Was the matching portfolio able to take on more illiquidity as a result?
We started to build up a more illiquid portfolio that will give us more matching characteristics, but also a better return because of the illiquidity premium. Two good examples of that are a long-dated property portfolio and a sterling index-linked corporate bond portfolio we have been building up. There are other mandates I am currently looking at, but I won’t tell you about them as I have not got to the point of doing it. We have increased the funded hedging of the matching portfolio significantly – it still has swaps in there, but the objective is to try and pick up more illiquidity premium in matching-type assets and in time that will become the target-matching portfolio when the scheme gets to that position.
How did the return-seeking portfolio change?
We have a large exposure to credit but we diversified that by reducing the exposure to both emerging and developed market corporate credit and investing about £1.2bn into global sovereign credit. I am not keen on putting more illiquidity into the returnseeking portfolio because it has a finite life, whereas having illiquidity in the matching portfolio is ok. I have been looking for return- seeking assets that are good diversifiers and not correlated with more traditional returnseeking assets. In November, we invested in a multi-asset volatility premium strategy run by Fulcrum Asset Management. This product tries to capture the volatility premium across four different asset classes – equities, bonds, commodities and foreign exchange – because in option pricing there is an implied volatility which is usually higher than the realised volatility. On the whole it is a return-seeking asset, but the correlation with traditional markets is low and it is liquid because it is all done with derivatives: buy the options and on a daily basis delta hedge out the market exposure which changes every day because options are not static.
Why did you increase the equity exposure?
Probably the most interesting thing we did in 2014 on the return-seeking portfolio was increase our equity exposure. However, if we had just increased the equity exposure on its own it would have increased the scheme’s technical provisions value at risk (VaR) measures and with that the bank’s pillar two capital requirements. So we therefore implemented an equity downside protection strategy at the same time as increasing both the developed equity synthetically and the emerging market equity physically by around £400m for each. The protection strategy essentially protects an element of the downside exposure of the scheme by purchasing put spreads, while selling some calls mitigates part of the cost of the hedging position.
How has the DC section changed?
Every three years we do a deep dive into our DC investment offering and 2014 was one of those years. When it was agreed the DB section would close to future accrual the sponsor agreed that the contributions into the DC section would revise up; at the moment the sponsor pays 8% of pensionable salary, which from 1 July will increase to 10% for the first £20,000 and 9% thereafter, and the matched contribution has increased to 7%. The flow of money into the scheme will increase, not only because there are the 8,000 members from the DB section coming across, but also because contributions have gone up. In May last year we also changed our platform provider from HSBC Life to Fidelity, so Fidelity manufactures white-labelled funds that have third-party managers beneath them. As a member you can go into what we call ‘Freechoice’ and there are now 13 funds available on that platform. Another way a member can enter the scheme is through the ‘Lifecycle’ strategy which starts in global equities before moving into a diversified growth fund and then into a long bond fund and cash – the idea being that members would buy an annuity. We put in a new ‘Cash lifecycle’ in February last year because we noticed we had about 3,500 DB members contributing into additional voluntary contributions (AVCs) and 90-odd percent of those were using that pot of money to take as their tax-free cash.
How have the new pension freedoms affected the DC section?
Because of the Budget we have introduced a third lifecycle which is for those who may wish to carry on investing in risk and go into drawdown; it moves from equities into a diversified fund and stays there. When explaining this to the trustees I called it the ‘Cerberus strategy’ because the body is the same it is just the end part which is different between the three lifecycles.
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