By Peter Martin
As mince pies and (in the Martin Household) – cremated turkey thankfully become a distant memory, what now for the well prepared trustee for 2016 and beyond?
So far on your journey towards full funding and the nirvana of self sufficiency, you have no doubt reviewed your growth portfolio to ensure it is diversified; interest rate and inflation risks are well-managed by judicious adoption of LDI and catching the falling knife of rising interest rates has been avoided by having evolved your bond portfolios appropriately.
But take a deep breath – success is a journey; not a destination.
There is yet still more to do as we start to consider the future of invested assets in a more fully-funded/self-sufficient/post-LDI world.
As we cast our runes and consider this future, the day will undoubtedly come when your scheme will be structurally cashflow negative (and for some this may have even arrived) – as the scheme has inevitably matured and you have a portfolio of mainly pensioners to manage.
Part of the solution may well be to draw the running income/yield -from invested assets – but this ‘kicks the can’ and may not in itself be sufficient. Assets could be disinvested – but that may be at market lows (and incur transaction costs). LDI manages the ‘balance sheet’ risk of interest rates/inflation but does not produce the income. Some trustees may look for buy-in of pensioner liabilities as a means of managing this investment conundrum. But not all.
For many a more holistic solution will ultimately be required.
Thus what will be needed over time will be a more focussed approach as to what cash you physically need over and above any contributions received over the coming years in order to pay the pensioners.
Therefore, investment of assets driven by physical cashflow needs will become a major theme, whereby income is explicitly generated and the invested assets structured to mature at the right level and at the right time.
Pension funds will inevitably evolve and ‘think more like an insurer’. This will become a natural evolution in approach for many and the mantra of investing for outcome will become more familiar.
Investing for outcome will involve and embrace both the liquid and the illiquid. Assets which produce quality, secure, sustainable income will also become increasingly sought after – especially those which have inflation characteristics.
We will no doubt see a welcome increase in the use of infrastructure, real estate and other ‘alternative’ assets as part of this paradigm. Reaping the premium of the ‘complex’ and illiquid. Pension funds are also well placed to take advantage of the disintermediation of banks and the opportunities that this can represent.
This should not be daunting and the asset management industry is indeed increasing the breadth and depth of opportunity for the well armed and well prepared trustee.
We are seeing multi asset pooled solutions which allow small schemes to participate in this evolution in thinking and approach. ‘Democratisation’ of pension fund investment in action and allowing access – with appropriate levels of governance, trustee knowledge and understanding.
The solutions adopted for the journey towards being more fully funded will in time need to evolve once that nirvana is in sight or at least on the distant horizon.
Foresight and careful planning means that trustees should at least consider this next stage in the lifecycle of their pension fund.
The well-prepared trustee will in future, perhaps, think more like an insurer. The shape of things to come? Cashflow Driven Investment.
Peter Martin is an independent senior investment professional and actuary and formerly head of manager research at JLT.
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