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Testing times
17 July 2020

Testing times

The COVID-19 driven crash across return-seeking assets and subsequent bounce (at least at the time of writing), have provided a serious test of pension schemes’ investment strategies. The investment performance across Defined Benefit (DB) schemes has been mixed. As with any crisis – albeit we may still be in the early stages of this one – we can take away some useful lessons.

Lesson 1: Right-size your risks:
  1. Diversify. Schemes with long-only exposures to markets such as equities or credit tended to suffer the most. Funds that can run market-neutral exposures, or invest in a broad range of asset classes, or take active risk-off positions tend to provide better diversification in an economy-wide crisis when correlations between other asset classes often increase.
  2. Ensure liability-side risks are appropriately sized. Despite the falls in return-seeking assets, low levels of hedging will have been equally as damaging to the funding levels of many schemes.
  3. Ensure your overall level of investment risk is appropriate in the context of your sponsor’s financial strength. Despite being an imperfect tool, we found a reasonable degree of correlation between the pre-crisis ‘value at risk’ of schemes and their actual performance, meaning that quantifying and monitoring investment risk has proved valuable for many schemes. It’s worthwhile noting that if your sponsor has been negatively affected by the crisis, you may wish to rethink whether your level of investment risk remains appropriate and also whether you should be targeting full funding sooner. It’s worthwhile noting that if your sponsor has been negatively affected by the crisis, you may wish to rethink whether your level of investment risk remains appropriate and also whether you should be targeting full funding sooner.
Lesson 2: Don’t panic!
  1. De-risking after the crisis struck would have meant missing out on the sudden, sharp market rebound.
  2. Positioning your scheme to capture excess returns following the depth of the crisis would have meant moving very quickly (and boldly). To do this effectively requires a decision-making framework aligned to long-term goals, and a governance set-up that enables rapid decision-making…
  3.  …but noting that we are potentially still in the early days of this pandemic and do not know where markets will go from here.
  4. Be open to new opportunities. Some new capital raisings, related to crisis opportunities, have already closed but longer-term, there may be a greater opportunity set in asset classes such as direct lending and distressed debt.
Lesson 3: Better habits?

We now have the experience under our belts of an entire meeting cycle played out in the virtual world. Ask your committee what is working well and what could work better.

Many trustee boards have found that shorter, more frequent meetings are easier and more efficient for everyone concerned.

It’s good practice to ask whether the current environment can show us a better way of doing things.

Notes/Sources

This article was featured in Pensions Aspects magazine July/August edition.

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Last update: 19 January 2021

Karen Heaven
Karen Heaven
Redington Ltd
Managing Director in Investment Consulting

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