The privatisation of the UK’s railways industry, completed in the 1990s, had a big impact on the way retirement provision for those working in the sector is organised today.
At present the Railways Pension Scheme (RPS), with some £16bn (€24.3bn) under management, is the largest pension scheme in the sector and also one of the largest occupational pension plans in the UK. The scheme’s assets are managed by Railpen Investments on behalf of the trustee. Railpen also manages an extra £1bn for other schemes in the sector including the British Railways Superannuation Fund and the British Transport Superannuation Fund.
The RPS is divided into 99 sections, one for each of the different participating employers and each with different funding levels and separate asset strategies.
Brendan Reville, investment director at Railpen, explains that there are significant differences between the way some of the sections invest, which is related to their degree of maturity and pensions liabilities. When the sector was privatised, all the pensions – including deferred pensions - and liabilities that existed at that moment were wrapped up in a bundle and put together in one section of the RPS.
This section benefits from a guarantee from the secretary of state and it differs from others that were originally set up with just active members and are generally quite immature.
Specialist approach
As well as structural changes, a new investment strategy has also been implemented, following a more specialist approach and moving away from the more traditional balanced route.
“We used balanced benchmarks and balanced mandates for a considerable amount of time; probably we didn’t stop using them until 2002,” Mr Reville explains. But, he notes, the use of specialist managers is not something new for the scheme. Back in the 1970s, the scheme used to invest around 4 per cent of its total assets in works of art, something quite unusual for the time. Although during the 1980s the scheme started to get rid of these types of assets and today no works of art remain in the portfolio. However, this early interest in more exotic investment distinguished it from other institutional investors.
“There has always been some unusual aspects to the asset strategy. It wasn’t straight down-the-line balanced,” he says.
Currently the RPS’ assets are managed through seven different pooled funds managed by 35 different asset managers. “There has been a considerable expansion in the number of managers over the last five years or so. But this number is actually in some ways misleading because we have become more specialist, particularly in our equity investments,” he says. “We have been taking geographic or global slices away from balanced managers and using specialist mandates to invest those assets.”
The global equity fund, the largest of the seven pooled vehicles, has a total of 14 different managers. “They tend to be fully global rather than multi-regional and they have specific regional mandates. So now there are more names, but probably fewer moving parts.”
RPS’ approach to equity investments has also changed recently. A decade ago, around two thirds of its equity assets were invested in the UK. “The first major shift we made away from that was in 2002 when we reduced our UK equity weighting to 51 per cent of our total equity pool.” This reduction has continued to the current 41 percent it will carry on decreasing over the near future.
“We are not going to go down global market capitalisation weight and we will still have an UK overweight relative to global markets.
When exposure to UK equities was being reduced, the portfolio also took a more proactive approach towards currency exposure by introducing a passive currency hedge, hedging 50 per cent of overseas exposure back to sterling. As the overseas weighting increased, so did the hedge ratio back to sterling, which now stands at 70 per cent. In 2004, RPS also introduced an active currency programme on top of the passive one.
On the fixed-income side, there are three pooled funds investing in different bond strategies. Mr Reville explains that the global bond fund, with assets around £2bn, used to come in two different flavours. In 2001, and as part of the process of moving away from balanced benchmarks, two different funds were set up, one hedged back to sterling and the other unhedged. “The reason for the unhedged fund is that we felt there was a possibility that some sections might need a fund to use for bond investments if there was significant UK inflation,” he says. Since expectations for high UK inflation declined over the following years, it was decided to merge both funds and carry on with a single bond fund, which is fully hedged back to sterling.
There is also a short-bond fund that only exists for one section within the scheme. It is
a very tightly controlled portfolio whose function is to meet short-term cash flow requirements.
A third bond fund is an index-linked pooled fund which a few mature sections invest in. Its benchmark is the UK index-linked index but managers have also been given explicit benchmark allocations to US Tips. “Effectively we have asked our managers to take advantage of the yield differentials between the UK and US Tips to give us some higher return. I suppose that’s what you call a medium to long-term tactical view on yields, which we instituted originally in 2001 and which we have reviewed on a frequent basis since then,” he notes. The allocation to US Tips moved from 0 to 15 per cent over that period.
RPS is moving more into the alternatives area, with three pooled funds investing in hedge funds, property and private equity, respectively.
Hedge fund investments, representing 4 per cent of total assets, are made through a cash plus with exposure to three fund of hedge fund managers and some 80 underlying hedge funds. Mr Reville says they had considered hedge funds at the beginning of the decade but only started investing last year. Their current hedge fund portfolios have a performance target of Libor plus 5 per cent. “We have guidelines for our managers that require them to target zero beta against both our equity and bond benchmarks. We are trying to make sure that this asset class is a good diversifier,” he says. “Where it does have beta exposures in it, these are exotic betas, things that do not exist in other pooled funds.”
Mr Reville believes in the benefits that hedge funds can bring to an investment portfolio and thinks the increased inflows into the asset class coming from institutional investors are not necessarily reducing return opportunities. “The amount of money invested in hedge funds is still trivial compared to the money invested in long-only equities and bond markets. If hedge fund investing becomes a significant proportion of the long-only markets then there will potentially be a problem but I don’t think at current levels there is.”
The property pooled fund comprises direct investments in UK real estate, while the manager also has a watching brief on overseas assets. “We have an annual strategic review and his recommendation over the last few years has been to stick with what we know in the UK.”
Finally, there is a private equity pooled fund that uses a range of individual funds and some funds of funds, with also some secondary deals along those funds. Investments in private equity started back in 1980s as an UK only asset class and became more internationally diversified during the last decade.
Appropriate monitoring
Taking into account the number of managers in charge, monitoring them appropriately becomes crucial and it is much more than just looking at their performance. “We have some global managers that take a deep value approach, whose performance we expect to be very volatile and we wouldn’t ask our trustees to dismiss them simply because they have had a period of underperformance,” he says. He adds issues related to people, the stability of the organisation and consistency in their philosophy.
“What you need to do in deciding whether to retain a manager is to look at all those items. You need to keep on top of the staff, the organisation and the investment process by going and visiting them on a regular basis.”
When choosing new managers, Mr Reville says they have enough information on databases to generate a list of those they would like to consider. “We don’t normally take advice from consultants at that point. We probably behave in a way that makes us look like a consultant from the managers’ point of view,” he explains. “We give RFPs that are relatively detailed and we also spend a lot of time on due diligence.”
The large size of assets under management and the international exposure of the investment portfolio makes the role of a global custodian crucially important. The trustees have been using for some time a dual custodian model with two global players sharing the bulk of the assets. Only last month, ABN Amro Mellon was reappointed as global custodian, whereas JP Morgan was terminated and replaced by Bank of New York. “About two thirds of our assets requires some sort of custody and the two would share that in roughly equal measures.”
