Matt Ritchie explores how market pressures are affecting the progression of glidepaths, and what this means for pension funds’ de-risking strategies

Having a goal is one thing, reaching it is another. And with the will of financial markets seemingly bent against pension schemes for the past five years or so, meeting funding objectives has proven to be a difficult task.

Aon Hewitt’s Global Pension Risk Survey, published in February, found that more than 90 per cent of UK schemes now have a long-term objective.

The survey revealed that funds expect to reach their intended destination over approximately 13 years on average. Considering the intended journey time was 11 years in 2009, funds appear to be going backwards.
So journey plans, glidepaths, flightplans - whatever you choose to call them - have grown in popularity. But while schemes may have goals in place, it seems they have not been making great strides in reaching their destinations.

“In some senses this is no great surprise,” the report says. “It is an acceptance of the reality that whereas one may have wished to reach an ultimate destination in a particular timeframe, if circumstances conspire against this, the basic variable that changes is the timescale.”

Progress

For all their apparent benefits, it is tempting to doubt the value of glidepaths given this lack of progress. The best laid plans of pensions managers and trustees, it seems, often go awry.

But BlackRock head of UK core institutional business Andrew Stephens says the circumstances thrown at schemes over the past few years would test even the most robust plans.

Although assets recovered relatively quickly from the crash, and have performed reasonably well, record low gilt yields have hammered schemes on the liability side of the equation.

“The fall in yields has been unprecedented, negative real yields going quite far out along the curve means of course that those liabilities have inflated far quicker than those assets,” Stephens says.

“The fact that people’s glidepaths have not delivered is not so much an indictment on journey planning itself, it’s more an indication of what’s been happening in the market. Frankly, just the yield movement itself has been the primary driver.”

Plotting the course

Markets may be uncooperative, but that does not mean plans should be abandoned.

Aon Hewitt partner Paul McGlone says a glidepath is about more than just having a goal. First schemes need to set a target, before designing a plan to get them there. This involves working out the mix of contributions and investment returns necessary to get to the funding target within an acceptable timeframe, all while taking an acceptable level of risk.

Thirdly, the glidepath should include contingency plans to deal with circumstances changing for better or worse.

“Having those three elements means you have a pretty robust glidepath,” McGlone says.

Aon Hewitt has noticed demand for journey plans go ‘ballistic’ over the past three or four years, and it is believed more than 30 per cent of schemes are now on a glidepath.

This increased demand has a number of drivers. Defined benefit schemes continue to close, meaning they have clearer targets at which to aim.

Challenging markets since the crash in 2008 have also increased the appeal of having a plan. According to Stephens, political interventions since the crisis have only made navigating through “hostile” markets harder.

Stephens says the value of having a plan was demonstrated in how schemes with glidepaths in place came through the financial crisis, compared with those that didn’t.

“Of course those schemes that had a glidepath in place ended up in a far better situation because they were able to adjust their asset allocation to reflect where they were relative to their plan. Pre-crisis that meant reducing their exposure to equities and other growth assets.” he says. “Shift forward a couple of years, those schemes that didn’t have plans felt the full effect of the 35 to 40 per cent fall in equities. The impact meant they suddenly found themselves needing a much longer recovery period.”

Lessons

Schemes cannot change what markets have already done, but they can take lessons out of the crisis. McGlone says schemes are increasingly setting de-risking trigger points, at which they ‘bank’ gains if they find themselves doing better than expected.

In the past, schemes would reduce contributions and maintain the same level of investment risk where assets did better than expected, but McGlone says over the past few years schemes have increasingly used good results as an opportunity to de-risk.

Schroders head of UK strategic solutions Mark Humphreys says there is plenty pension funds can do before they even set their glidepath.

‘Low hanging fruit’ such as accessing interest rate and inflation protection more efficiently through pooled LDI funds, and better tailoring scheme assets to return and hedging requirements has not been fully exploited by a great many schemes, Humphreys says.

“Those are some of the most important things for schemes to do, even before getting their triggers set in the right places,” he says. “You get the highest level of expected return with the lowest level of risk – get that sorted out and then think about your glidepath because you’re just making it harder for yourself if you haven’t done it.”

While there has been little progress to cheer about from pension funds since the crisis, Humphreys says that the picture is improving.

