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Kingfisher Pension Scheme head of group pensions Dermot Courtier and pensions investment manager Matt Fuller talk to Sebastian Cheek about recent changes to the DIY retail group’s defined contribution scheme and the £3bn defined benefit fund’s journey to self-sufficiency.

“We have aligned the new five-year cash default fund with the new state retirement ages. Basically the decumulation phase begins five years from age 66, 67 or 68, which I think is a unique arrangement.”

Dermot Courtier

Is more of your focus on DC than DB at the moment given the pension freedoms? Matt Fuller: It is fairly evenly split. We have a DB Investment Committee and a DC Investment Committee which we established in 2009, recognising the investment side of DC was not receiving as much attention during the DB committee meetings as the trustees wished.Dermot Courtier: We have an overall trustee board that meets four times a year and the DB and DC committees also meet four times a year. We have created a governance structure whereby both the DB and DC investments are given the same amount of time. We made those changes in 2009/10 and I think from a governance point of view we were ahead of the game and we have been able to tweak to our current arrangement rather than do a fundamental switch in the wake of freedom and choice.What changes did you make to the default fund following the introduction of freedom and choice? MF: We had actually already started a DC default review in 2013 to help establish the objective for the default fund. We performed a lot of demographic modelling looking at members’ salaries, ages, contribution rates etc. A lot of our members are low earners and the majority of theirincome is going to come from state pension so we worked backwards from seeing what return would be required if we sought to target two thirds of the members’ final salary at retirement, recognising that the state pension would constitute the majority of their retirement income. The analysis showed that if the default option could achieve CPI-plus 3%, net of fees, it would enable the members to achieve the additional element on top of their state pension to achieve this. The committee looked at the risk-adjusted returns of the default fund over a 30-year period. They also not only looked at the expected return and volatility the blend exhibited but also the range of outcomes (i.e. looking at the range of potential outcomes from the 5th to 95th percentile over that timeframe to try to get the balance between risk and return right).DC: Originally the focus was on the growth phase but the focus switched to the de-risking phase and we now target 100% cash over a five-year decumulation period. This recognises that for the next five years or so the majority of people will take 100% cash as they have not been in the scheme long enough since auto-enrolment to accumulate funds of significant value to facilitate drawdown. However, once auto-enrolment rates increase and people have been in the scheme longer, then they will have bigger pots so we will re-visit in three to five years’ time. We have aligned the new five-year cash default fund with the new state retirement ages. Basically the decumulation phase begins five years from age 66, 67 or 68 which is a unique arrangement in DC at the moment. Before freedom and choice we had a traditional 10-year lifestyling fund which led into 25% cash and converted a member’s pre-retirement fund into an annuity. At that time most people had a target retirement age of 65, but knowing we are moving to state retirement ages, 65 could be 68 now.What does the accumulation phase now look like? MF: Before the review the default was 50% diversified return fund and 50% passive equities with the equities being all market cap, 70% global and 30% UK. This was changed so that now the passive equity element is still 50%, but half of that is a fundamental index approach and half a market cap approach, both are on a global basis and 75% hedged back to sterling. The fundamental index is the FTSE RAFI All- World 3000 index (75% hedged) which focuses on fundamental factors such as dividends, cash flow, sales, book equity value and applies a weighting to each. We have conducted a lot of trustee training over the years and one of the conclusions the trustee board reached was investing purely on a market cap approach was not the only, or best, way to invest on a passive basis.Who runs the default fund? MF: State Street manages the diversified return, passive equity, two of the bond funds and the cash fund. We also have Schroders and the Invesco Perpetual High Income fund combined on a 70/30% basis under a white-labelled structure, so it is one global active equity fund. We also have HSBC running a Sharia fund, BMO for an ethical fund, Aberdeen for emerging markets and L&G running a property fund.DC: But the overall provider in terms of the administration platform is Zurich and all of the funds sit on the Zurich DC platform.Do you still maintain a direct relationship with the managers? MF: We monitor the managers on the DC side as much as we do the DB side so we had Mark Barnett from Invesco Perpetual present to the trustees after Neil Woodford left because the trustees wanted to get comfortable the fund was still the right one to have. So, we still have direct conversations with the managers which enable us to maximise cost efficiencies. So for instance, we were able to complete the passive equity transition on an in-specie basis rather than sell out of one fund and go into another as you normally would on a platform. From the analysis provided directly by the investment manager, the scheme saved approximately £90,000 across the membership and Zurich worked with us throughout that project.Why did you stick with lifestyle? DC: We reviewed target date funds (TDFs) but the trustees decided to stay with lifestyling because TDFs lend themselves to higher volumes of employee numbers than we can actually offer. With a TDF you set certain years and have a cohorts of people who will retire from that given year – and when you look at our membership profile, while we have tens of thousands of employees we don’t have hundreds of thousands. It makes sense when you look at the size of NEST. But we keep it under review.How has the charge cap affected the default design? MF: The annual management charge for the default strategy is 42.5 basis points for the growth phase and that reduces in the consolidation phase. The diversified return fund comprises active allocation at the top level but the underlying securities are passively invested. There are elements of commodities, infrastructure and property accessed through exchange traded funds (ETFs) but an active decision is made as to how much to have in each asset class, which helps keep the fees for the fund on a competitive basis. The ETF route enables daily liquidity. I do have sympathy with those who say you don’t need daily liquidity, but we have to work within the environment we have and the platform requirements. There are allocations to commodities, infrastructure, property as well as high yield debt, emerging market equity and debt so a reasonably broad basket of assets.Some DGFs have a high exposure to equity risk. MF: We recognise the DGF has high equity content and we’re looking at approximately 80% exposure in the growth phase, but we are conscious it is a growth phase so while you are trying to manage risk you do need the growth from equity performance. One concern would be that if you have high equity content and equity values fall people make the wrong decision at the wrong time, but we are comfortable people in the default will be there a long time. Experience since auto-enrolment, and previously during the credit crunch, has shown that members rarely change their investment strategy.Can you describe the DB scheme’s de-risking journey so far? DC: The scheme closed to new members in April 2004 and then to future accrual in July 2012. In 2004 as part of the valuation discussions, an agreement was reached jointly between the trustees and employer to begin de-risking the scheme. At the time our asset allocation was basically 80% return- seeking assets and 20% liability driven investment (LDI), but today we are 72% LDI and 28% return-seeking assets and within that we have a special purpose vehicle (SPV). When we went through the 2010 valuation the trustees and company reached a conclusion to establish the SPV which runs from 2010 for 20 years and to establish a flightplan to self-sufficiency by 2030, known as the secondary funding objective (2FO). In 2006/7 we started the hedging programme and we used to complete regular switches, but given where we are with the 2FO we now implement more dynamic switches based on triggers in place with the company. The company has been funding at an accelerated level to help the scheme get to the 2030 self-sufficiency target. We switched £100m in March 2014 and £50m in April 2015 and we are monitoring the next trigger level the moment.What does the matching portfolio look like? MF: We have one main LDI provider which is Insight Investment who we appointed in 2014 after a review in which we decided to take a more actively-managed approach to the LDI portfolio. We also have absolute return bond portfolios with GAM and Insight and multi-asset credit fund with Pimco. We previously held a lot of corporate bonds and they had performed well, but as we move into a rising interest rate environment the trustees are conscious they about having a lot of corporate bond and duration exposure so they reshaped the portfolios into those three funds.How does the SPV work? DC: It contains four assets: two B&Q stores, one support service office in Chandler’s Ford, Southampton, and one distribution centre in Swindon. The scheme receives the inflation-linked rental income on those properties, which is c£13m a year through to 2030.What else is in the return-seeking portfolio? MF: We have an active emerging market equity and debt portfolio and a passive EM currency fund managed by Rogge. The long-term view is the EM should perform well so the committee decided to implement a specific EM allocation which equates to roughly 10% of the return-seeking asset portfolio. We have a global farmland fund, a direct lending fund and an alternative asset fund. The trustee board was keen to access alternative asset exposure but were not in a position to say, for example, ‘we will overweight commodities as opposed to high yield debt this quarter’, so it is down to the manager, LGT, to decide the allocation. The fund contains private equity, hedge funds, EMD, property, insurance-linked securities, high yield debt, etc.DC: The farmland and direct lending funds sit in our best ideas section, which contains asset classes that allow us to diversify but at the same time give us an equity-like return, if not better.What next for the DB scheme? DC: We are now looking at governance and where we have appointed managers on the LDI and return-seeking sides, we are going to put in a regular programme of monitoring to satisfy ourselves from a trustee point of view the managers are delivering the results we expect. There are also interesting opportunities in the insurance market where there may be opportunities to consider converting the matching assets into insurance-based assets.