far

To help achieve this aim Unal has set up a new legal entity and project called SONEAN (the first two letters each of social, network and analysis). This has begun to rigorously examine connections between directors at Europe’s largest companies, as well as developing new methodologies and processes, he says. It aims to extend further to cover regions such as Asia and the Middle East. “We are tracing back thousands of directors’ social network capital to see what and where they studied, who else they have worked for, which governments and NGOs they have advised,” he explains. An analysis of their multiple ties and how it affects organisational outcomes will follow.

It’s a challenging task but Funds@Work boasts experience in the unique area, having connected data on networks between thousands of institutional investors, asset managers and consultants since 2002. SONEAN already offers several tailored services, but the team behind Unal is striving to develop its corporate-ecosystem database further to make investor portfolio screening of social networks possible for the very first time.

Technology makes this the perfect time to attempt such a bold project, Unal says, with online social media allowing additional insights. He reckons the success of social media platforms like Facebook and Twitter is also making investors more aware of social networking, even if he says these sites are just a fraction of his sources. “When we published our first analyses in 2008, a lot of people struggled to understand the concept of social networks, let alone analysis,” he says, “but awareness is growing rapidly.”

Network impact on portfolios

Despite investors requiring “a whole new mindset”, Unal is confident that they will share his vision on the need to analyse social networks. He argues that the environmental, social and governance movement flourished in the wake of the Enron scandal of 2001, yet can be “inadequate” at discovering personal conflicts of interest before they compromise performance. “A social-network view can fill that transparency vacuum and allow for better corporate governance too,” he says.

Social network analysis can also reduce the disadvantage of remoteness in a globalised investment industry, according to Unal. “If you are an investor from Singapore with exposure to dozens of European companies, you might find it useful to discover what kind of networks are having an impact on your portfolio,” he argues.

While the precise impact of social networks is a complex issue, a portfolio screening would likely lead to an investor overweighting ideal companies. These would likely have directors with a diverse set of ties to different social spheres in various parts of the world. “Say, for example, the network heterogeneity of the company in which you are going to invest is much higher than its peers, this is clearly an indication for greater innovation potential,” Unal says.

“More research needs also to be done from our side on the performance effects of interconnections at board level, but that is exactly why we set up SONEAN. We really want to equip investors with a whole new toolset so they can ask smarter questions and look beyond financial data to the human element of business,” he says.

Part of the whole

Not only looking at companies in isolation and focusing on financial and ESG data, but also considering the embeddedness of corporate executives will provide new insights helping investors to better explain why people act the way they do, according to Unal. Identifying the overall network of players will allow investors to spot central actors, network clusters and many more structural features of the network that might impact on performance.

Unal is under no illusions about the scale of his team’s pioneering ambitions, but with colleagues who match his academic expertise in social network analysis, he feels the time is ripe to bring the concept into investment strategies. “We have to define an entirely new market, but we would love to leave a small legacy in making investors aware of the power of social networks,” he says. “After all, what more is an organisation than an embodiment of all its people?”

Deficit and underfunding at the £6.7-billion ($10.4-billion) pension fund for employees of United Kingdom retailer Marks and Spencer had long weighed down one of the high street’s best known names. But a sustained, conservative investment strategy characterised by a “keen focus on risk management” and “an understanding of the scheme’s liabilities” has helped to turn the M&S scheme around. The fund’s decision to shrink its equity allocation and boost its fixed income portfolio has helped cut the deficit from $2 billion in 2009 to $450 million in March 2012. It has made strategy at the closed defined benefit scheme with around 125,000 members, of which just 14,000 are active, a template for other funds in de-risking mode.

Mixing and matching

In an interview from M&S’s Paddington Basin headquarters in London, Brian Kilpatrick, the head of Marks and Spencer Pension Trust Investments, explains the fund’s liability matching strategy. M&S has portioned 70 per cent of assets to a diversified fixed income allocation that includes investment in global sovereign exposure, a global credit portfolio, a material exposure to gilts as part of its growing liability-driven investment (LDI) strategy and emerging market debt. Here, Kilpatrick is encouraged by the “relative strength” of emerging-economies’ sovereign balance sheets compared with those in the developed world during the financial crisis. In the last year the fund’s best performing mandates have been benchmark-agnostic fixed-income absolute-return strategies.

Kilpatrick explains why not all of the fixed income portfolio is purely matching and the strategy the fund uses to counter this. “Some investments within the allocation have very high matching characteristics like gilts, but other allocations, like sterling corporates, aren’t purely matching because they include a credit-risk premium. When we construct an LDI hedge, we look at the different duration exposures within the fixed income portfolio and then use swaps to plug any gaps, relative to the liability duration at any point across the curve so we get the shape of the hedge where we want it.” Sterling corporate bonds are a good example of this strategy at work, he explains. Their short duration doesn’t match the longer term liabilities of the scheme so the fund uses swaps to “move duration along the curve”.

So far the scheme has hedged the majority of its interest rate and inflation exposure and the LDI strategy will evolve as the scheme continues to de-risk. “We will be opportunistic in our de-risking, de-risking when we are ahead of our journey plan and adding to our gilt portfolio when the trustee considers yields as being attractive,” he says. Explaining the rational behind the strategy, Kilpatrick says, “We have seen some schemes negatively impacted by interest rates falling over the last year or so; the consequent funding level risks can be material. Because we are uncomfortable being exposed to a rewarded risk of this magnitude, we have evolved our LDI portfolio as conditions permitted risk to be reduced.”

De-risking framework

The remainder of the scheme’s assets are portioned to growth investments comprising a 12-per-cent equity allocation, down from 40 per cent in 2006 when Kilpatrick fist joined M&S from the National Association of Pension Funds, where he was investment advisor. The rest is in infrastructure, private equity, hedge funds, property and bespoke opportunistic allocations that were born out of the financial crisis. Exposure to equity markets is largely indexed and the scheme has a dynamic de-risking framework in place, based on agreed funding level de-risking triggers, monitored frequently by the trustee. De-risking trades will be executed when these triggers are hit, but the composition of those trades will depend on respective market conditions when funding-level triggers are reached, Kilpatrick explains.

He says that the scheme’s infrastructure allocation is a mix of low-risk public-finance initiative assets, sought after for their liability-matching and inflation-linkage characteristics, plus more opportunistic allocations in the US. However, it doesn’t include any emerging market infrastructure. Hedge fund exposure includes allocations to two multi-strategy funds of funds and a number of single strategy funds. This includes some “more rewarding” specialised strategies that have focused on picking up distressed assets during the financial crisis and have earned “significant investment returns for the scheme”. Going forward, Kilpatrick says the fund plans to increase its alternatives allocation in private equity and infrastructure. It invests in private equity only via “traditional vehicles”.

Kilpatrick describes the funding level as “integral” to asset allocation at the scheme and the deficit has certainly driven some of the pension fund’s most innovative strategies – none more so than the decision to draw income from a $1.5-billion portion of the company’s property portfolio. Under a property partnership set up in 2007, M&S retains control over the selected properties, however the pension scheme is entitled to receive an annual profit distribution earned through leasing the properties back to M&S. As a result, the M&S Pension Scheme was able to recognize the fair value of these future income streams as an asset in its accounts, leading to an improvement in its funding position.

Marks and Spencer’s large diversified fixed income portfolio contrasts with other UK corporate pension schemes, which still tend to have big equity allocations. For Kilpatrick, it’s the safest strategy to steadily de-risk. “We know the return above gilts we need to meet our glide path,” he says.