By Peter Daniels, Partner and Head of FM Evaluation at Barnett Waddingham
Widespread evolution of investment strategies and governance
For many DB schemes, there has been a fundamental shift in their financial circumstances over the last few years. Funding levels have generally improved, bringing many schemes within touching distance of an insurance transaction. The emergence of surpluses and anticipated reforms in the pensions market have led some schemes to consider the alternative approach of ‘run-on’. The rise of other ‘endgames’ and consolidation vehicles provide other options, with the DB Funding Code likely to accelerate conversations in these areas.
The above is expected to lead to trustees reconsidering their investment arrangements, including the strategy itself, but also the governance model and level of delegation. The focus should be on making sure the model fits with and is proportionate to the scale of the investment challenge ahead.
Reconsideration of providers for certain schemes
We also anticipate greater use of independent strategic advisers, who can bring impartiality to discussions around the choice of endgame/run-on objective and the path towards it. For schemes that already outsource through an FM arrangement, we expect more reflection on their choice of provider as well. Circumstances change and the provider that was appointed to generate returns to plug a funding deficit is not necessarily the right provider to manage investments as an endgame approaches.
Innovation to support winding down of illiquid portfolios
We are seeing a number of schemes wanting to move to more liquid portfolios. This is particularly prevalent in FM portfolios, where delegation of decision-making has often led to more complex portfolios. Improving liquidity is a difficult and expensive task. Some illiquid investments are locked up in vehicles which are expected to take five to ten years (or longer) to distribute capital. Exiting these vehicles early is possible but often at a heavy pricing discount. The systemic demand for liquidity has created a buyers’ market.
We expect continued market innovation to support investors wanting to make their portfolios more liquid. Some consultancies have launched their own illiquid fund ‘exchange platforms’. At BW, we have supported clients to consider the full range of options, including direct conversations with secondary private market funds, as well as exchange platform options and the traditional secondary market route. Considering the range of options is likely to lead to better pricing for your unwanted illiquids, rather than considering one option in isolation.
For schemes in outsourced arrangements, this is an area where your oversight provider could bring added value, working in collaboration with your FM or OCIO provider, and using their independence to provide further routes to sourcing liquidity.
The evolution of sustainable investing, but still a UK priority
Today, sustainable investing is increasingly politicised, particularly when it comes to climate change. The Environmental, Social and Governance (ESG) phraseology appears to be getting phased out after much backlash in the US. We are seeing some managers take different approaches either side of ‘the pond’ to appeal to different investor appetites and regulatory environments, presumably a trend which will continue in the Trump 2.0 era.
Nevertheless, we do expect sustainable investing to remain on the UK agenda and perhaps become more prominent in 2025 for DB schemes who have been prioritising more strategic matters in recent years.
For more on sustainable investing in 2025, my colleagues Pete Smith, Head of Sustainable Investment and Clare Keefe, Senior Sustainable Investment Consultant discussed their thoughts on this video which is well worth a watch.
Outsourcing with larger schemes: OCIO growth and LGPS reform
We have seen a number of large, high profile DB schemes move to an OCIO approach recently. Much of this has been fuelled by corporate appetite to dispose of in-house investment operations as their schemes mature – we expect this trend to continue to some extent. An area to watch out will be the Local Government Pension Scheme (LGPS) market, with reform expected to lead to greater consolidation and asset pooling, itself a form of outsourcing. We expect a step-up in investment governance around asset pooling as the market evolves, such as increasing levels of investment oversight.
Innovation to enhance oversight for smaller schemes
We believe that smaller schemes (below £50m in AUM) typically do not have an adequate level of oversight for their FM arrangements. We find these schemes are often constrained by adviser budgets and the limited value of lower-cost oversight services. Ironically, these are usually the schemes which need oversight the most.
We expect more market innovation to make oversight services more compelling for this segment of the market. At BW, we have developed our own approach to this – enabling scheme-specific performance evaluation and a framework for holding the FM provider to account.
How we can help
Now is an ideal time for pension schemes to take a step back and consider whether your investment arrangements are aligned with the challenges which lie ahead. 2024 was an eventful year for BW’s FM Evaluation Team, marked by our success in winning the UK Pensions Awards FM Evaluator of the Year. Our submission focused on adding value for our clients by leveraging our strategic investment expertise alongside our in-depth knowledge of the FM market. Reflecting on the team’s achievements over past year and the impact we’ve made on clients fills me with immense pride, and we are certainly determined to retain our title for 2025.
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