02 March, 2021

 

The historical slogan was about a dog being a lifelong companion, not just something to be gifted at Christmas and then parted with after the novelty wore off. The past twelve months has shifted the emphasis onto a dog being more than just for lockdown. While we have all been stuck at home and foreign travel is off the table, many have turned to pet ownership. In fact, the increase in demand for dogs has even seen the price for puppies soar. There are reports of doubling and even quadrupling of price for some breeds. Animal welfare groups are now expressing concern that when lockdown ends, there could be a large number of pet owners who decide their furry little companions have served their usefulness and it is time to part company. But since puppy prices are not part of CPI calculations, what does this have to do with pensions or fiduciary management?

 

Over the past 10+ years, increasing numbers of UK pension Trustees have turned to fiduciary management to help improve the funding level of their pension schemes. Many turned to fiduciary management as a means of implementing a funding journey plan. The fiduciary manager would build a liability driven investment (LDI) portfolio for the scheme, taking on the complexity of effectively hedging the interest rate and inflation sensitivities of the scheme. In addition, they would deliver a diversified return-seeking portfolio and active asset allocation to help close the funding gap. They would also select, monitor and replace (as necessary) the underlying managers for the mandate. As the funding levels improve, the schemes have been able to de-risk. And like the new puppies bringing joy and distraction to their owners throughout lockdown, by and large fiduciary managers have delivered improved funding levels for their clients. But with the better funding position achieved, some Trustees are beginning to wonder whether they still need their trusteed companion any longer. Is there an equivalent of the Battersea Dog and Cats Home where Trustees can drop off their fiduciary manager for which they feel they no longer have a use?

 

Or instead, have Trustees not recognised there is more to the journey? A fiduciary manager should be able to see the Trustees all the way through to their end goal. For many schemes, that end goal could be buy out. The Fiduciary manager can help the Trustees in a number of ways towards buy out. Firstly, the fiduciary manager can reposition the asset portfolio so that it is able to be transitioned to an insurer. This could involve both the winding down of any illiquid holdings as well as the repositioning and deleveraging of the LDI portfolio. A fiduciary manager should be able to navigate the liability and asset dynamics and coordinate with a risk transfer team – whether one part of their own organisation or that of another’s - to achieve a successful buy out.

However, it is worth noting that not every scheme will be targeting buy out or be able to achieve one even if they want to. For many schemes, a de-risked portfolio that focuses on long term run off and careful management of pension payments is the goal. For these schemes, a well-designed cash flow driven investment (CDI) approach will be the end game. In these circumstances, a fiduciary manager will be able to construct a portfolio of contractual cash flows, building on the LDI approach and carefully managing changes in hedging dynamics. In this scenario, the fiduciary manager is no longer building and monitoring a diversified return-seeking portfolio, but instead is constructing a dynamic portfolio of credit (potentially liquid and semi illiquid), as well as careful interest rate and inflation hedging, using opportunities to deleverage once available. There is also the need for adjustment caused by any large cash flows or transfer values. Coordination with the scheme actuary becomes vitally important in this approach.

 

A potential next stage of development for fiduciary managers will be to help those Trustees, as well as their corporate sponsors, in implementing efficient financing options. For example, there are ways of introducing surety bonds to a scheme to provide support for CDI approaches. Surety bonds are similar in effect to a letter of credit, but from an insurer rather than a bank – so do not use up existing credit lines. Such an approach could even be wrapped into a master trust arrangement to provide enhanced governance and efficiency to the scheme on a long-term basis. Finally, there is the possibility of introducing a captive insurance solution that could house the pension obligations while providing efficient use of capital for the sponsor rather than paying the premiums associated with a buy-in or buy-out.  And the list goes on.

 

So as the end of lockdown is now finally in sight, it is time to consider what to do with that dog come 22 June. As you return to the freedoms we once enjoyed, your relationship with the dog can evolve. Instead of being a constant companion in lockdown isolation, the dog can provide a bright start to the day and then a joyous welcome home after a day at the office.  Or even take advantage of the new flexibility of working from home to enjoy the dog’s company a few times during the week. Similarly, just because the scheme is de-risking, the relationship with the fiduciary manger and the solutions they can provide can adapt and change, depending on whichever end game goal you are seeking. Engage with your fiduciary manager to explore the end game options and how they can assist in getting you there. There is more to fiduciary management than the journey to better funding.

Dan Melley
UK Commercial Leader of Investment Solutions

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