The HSBC Bank Pension Trust (UK) spent 2014 implementing a series of innovative changes to the investment strategy of both its defined benefit and defined contribution schemes. Chief investment officer Mark Thompson tells Sebastian Cheek about an eventful year.
“We benefitted significantly from the early LDI hedging such that at the end of 2013 the positive mark-to-market on the swaps was around £3.6bn.”
Mark Thompson
Can you give an overview of the pension schemes that come under the HSBC Bank Pension Trust’s umbrella? The fund is a hybrid scheme – it has a defined benefit (DB) and defined contribution (DC) section under one set of trustees. The DB has approximately 120,000 members; about 8,000 are actives, between 50,000 and 60,000 are deferred members and the rest pensioners. The DC section has about 70,000 members; about half-and-half active and deferred members. The DB section is closing to future accrual at the end of June, so those 8,000 active members will transfer across to the DC section. The DB section is somewhere between £22bn and £23bn in assets under management and the DC section has £2bn in assets.
What spurred the changes to the DB investment strategy? As a result of the 2011 valuation we tightened up on our mortality assumptions and we agreed with the sponsor a reduction in the expected return on the portfolio, i.e. making the discount rate smaller and therefore the liabilities larger. The scheme had been an early adopter of liability driven investment (LDI) back in 2006 driven largely by the sponsor because of the risk of the scheme having an impact on the bank’s capital position. That LDI protected the scheme when rates went very low and the result of the 2011 valuation revealed we had no deficit at all and were fully-funded on a technical provisions basis. We then came to a further agreement with the sponsor we call the general framework which saw the trustees adopt an objective of trying to get to a lower-risk self sufficiency position by 2025, which will then be the target-matching portfolio. There are two ways to get to the target-matching portfolio: one is betterthan- expected investment performance and the other is to get extra funding from the sponsor. The sponsor agreed three contributions of £64m a year in 2013, 2014 and 2015 to put us on the right trajectory.
What does the new strategy look like? We agreed to have the fund split into two parts: a matching portfolio and a returnseeking portfolio. When the matching portfolio would have enough assets in it, it would become the target-matching portfolio I was talking about. It is where we have all the swaps and gilts so it is a lower risk, liabilities-matching portfolio. We also have a return-seeking portfolio and if it does the job it is supposed to, by 2025 we would no longer have a return-seeking portfolio because we would be all invested in the target- matching portfolio.
How did you change the matching portfolio? We had benefitted significantly from the early LDI hedging such that at the end of 2013 the positive mark-to-market on the swaps was around £3.6bn. The hedging had protected us from falls in interest rates but it was also a bit of a drag on performance because it was in cash rather than reinvested across the portfolio, so we needed to undertake a recouponing exercise. This involved resetting the swaps position to keep the same overall hedging exposure but releasing the cash that was trapped to reinvest in the portfolio. When we first established the LDI position we were able to do it under favourable terms because the counterparty on the other side of the swaps was HSBC Markets. One of those terms was that collateral was only posted one way – HSBC Markets posted us collateral but we did not have to post it the other way – so if we had recouponed at the end of 2013 it would have been penal to the bank. So we had to negotiate how to move to a two-way credit support annex (CSA). In the meantime during the syndication of 2068 index-linked gilts in September 2013, we spent £2bn of the cash collateral on buying index-linked gilts which we asset swapped with the bank. It did not increase our hedging exposure and we were buying gilts at a point when liquidity allowed us to and at favourable zero-volatility spreads. By December that year we had agreed terms to move to a two-way CSA, we therefore recouponed and spent the early part of 2014 buying more gilts with the remaining £1.6bn and unwinding the swaps we no longer needed, because by buying the gilts we were getting interest rate and inflation exposure. So we moved to a more funded position in the matching portfolio.
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