Summer 2015
For professional investors only. Not suitable for retail clients.
Schroders
Pensions Newsletter
Pension scheme recovery plans
derailed by plunging gilt yields
This year’s collapse in gilt yields is likely
to have left a large number of pension
schemes struggling with their deficit
reduction plans. The typical scheme’s
funding level has plummeted from 67% to
62% (on a buyout basis) in the 12 months
to March, its worst level for over two years,
according to Schroders’ funding level
tracker (see chart and box).
Pension schemes with actuarial valuations
in the spring will have been particularly badly
affected. They will have to use the snapshot
taken at the end of March to decide their
cash contributions for the next several years.
Many will now find that their previous deficit
recovery plans are behind target.
This is confirmed by the Pensions Regulator
in its latest Annual defined benefit funding
statement, where it says: “Despite all major
asset classes having performed well and
schemes having paid £44 billion in deficit
repair contributions over the last three
years, our analysis suggests that many
schemes with 2015 valuations will have
larger funding deficits due to the impact of
falling interest rates and schemes not being
fully hedged against this risk.”
When these schemes last carried out their
triennial valuations in 2012, many hoped
that gilt yields had reached their lowest
point. Instead, gilt yields have been buffeted
by fears of deflation, economic stagnation
and, in particular, announcements about
quantitative easing in the eurozone. As a
result, yields have continued to fall and, as
at the end of March, those on long-dated
gilts were 1% lower than they were three
years earlier*.
Unfortunately for these schemes with
March valuation dates, this reduction in
yield could have added between 15% and
20% to the typical scheme’s liabilities since
their last triennial valuation. As the Pensions
Regulator implies, this will have been a
particular disappointment for pension
trustees who have seen their scheme’s
assets perform strongly over the last three
years. Rising liability values mean that they
have been running to keep still. Based on
our funding level tracker, a typical scheme
with a March valuation date could find
that its funding level has improved only
marginally from where it was in 2012.
Contents
Great response to our value
for money competition
2
A deepening deficit could put
pressure on rates
2
Forthcoming events
3
3
Big city, bright lights,
better returns?
Making purchasing power
predictable for DC pensioners
4
While there may have been some recovery
since March, that may not be much
consolation for the many schemes that
had to conduct formal actuarial valuations
in the spring. And as the regulator has
warned, “those schemes which are
relatively unhedged against interest
rates and inflation should be aware of
the degree of risk exposure that remains
unhedged.” In light of that, they may want
to seek advice about how to address
these risks more effectively, possibly by
formulating and implementing a liabilitydriven investment strategy.
*FTSE Actuaries UK Conventional Gilts Over
15 Years Index.
Despite the turbulence, funding levels have moved only marginally in three years
75%
70%
65%
Our funding level tracker uses annual
defined benefit asset and liability
values from the Pension Protection
Fund’s Purple Book. Between these
updates, our UK Strategic Solutions
Team estimates how funding levels
have changed each month.
–– Changes in asset values are
based on values for market
indices that represent the average
pension scheme asset allocation
60%
55%
50%
Mar 06
Mar 07
Mar 08
Mar 09
Mar 10
Mar 11
Mar 12
Mar 13
Mar 14
Mar 15
UK pension schemes' weighted average funding level
Sources for funding level estimates, total asset and liability values (buyout basis) and average asset allocation: Pension
Protection Fund as of 31 March each year (to March 2014). Interim asset returns: MSCI, FTSE, Barclays, Bloomberg,
as at 30 June 2015 and IPD and HFRI, as at 29 May 2015; gilt yields: Bank of England, as at 30 June 2015.
www.schroders.com/ukpensions
–– Changes in liability values
are based on yields on gilts
that are similar to a typical
scheme’s liabilities.
2
Schroders Pensions Newsletter Summer 2015
Great response to our “value for money in
140 characters” competition
We were hugely encouraged by the
response to our competition to find a
“Tweet-length” definition of value for money.
Nearly 60 trustees and advisers took the
trouble to enter and our team of judges
greatly enjoyed sifting through their efforts.
After much agonising we were able to pick a
winner from a shortlist of entries, any one of
which would have richly deserved the prize.
The huge range of answers demonstrates
just how difficult a job trustees and
members of the new independent
governance committees face when
confirming that they are offering value
for money in their pension schemes.
As an industry we could do worse than
be guided by some of the entries to
our competition.
Our judges were sorely tempted to plump
for the shortest and simplest: “Schroders’
investment strategy”, submitted by an
entrant clearly possessed of excellent
judgement. Reluctantly, however, we
thought that even a certain international
sporting body might have balked at such
lack of humility. (For the avoidance of doubt,
we’d like to emphasise that no money
changed hands.)
The competition also revealed some
hidden creative depths. A pair of our
entries were in the form of a haiku, which
the Oxford English Dictionary describes as:
“A Japanese poem of seventeen syllables,
in three lines of five, seven, and five,
traditionally evoking images of the
natural world.”
than 80 characters and all made reference
to cost, which seems to us a vital ingredient
– if not the whole recipe – in value for
money. From Finula Cilliers of Rothschild we
appreciated the pithiness of: “Reasonably
priced; good risk-adjusted return” at a mere
40 characters. Again, Kevin O’Boyle of the
BT Pension Scheme neatly dealt with the
cost factor but also managed to put the
customer first with his: “You know what you
are paying and believe it is worth it”.
We had:
Start with what’s needed
Use rest of budget for “wants”
Shun superfluous
And:
Value for money;
remembering quality,
but cost forgotten.
But the entry we thought best distilled
the essence of value for money in a
pension came from Hamish Wood of
Aegon: “Enabling members to achieve
an acceptable retirement income at a fair
price.” This, we thought, perfectly balanced
the interest of members with those of the
provider, while the mention of “fair price”
underlined the importance of keeping costs
at a level acceptable to both sides of
the transaction.
We liked them both, but for sheer simplicity,
few could beat: “The amount you would be
happy someone charging your Mum”.
We were impressed by the metaphorical
flourish of: “Value for money is neither a
gold plated tap (style over use) nor a plastic
fork (too cheap to be effective).” However,
we felt this was probably a better definition
of what value for money isn’t rather
than what it is. Another entry also chose
everyday objects to bring the concept to
life, with: “VFM for me is the ability to buy
a shirt, pint or a curry that delivers what it
says it should and makes me want to come
back and buy more”.
Many thanks indeed to everyone who
participated, whether online, at our DC
conference in May or via mallowstreet.com,
the web-based pensions community. Many
congratulations to Hamish, who with notable
self-sacrifice has taken the decision to shun
the bottle of champagne we were offering
and take his prize as a £50 donation to a
charity of his choice.
In the end, however, brevity won the day.
Our three shortlisted entries were all less
A deepening deficit that could put pressure on rates
The UK’s current account deficit came
close to a new record high as a share
of GDP in the first quarter of 2015.
A deepening current account deficit can
ring alarm bells with investors as it may
reflect an overheating economy and be an
early warning sign of the excessive build-up
of debt. The UK has historically endured
a number of balance of payments crises,
many of them ending in some sort
of currency devaluation (see chart).
Is this time different? The trade deficit itself
remains small at around 2% of GDP. More
important have been increased transfers
to Europe and the International Monetary
Fund, along with falling investment
income. Transfers are unlikely to change
much, unless the government manages to
negotiate reduced payments to international
organisations, although investment income
may recover.
But the government’s substantial fiscal
deficit is also a big part of the problem,
as it is being financed by a substantial
increase in overseas borrowing. In time,
as the government deficit shrinks,
so should the current account deficit.
However, sterling remains vulnerable to a
sudden change in sentiment through this
period, and that might mean that it will have
to be defended with higher interest rates.
The UK’s growing overdraft with the rest of the world
Current account balance (% of GDP)
3%
1967: Harold Wilson’s “pound in
your pocket” devaluation
2%
Mid-1970s on:
North Sea oil
1%
0%
2008: global financial crisis
-1%
-2%
-3%
-4%
-5%
-6%
1973-74:
oil prices quadruple
1976: sterling crisis
forces Chancellor
Healey back at airport
Late 1980s:
Lawson boom
1992: UK forced out of
Exchange Rate Mechanism
56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14
year
Source: Thomson Datastream, ONS, Schroders, 31 March 2015.
3
Schroders Pensions Newsletter Summer 2015
Forthcoming
events
Big city, bright lights,
better returns?
Mark Callender, Head of Real Estate Research, explains how carefully constructed
property portfolios can capitalise on a future increasingly centred on cities.
City populations are growing at the
expense of the countryside
City 66% growth
1990
1990
Rural 2% growth
Institutional Conference –
29 September, London
Our annual get-together at London’s
Savoy Hotel aims to update key
pension fund decision makers with
our latest investment thinking.
A key topic this year will be how
investors should grapple with
the rapidly changing landscape
of environmental, social and
governance investing. We will also
be looking at our unusual approach
to multi-asset management and
outlining our views on the fixed
income market.
Whether you are a trustee, a member
of an independence governance
committee, a sponsor, or an adviser,
please come along in September.
2050
And big cities are growing much
faster than the rest of the population
UK
Rome
Germany
Dynamic
people
Italy
Berlin
These regular morning sessions held
around the country are designed
to help trustees and members
of independent governance
committees who want to increase
their investment knowledge. They are
open to anyone involved in pensions.
The next events are:
6 November, Leeds
Better
education
Superior
culture
Dallas
Tokyo
Richer
company mix
-10 -5 0 5 10 15 20 25 30 35 40
Forecast population growth, 2015-30(%)
11 world cities accounted for...
Register at
www.schrodersevents.co.uk/SAC2015
Trustee training
Why do big cities grow faster?
London
USA
Japan
2050
Bigger clusters of
comparable companies
Yet new building is
relatively subdued...
Net office additions (% of stock)
50%
1997
2005
...of the value of office deals in
2012-14
2011
2019
...so the background
looks promising
But investors shouldn't confuse geographical spread with
economic diversification...
Energy
Aberdeen
Calgary
Houston
30 October, London – Part 1
27 November, London – Part 2
World Trade
Sign up at
www.schrodersevents.co.uk/TT2015
Hamburg
Los Angeles
Singapore
Global fixed income web
conference
Austin
Bangalore
Karlsruhe
Technology
Our next monthly online review of
the global fixed income market will
be in September.
Find out more at
www.schroders.com/watch
...and with yields low, they need to be imaginative as to how they invest
For more information, contact Tom Dorey, Head of Real Estate Product,
020 7658 3020 or tom.dorey@schroders.com
Sources: United Nations (2014); Oxford Economics (2014); Real Capital Analytics (2015); CoStar and Property
Market Analysis (2015); and Schroders.
4
Schroders Pensions Newsletter Summer 2015
DC after the Budget: making purchasing
power predictable for pensioner members
Whether they like it or not, trustees and
independent governance committees
are going to have to deal with a growing
number of members who stay in the
scheme after “retiring”. Despite the
headlines about facelifts and Ferraris, we
suspect the mundane truth is that many
will follow the line of least resistance with
their pension savings. They will do nothing
until they are forced to make a decision –
and few schemes will want to coerce their
members. For both retirees and schemes,
a well-designed default fund that could
turn seamlessly from forming the basis of
a pension savings vehicle into the basis of
a pension paying vehicle might suit their
circumstances well.
Such a fund would offer flexibility in a world
of much more fluid retirement. Members
often do not know when they will retire or
whether they will continue working part
time. They may need to move into full
drawdown earlier than they expected, or
take a partial income now and more later.
Some may only need an income while they
wait for a better moment to buy an annuity.
A fund that could accommodate these
requirements would be enormously helpful
for the individual. It would also vastly
simplify the task of sponsors, trustees
and members of independent governance
committees who may need a fund that
can form the backbone of limited or full
drawdown arrangements. So what would
such a fund look like?
But to provide greater predictability, we
believe it is quite realistic to aim to put a
floor under losses using a mechanism that
targets volatility. A systematic approach
where heightened volatility provides a signal
to reduce risk in a multi-asset portfolio – by
reducing reliance on equities, for instance –
can be effective in seeking to limit “peak-totrough” downturns by a set percentage.
Some growth will be important. Only a
lucky few are likely to have saved enough
for a retirement that could last 20 years or
more, while inflation could prove a growing
problem. Even more important, though,
will be the need to avoid big losses, as few
pensioners will have any way of making up
for lost ground after they stop working.
The combination of this built-in floor with
a multi-asset portfolio would, we believe,
create a retirement fund that could be
used to generate a highly predictable
(and inflation linked) income as part of a
simple drawdown plan. This should give
the pensioner a high level of confidence
that their financial needs will be covered for
however long they might live.
Luckily, these investment requirements are
almost identical to those of savers in
their final years before retirement. In both
cases the key requirement is to generate
some growth without taking big risks.
The foundation of any approach designed
to meet this aim, we would argue, should
be a well-constructed, expertly-steered
multi-asset portfolio that provides the
right balance between risk (through
diversification) and growth (by using
assets like equities).
So we believe that there should be no need
for most savers to switch funds when they
retire. A fund that could provide “best-buy”
features for DC savers before and after
work would help smooth the transition into
retirement and would, we believe, be highly
attractive to both individuals and sponsors.
Delivering a predictable stream of income after work stops
Pre-retirement
Drawdown
£160k
Value of savings
Last year’s Budget changes and the
subsequent introduction of the charge cap
are understandably crowding out much else
on the agenda of defined contribution (DC)
pension schemes right now. The pressing
priority is to put in place a default fund
that fits the needs of members before they
retire. But what happens afterwards is an
issue which will, we believe, loom steadily
larger for anyone involved in DC provision.
£100k
£92k
Drawdown (p.a.)
£8k
Contact
James Nunn
UK Institutional Business Development
+44 (0)20 7658 2776
ukpensions@schroders.com
55
65
Source: Schroders, this chart is a schematic illustration only.
Value of savings
Target Floor
75
Age
85
Annual Drawdown
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