“There’s been a pick-up in yields, equity markets have continued to do well, so we’re starting to see triggers hit, funding level triggers hit, de-risking activities happening, which we hadn’t really seen in the previous couple of years.”

Capacity

At first blush it would seem that improvements to schemes’ funding levels could only be a good thing. But there are questions around whether there is a big enough pot of gold at the end of the rainbow.

The ‘end points’ schemes aim for when plotting their flightplans vary. Aon Hewitt’s research found 45 per cent of schemes are aiming for self-sufficiency, while 20 per cent are targeting buyout.

The most recent Pension Protection Fund assessment of DB schemes’ funding positions estimated overall liabilities of UK schemes to be over £1.2 trillion. Combined with Aon Hewitt’s findings, this would indicate there is nearly £250 billion in liabilities eventually headed for the insurance market.

Pension Insurance Corporation’s co-head of business origination Jay Shah says insurers have written £5-£10 billion in pension de-risking business per annum for the past five years, depending on whether longevity swaps are included.

The market could handle up to £20 billion a year “without much changing”, Shah says.

“To the extent that yields start to move upwards - and we’re seeing some indication of that over the last few weeks - certainly we’ll see the affordability of buy-ins and buyouts improving if that trend continues. Which could lead to a significant increase in demand.”

This could result in resource constraints, Shah says, largely in the legal and actuarial capacity of consultants and insurers. Capital requirements could also come under pressure, likely resulting in an increase in pricing.

“But ultimately if that trend continues I’m sure you’ll find more insurers and capital coming into the market and there are indications of interest already,” Shah says. “That would lead to a stabilising effect. But I think there may well be a time lag between a spike in demand and the capital providers being able to react to that.”

Benefit

McGlone says that pension funds’ tendency to look for similar de-risking opportunities, and an undersupply of gilts relative to overall DB liabilities means a widespread rush to buyout is not a
great concern.

If yields were to improve significantly prices would swiftly be pressured by the sheer number of willing buyers, McGlone says. The law of supply and demand would ensure the brakes came on an improvement in yields well before a great many schemes got to the position to buy out.

Indeed, the relative scarcity of quality assets and advisory resources are all the more reason to have a journey plan in place.

“With a lot of this stuff schemes are actually all competing for the same thing. If you’ve got a flightplan in place that allows you to spot an opportunity and act on it quickly, you’re more likely to be at the front of the queue.”

But journey planning will not necessarily be of equal benefit to all schemes.

The sponsor covenant may be so strong that getting to the end point is not an issue. Conversely, so-called ‘zombie schemes’ with liabilities well in excess of their assets and the sponsor’s balance sheet may find plotting a course to full-funding a futile exercise.

But, from a trustee perspective, having some idea of the best course to take is undoubtedly helpful.

Independent Trustee Services managing director Chris Martin has a “strong conviction” that having a plan is worthwhile, regardless of the scheme’s funding position.

“Our view as a professional trustee is that all schemes should have some kind of a long-term objective. That might be a formal glidepath or it might be something less formal, but if you’re a trustee running a scheme, just as a director running a company, you need an objective and a strategic plan.”

Many schemes opt for a full fiduciary approach, whereby the ongoing monitoring of progress along the glidepath is carried out by a third party. Martin says this can be appropriate, particularly for smaller schemes, but there is benefit to a scheme keeping this role in-house where it can.

“Triggers can be very black and white, but with a DIY route within a clear governance framework mean that you can hit a trigger, pause for a day or less , and just take into account all the other factors surrounding the scheme and the sponsor. It may just be that it isn’t the smartest day to pull the trigger. There are subjective elements that you can’t build into a trigger.”

For many pension funds, having a glidepath in place can take pressure off trustees and allow them to focus their efforts on the areas where they can make the most difference in improving how the scheme is run.
Stephens says having a plan allows trustees to take a higher level view of the performance of their schemes. It enables trustees to assess asset manager performance and asset allocation against a defined plan, increasing the likelihood of progress being made.

“Where trustees have well articulated plans in place, the tweaking that is happening at the macro level, rather than at the micro level which can have very little impact on the overall success or otherwise of the scheme.”

Matt Ritchie is News Editor, Pensions Age

Share Story: