Articles - Derisking in volatile times

Most DB schemes in recent years have either started, or are well progressed, on a de-risking journey – moving from high-risk assets, such as equities, to assets that better match their liabilities (gilts, corporate bonds and LDI). The Pensions Regulator’s draft Funding Code of Practice takes this one stage further, by requiring schemes to put in place a de-risking plan so that they have a “low dependency” on their employer by the time they are “significantly mature”.

 Chris Ramsey, Partner and Head of DB Endgame Consulting at Barnett Waddingham

 But this creates several big questions for trustees. For starters, how should trustees make decisions on whether and when to de-risk? Should trustees worry about market volatility? And how should de-risking be managed in practice?

 Here are my top tips on managing your scheme’s de-risking journey:

 How much does volatility matter?
 We’ve all seen and heard that markets are volatile – but how much can that volatility affect pension schemes in their de-risking journey? In short, volatility matters a lot!

 For example, let’s say a scheme that was 100% funded at 1 January 2013 started a ten year de-risking plan, with 10% of its assets switching from equities to gilts each year. In this simplified example, the only choice the trustees would have had was when in the year they make the 10% switch from equities to gilts.

 The following chart illustrates just how wide the potential outcomes for this scheme were – with the best possible outcome being the scheme is 146% funded on 1 January 2023, the worst being 108% funded, and a full spectrum in between.


 Most DB schemes in recent years have either started, or are well progressed, on a de-risking journey – moving from high-risk assets, such as equities, to assets that better match their liabilities (gilts, corporate bonds and LDI).

 All of these options had the same investment strategy and same journey plan on paper – the huge fluctuations are only caused by the trustees’ choice of when to implement the de-risking throughout the year.

 I wish I could say I had an easy way to make sure your scheme always picked the best or near-best time to de-risk – but that is not possible. None of us knows what markets are going to do next, and so trying to get a trustee board to predict this isn’t realistic. So what can you do?

 The best you can do is firstly decide what is “good enough” in your circumstances – i.e. what you would be happy with – then capture that opportunity if it emerges.

 Deciding what is “good enough” – when should you de-risk?
 Before getting into the detail of when to de-risk, you need to take a step back and think about how much to de-risk or whether it is the right thing to do at all.

 This is about getting the balance right between reducing risk (and expected return), reducing the contributions payable by the employer, trying to get to your target faster, or some combination of the three.

 Just because you think you are “ahead” doesn’t automatically mean you should de-risk – the employer in the example scheme shown in the chart below could argue that it would instead like to continue to take risk for longer to try to get to buy-out sooner.


 Once that high level principle has been established it is time to get into the detail. There are many different ways of approaching de-risking, but I like to build de-risking strategies around the following two key principles: 

 Impact on funding
 In most cases, you’ll want to make sure that your proposed de-risking doesn’t mean you ask for more in contributions from the employer.

 This means understanding what the impact will be on the discount rate your Scheme Actuary will propose. 

 Impact on journey plan
 I would also think through the impact on your long-term journey plan.

 For example, if buy-out is your goal, your de-risking framework should check that you are still on target to reach buy-out in a sensible timeframe after you have done the de-risking.

 The last thing you would want to do is de-risk too much, and make buy-out an unrealistic goal.

 How do you capture an opportunity?
 Markets generally persist for a short while after a shock. The same analysis as above showed that over the 10 years to 31 December 2022 on average “good” opportunities to de-risk persisted for around a month before something else happened which caused the funding level to drop. In this context, how do we capture a good opportunity?

 1) Identify the opportunity early
 Before you can capture an opportunity you need to know that it is there in the first place. It is therefore critical that you have a monitoring system in place that gives you the information you need, and have your consultant monitoring it regularly. We use our Illuminate Monitor system to give up-to-date information to our clients on the metrics that matter to their scheme, helping them to identify an opportunity as it emerges – not just at a trustee meeting eight weeks later (for example).


 2) Make your decisions up front
 But having the right information at the right time isn’t good enough in and of itself. You also need to be able to take the necessary decisions quickly enough, and then also quickly implement the changes. This is where a lot of schemes could make changes to add value.

 A month is not very long for trustees to decide what to do, consult the employer and then implement a change. And of course that is just an average – markets may move against you before then.

 That is why in my view is it is much more effective to make these decisions and have the discussion with the employer in advance. That way you have a good chance of moving quickly.

 There are various flavours of this type of arrangement – from de-risking triggers that are implemented without trustee input (“hard triggers”), triggers that are implemented only after trustee final sign off (“soft triggers”) or something more informal. Each of these approaches have their upsides and downsides, but the important point is they are all much more effective than the traditional model of considering quarterly reports at trustee meetings.

 3) Consider the practicalities
 With any de-risking process you also need to think through the practical side. If trustees are going to need to sign documents, who is around to sign them? Have the signatory mandates been updated? Has your investment consultant got the documentation they need from the investment manager to implement the trade?

 These issues may seem trivial, but they can frustrate a de-risking process if not thought through in advance.

 In summary – market volatility can make a big difference to the future of your scheme. The best way to manage this is to:

 Agree if, when and how you will de-risk in advance;
 Monitor your position daily so you know if an opportunity emerges; and
 Be prepared to move quickly. 

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