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The writer is a former global head of asset allocation at a fund manager
A year ago soaring bond yields and a collapsing currency threatened to bring down the British financial system. Fixed income markets forced a change in government, despite — although some still argue because of — an emergency intervention by the Bank of England. A year on, supporters of Liz Truss are still furious at finance-types for a pension fund strategy known as liability-driven investment (LDI). Meanwhile, City folk blame her for recklessly tripping this wire. Both charges have substance, but history isn’t written by the losers and the Trussites lost in spectacular fashion.
Perhaps the biggest winner has been the diminishing pool of defined benefit pension schemes. Saved from operational collapse, solvency levels have improved beyond recognition. Pension members can look forward to greater security in retirement. And sponsors can look forward to the end of deficit reduction contributions.
The chaos unleashed by the gilt crisis has given way to sustained political attention towards British pension scheme management. Ranking second only to the American system by asset value, their collective size is unusual. But, fragmented into thousands of defined benefit and defined contribution schemes, they punch below their collective weight. Truss learned that ignoring the structure of these substantial assets brings political risk. Now chancellor Jeremy Hunt is exploring potential economic rewards to be had by harnessing them.
The government is consulting around changing rules and incentives that have led schemes to match their liabilities more closely with assets. And Hunt has not been shy in broadcasting his desired direction of travel. First, he’s encouraging consolidation to professionalise governance and create the economies of scale that would enable lower cost in-house investment management. Second, he’d like to raise the stock of risky assets held by pension funds.
Some suggest that consolidating the 4,500 smallest private defined benefit schemes into a brand new public superfund would achieve both goals. In a recent submission, the Pension Protection Fund argued that its mandate should expand to become such a consolidator. But increasing risky assets runs against the grain of the Pension Regulator’s draft DB Funding Code of Practice, due to come into force next April. This requires trustees to set funding targets, then establish a plan towards an asset allocation which broadly matches assets with actuarial liabilities. As such it is widely understood to encourage schemes to de-risk their investment portfolios.
“In describing assets as productive or unproductive, the government seems to be offering a sotto voce vibe that it doesn’t support aggressive de-risking along the lines laid out in the code,” says Pete Drewienkiewicz of Redington, an investment consultancy. Add some new rules that limit pension funds’ ability to match assets with liabilities using leverage, the prospect of abundant gilt supply from both the Treasury and the BoE, and a lengthy bond bear market that has rewarded hedging hesitancy handsomely and it’s easy to see that the regulator will have a more challenging time.
We all have a stake in a functioning pensions market. Last September showed quite how high the stakes are. Private occupational pensions owe their existence to their privileged place in the tax system, so while schemes exist to serve their members, it is not unreasonable to look to them for wider public benefit.
Hunt’s appetite to harness private pensions is built on the best of intentions. But by in effect briefing against the Pension Regulator’s direction of travel, the government risks making it a lame duck. The longer this continues, the more the regulator’s credibility will be diminished. And if the events of last year have taught us anything, it’s the importance of institutional credibility.