Articles - Making your assets work harder in run on

 By Chris Pritchard, Principal and Co-Head of Insurance Investment at Barnett Waddingham

 Many schemes have de-risked to the point of holding portfolios invested entirely in investment-grade corporate bonds and hedging assets with the expectation of transacting a buy-in. With run-on now a very credible alternative, a lot of these schemes will be in a position where they have de-risked too far. To quote Charles Darwin: "It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change." Trustees should consider a change to their investment strategy as both the regulatory regime and macroeconomic landscape shift.

 Four key principles for a run-on strategy
 The objective of running-on a DB scheme is ultimately to generate value that can be distributed to stakeholders, while ensuring the security of members’ guaranteed benefits is preserved.

 To achieve this, there are four key principles that any run-on strategy should adopt:

 1. Return generation

 A well-constructed allocation to assets that generate a return above cash should form a part of the strategy in order to build a surplus. Schemes with longer run-on periods are more likely to be in a position to capture longer-term investment opportunities, such as those associated with megatrends, creating additional value over time.

 2. Risk control

 The security of member benefits is paramount. Key investment risks should be managed, such that there remains a very high degree of confidence in member benefits being paid with minimal reliance on employer support. The period of time that a scheme runs-on for will impact the degree (and types) of risks it is exposed to. For example, those with longer time horizons may be more highly exposed to physical climate risks.

 3. Buy-in aligned

 Most schemes that run-on will do so for a period of time, before eventually securing a full buy-in of the liabilities. The investment strategy should therefore be consistent with this goal, including maintaining sufficient liquidity to allow the scheme flexibility to pivot towards a buy-in at short notice if circumstances should change.

 4. Liquidity

 The portfolio should have a high allocation to liquid assets, so that the scheme can pivot to a buy-in should the sponsor covenant deteriorate, or should a change in attitude from either trustees or sponsor result in a shortening of the run-on timeframe. This may mean limiting the use of illiquid funds, though a modest allocation can still offer a valuable source of returns and income generation if the timescales for investing align well with the expected time running on.

 A well-diversified income producing portfolio can achieve all of these objectives.

 Less-liquid income-producing assets can include true diversifiers such as insurance-linked securities. There has also been significant recent developments in the industry in evergreen structures for illiquid assets – giving schemes access to assets such as private credit and infrastructure with greater liquidity and flexibility than investing in closed-ended funds.

 Allocations should not be static – it is important to be dynamic across different asset classes to maximise value as the scheme’s funding position changes, and as market conditions change.

 We will be publishing stand-alone blogs on our thoughts on the best approach to investing in each of these asset classes in due course.

 What about other asset classes such as equities?
 Our portfolio does not have any exposure to equities and minimal exposure to other volatile growth assets. This is because we favour a risk controlled approach to generating surplus. Investing in income producing assets has the benefit of:

 Greater security and certainty of return.
 Alignment of the portfolio with the purpose of running-on.
 In particular, surplus is likely to be used for two reasons:

 Providing additional benefits to members (either in the form of additional DB or DC benefits). Again, for this purpose, we favour income producing assets as these types of assets move in a similar way to liabilities provide a greater degree of certainty to the security of additional benefits.
 
 Return of surplus to the employer – in which case we have assumed surplus returned to the employer should be both stable and predictable. For this purpose, we would favour income producing assets over equities.

 What should trustees be doing?
 Whether you have already made a decision to run-on, or you were in 'wait and see' mode ahead of the government’s response to recent consultations and are now giving run-on further consideration, you should make sure you are getting the most from your assets.

 Switching a 50:50 credit and gilts portfolio to an investment strategy that is aligned with our portfolio above could generate an additional return of £50m+ for a £500m pension scheme running-on for 10 years.