As a barometre of industry feeling , I would mark this year’s PLSA conference as reading “fair – outlook stormy”.
A stormy outlook for investment strategy
Having survived a total breakdown in its funding strategy only 8 months earlier, the investment side of the pensions industry is giving itself a pat on the back. The reality is rather different. The Treasury and Bank of England know now that pensions have been found wanting and have needed a further bail-out, the price of the October 2022 intervention looks like an October 2023 intervention where the demand will be for investment in UK Growth.
The PLSA has done its bit – to manage what that intervention might look like, by launching a 12 point plan to make it easier for its members to invest in illiquid assets that meet the agenda of pensions, society and the broader economy but these do not look to me – sufficient to stave off a much more brutal approach where trustees sponsors and savers face the loss of Government incentives – unless action is taken to invest more productively.
The “stormy” outlook is partly the gathering threat of the Treasury, demanding more risk be taken and partly the realisation that in a world without quantitative easing, the mainstay of pension funding – gilts – is looking an increasingly risky means to protect future liabilities. One of the most asked question of the PLSA’s investment conference, was “who is going to buy the gilts if we offload them?”
With interest rates set to remain high, mature DC savers are particularly exposed to falls in gilt prices but as DB plans get in the long queue for buy-out , the question is just how long are they prepared to maintain their hedges at the high cost of new collateral buffers. With UK pension schemes owning the majority of long-dated gilts, the worry is that they are trapped – and will have a tough time if they choose or are required to “re-risk”.
A stormy outlook for cashflow management
A further legacy of the events of 2022, is the ongoing lack of liquidity to meet pension payments. Many schemes sold their liquid assets to meet collateral calls as gilt yields spiked and now have a lot higher exposure to private markets than they intended. Selling gilts , private equity or even illiquid growth assets to pay pensions is tricky, risking further falls in the asset base of pensions.
A lot of reliance is being placed on the quality of the private credit that has been bought and there is concern that not all of it this debt is easily redeemable. Cover for pension payments has fallen sharply as a result of 2022’s calamitous rewrite of valuations of all pension assets and the prospect of relying on ongoing valuations of assets in the private markets to meet today’s obligations is clearly not making many CIOs comfortable.
The uncertain outlook for DC investment
For all the talk outside the conference, there was actually very little discussion about DC investment solutions. As mentioned above, the exposure of many mature savers to falling gilt and bond prices has left many savers facing big falls in their pots without a proper explanation about why this happened because of a low-risk investment approach.
There was a lot of “fantasy investing” of DC defaults in growth assets but – when the conversation turned to what today’s reality is , the consensus is that – for all but a handful of schemes , there is little budget for such assets and no capacity to pass on extra investment costs to savers. There was also concern expressed that DC’s excursion into private markets risked purchasing at inflated valuations where trustees found themselves outsmarted by venture capitalists, hedge fund managers and other wheeler dealers.
For all the talk of “fiduciary management”, I sensed a fear about “fiduciary incompetence”.
If DC is to be required to invest more in illiquids, I worry about implementation and management.
Uncertainty of purpose
The one conversation I had expected to have had at PLSA’s investment conference was about strategy and purpose. The very high preponderance of sellers to fiduciaries was part of this, but more worrying was the lack of sponsors in the hall. UUK was the only sponsor I had a meeting with over three days.
Without getting to hear from the sponsors about what their plans are for pensions , it is difficult to gauge what the future of DB and DC plans will be. LGPS is fine and seems to sit outside this debate, but I wonder what the corporate appetite is for risk sharing. UUK are clearly exploring conditional indexation , not just with USS but with the DWP. Are other such conversations happening and is there an appetite for resetting the employer covenant to funding best endeavour approaches with a defined contribution while allowing liability management to happen through longevity pooling and a new deal with members that schemes pay what they can by way of pensions.
These discussions were notably absent , we need to hear more from sponsoring employers and we need to hear from commercial DC providers, to what extent they’d be prepare to organise such pools. There were sessions on risk-sharing but we are a long-way from it happening for anyone but Royal Mail.