DB trustees urged to evaluate endgame strategies amid Covid-19 disruption

Trustees should re-evaluate their defined benefit (DB) schemes’ endgame and investment strategies because of the challenges caused by coronavirus, according to State Street Global Advisors (SSGA).

With funding likely to have deteriorated and sponsor covenants likely weaker amid the pandemic, a report from SSGA said it is to be expected that schemes’ end points have at least become more distant.

With regard to funding, the report stated trustees might have to take more investment risk and improve the efficiency of their portfolios in order to get the returns required to improve funding, while also maintaining hedging of interest rate and inflation risks.

This might require schemes to take on increased leverage, which can be done through a segregated liability driven investment (LDI) strategy for larger schemes or using leveraged pooled funds for small- and mid-size schemes.

The liquidity of some schemes could allocate a greater proportion of assets in a cashflow-driven approach in order to make pension payments, investing in assets expected to produce income flows in the short and medium term.

SSGA said this might be a structured portfolio of corporate bonds, chosen to ensure that the bonds included have a high probability of delivering the required cashflows, with some flexibility applied to cashflow forecasts in case of downgrades or defaults.

The report also called for trustees to re-evaluate the covenant of their scheme and any implications for funding and investment strategy, though conceded that their situation may remain unclear in the short term.

While The Pensions Regulator has already said deficit recovery contributions could be deferred for three months in order to ease cashflow pressures, the report noted that contribution holidays could be prolonged, raising the risk of schemes’ liquidity coming under pressure.

The SSGA report concluded: “The outlook remains highly uncertain and it would seem unwise to take dramatic action right now. Trustees need to have a watching brief on their sponsor covenant and a good ongoing dialogue with the sponsor. As the dust settles, there will need to be a re-evaluation of the scheme’s long-term objective and its timing and the journey plan for getting there.

“The revised funding strategy needs to sit alongside a consistent investment strategy that may involve more leverage to increase or retain growth exposure whilst maintaining or increasing LDI exposure and may include a cashflow focused element.”

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