The good, the bad, and the ugly. For a lot of people in the pensions industry, autumn arrived with some unwelcome guests – volatility, uncertainty and anxiety. We can trace their advent back to the now-infamous ‘mini-budget’, unveiled in late September by the former Chancellor, Kwasi Kwarteng. The market reaction was merciless. Gilt yields soared, sterling slumped in value, and there were significant consequences for many pension schemes, which use gilts and gilt derivatives in their investment strategies. |
By Samora Stephenson, Head of Fiduciary Manager Oversight at Hymans Robertson The resulting dash for collateral – which affected all schemes using leveraged Liability Driven Investment (LDI) strategies – created torrid conditions for pension scheme trustees, affecting both schemes managed in a ‘traditional’ investment advisory way, and those steered by a fiduciary manager. In this article, we take a closer look at how the fiduciary management industry responded to these challenges. We focus on some of the behaviours we saw, but note that the experience for all mandates will be different. The good
What benefits did fiduciary managers bring? Trustees with fiduciary arrangements were able to sail through the first half of the crisis, and its build-up, without breaking a sweat. They were spared last-minute meetings to discuss rebalancing, and the signing of disinvestment forms to meet collateral calls – which were coming thick and fast.
Which models worked best? The bad
The perils of being one step removed However, things eventually reached a tipping point when many fiduciary mandates were pushed to their limits and lacked confidence that they could maintain the same level of liability hedging while meeting their current growth targets. At this point, many fiduciary managers asked their clients to change the terms of their mandate, often at very short notice.
Short-notice requests for sweeping changes to mandates raise eyebrows Some fiduciary managers asking for unlimited discretion on reducing hedge ratios. In many instances trustees were given little reasoning around how, and to what extent, this discretion would be used. These requests for discretion being applied across a fiduciary manager’s client book in almost blanket fashion, even where it was not required. For example, schemes with low-risk portfolios and ample spare collateral were asked to allow their fiduciary manager unlimited discretion to reduce hedging assets on their behalf.
Pooled fund failures To be clear, this problem also affected many schemes that make use of an advisory model rather than a fiduciary model. However, this experience gives the lie to the common perception that fiduciary management has some magic dynamism that always leads to better outcomes. In this instance, everyone was in the same boat – whether they’d paid for an advisory ticket or a fiduciary one.
The ugly Worryingly, we saw instances where bad outcomes were swept under the rug, and communications that should have been key updates buried in long emails or presentations. For example, we saw some schemes lock in substantial losses when their fiduciary manager had failed to maintain the target level of hedging over the volatile period, and re-bought gilt exposure at higher prices. But the update from the fiduciary manager was that hedging had been reduced to protect the client and, unsurprisingly, they didn’t want to dwell on the pound and pence effect this had on the scheme’s deficit! For any trustee reading this who thinks they still don’t have the full picture, make sure you ask your fiduciary manager these questions: Were target levels of hedging maintained throughout the period from 23 September to 30 September (the first spike in yields)? If not, why were they reduced and were hedging levels re-raised following the reduction? If so, what was the effect of this in terms of funding level in percentage terms and monetary terms? After 30 September, were hedging levels adjusted? If so, what were they before, and what are they now? What has been the effect of this in terms of funding level percentage terms and monetary terms? Do you think our investment strategy should change going forward? Will we need to accept more funding level volatility in the future? If so, what is the expected difference in rising yield scenarios as well as falling yield scenarios? To sum up...
The good outcomes
The bad outcomes Some fiduciary managers that make use of pooled LDI solutions ran into difficulty and liability hedge levels were forcibly reduced, even when total portfolios were very liquid and had plenty of collateral. This hurt funding levels.
The ugly outcomes We expect there are many trustees out there who don’t understand how their fiduciary managers handled the crisis. They won’t know if the fiduciary manager took actions that led to bad outcomes.
Final thoughts... As the year draws to a close, let us hope that we’ll see less of volatility and uncertainty, and more of calm and predictability, so that trustees can take stock and answer the big question on everyone’s mind: how should investment strategies evolve to cope with the ‘new normal’? |
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