March 2012
For professional investors and advisers only
Risk management for
smaller pension
schemes
Mark Humphreys, Head of UK Strategic Solutions, Schroders
A number of studies have shown the investment outcomes of smaller pension funds to be inferior to
those of their larger counterparts. This has a knock on effect on funding levels, and the average
buyout funding level of schemes with more than 10,000 members has been 4 to 8% higher than that
of schemes with between 1,000 and 5,0001 members in each of the past six years. The divergence
in investment outcomes can prove costly for the sponsors of smaller schemes, who must counteract
poorer funding levels with higher contributions. However, with a number of investment managers
and consultants taking steps to improve the array of investment products and services on offer to
smaller schemes, help may be at hand.
The relationship between scheme size and investment outcome is partly due to the economies of
scale available to larger schemes. Lower administration and fund management costs combined with
larger governance budgets enables these schemes to access a wider range of investments, such as
private equity and other alternatives. This increases diversification and provides a wider opportunity
set from which to generate excess returns.
Furthermore, the divergence of outcomes between schemes of different sizes is reinforced by the
current inaccessibility of sophisticated risk management solutions for smaller schemes.
In addition to Liability Driven Investment (LDI), the range of strategies available to pension schemes
includes endgame planning (‘flight paths’), which help schemes manage their progression towards
an end goal of buyout or self-sufficiency; and equity downside protection strategies, which enable
schemes to limit the downside risk of their growth assets (possibly funded by sacrificing some
upside potential).
The universe of risk management solutions on offer is constantly evolving, with new strategies –
such as longevity hedging and the separate management of interest rate and inflation risk –
emerging to meet the needs of individual schemes. For example, equity derivative strategies can
now provide schemes with more efficient (and cheaper) downside protection, while synthetic gilts
enable them to benefit from the higher yield on gilts versus swaps without tying up a large proportion
of their assets in low returning physical bonds.
The strategies listed above can provide substantial benefits in terms of protecting schemes from
downside risk and enhancing funding levels. However, while the variety and complexity of solutions
on offer has increased significantly over the last decade, the implementation of these strategies is
still primarily limited to larger schemes.
While the majority of smaller schemes have been excluded from the benefits afforded by these
sophisticated strategies, there is a growing awareness of this segment of the market, and efforts are
being made to ensure that the needs of this client base are met to the same high level as those of
larger schemes.
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The Purple Book 2006, 2007, 2008, 2009, 2010, 2011
Risk management for smaller pension schemes
For professional investors and advisers only
In the past, the costs of sophisticated risk management solutions tended to be prohibitive for smaller
schemes, as many were bespoke services available only to clients in segregated mandates.
However, a number of fund managers are now widening the range of strategies which can be
accessed through pooled funds and a variety of strategic products and services are being released
with smaller schemes specifically in mind, including the equity risk management and flight path
strategies detailed above.
Many schemes assume they are too small to access risk management solutions: however, the
market is evolving, and with the steadily increasing accessibility of sophisticated strategies, an
enquiry with their investment manager could leave them pleasantly surprised.
Important Information
The views and opinions contained herein are those of Mark Humphreys, Head of UK Strategic
Solutions at Schroders, and may not necessarily represent views expressed or reflected in other
Schroders communications, strategies or funds.
For professional investors and advisers only. This document is not suitable for retail clients.
This document is intended to be for information purposes only and it is not intended as promotional material in
any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial
instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax
advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment
Management Limited (Schroders) does not warrant its completeness or accuracy. No responsibility can be
accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has
to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any
other regulatory system. Schroders has expressed its own views and opinions in this document and these may
change. Reliance should not be placed on the views and information in the document when taking individual
investment and/or strategic decisions.
Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA.
Registration No. 1893220 England.
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