Consultants and asset managers presenting on topics ranging from choosing a portfolio manager to alternative investments, all emphasised the need to better inform potential clients.
Ian Sykes, director of investment consulting at Buck Heissmann, called on advisers, fund managers and industry bodies to “build confidence” in liability-driven investment (LDI) strategies, which employ complex derivative instruments.
“Pension funds might be wary of them but swaps are here to stay and will revolutionise pensions risk management,” said Mr Sykes at the UK and Irish Pensions and Investing Summit.
While many large pension schemes are already comfortably using derivative instruments, the development of pooled swap products is making liability-matching accessible to smaller pension funds for which custom-built swaps contracts have not been a feasible option. Asset managers launching pooled LDI products evidently realise that more concerted efforts must be made to improve trustees’ understanding of such strategies. Goldman Sachs Asset Management has led the way by organising a series of free monthly seminars on the basics of pension investing for UK pension fund trustees in conjunction with the University of Westminster. And, following its launch in September of new liability-matching products, Bank of Ireland Asset Management is also running training sessions on LDI for Irish pension fund trustees.
Judging by the comments of one UK pension scheme at the Dublin conference, industry practitioners will have to work hard to banish widespread investor scepticism about LDI.
David Bennett-Rees, trustee director of the University of London Pension Fund, said trustees in the UK regard the derivative instruments being promoted as an LDI strategy as “a rip-off”. He claimed that if an LDI strategy using derivatives returned 6 per cent but charged up to 2.25 per cent in various fees, the pension fund “might as well go into cash.”
“The problem with LDI products is that no-one is absolutely certain what the costs are. Is the pension fund getting proper insurance or is LDI more profitable for the product-provider?” asked Mr Bennett-Rees.
However, he maintained that LDI was a “useful tool” for pension funds in the UK, most of which were under-funded on an actuarial basis and could only be adequately funded by absolute returns and not simple bond yields.
Mark McNulty, head of LDI at BIAM, said trustees should not go near LDI strategies, which use swaps unless they understand how these instruments work. “If you go in with your eyes shut, these products can cost a lot of money,” he warned.
According to research by Greenwich Associates, most UK pension funds are presently steering clear of LDI. Only 5 per cent of schemes have implemented an LDI strategy, although 12 per cent of pension funds with more than £2bn in assets use LDI.
But almost 10 per cent of survey respondents said they have plans to subscribe to an LDI product, including almost 15 per cent of medium-sized pension funds.
Interestingly, the education deficit is not hindering demand by UK pension funds for absolute return strategies, which often “go short” in the hope of profiting from falling stock values.
The survey found that 17 per cent of UK pension funds already use absolute return strategies while another 14 per cent plan to do so in the future. And a not insignificant 18 per cent of schemes with under £350m of assets are currently using or planning to implement absolute return strategies.
Due to under-funding and low interest rates, many UK pension funds are reluctant to give up potential excess returns by shifting heavily to bonds. Pension funds instead want to preserve capital while retaining the opportunity to benefit from outperformance in the equity markets.
Why should pension schemes be more favourably disposed to absolute return products than to LDI? As with alternative investments such as hedge funds, private equity and commodities or structured products such as collateralised debt obligations, a process of education must take place before the investor is ready to invest. All of these investment strategies are complex and costly for the investor.
The answer would appear to be the negative press that certain investments fairly or unfairly attract. Hedge funds get a bad press because of high fees and periodic blow-ups. On the other hand private equity funds, despite facing increasing scrutiny from concerned regulators in the UK and US, are not burdened with the same strong stigma of risk and cost. Like hedge funds, many first-time investors in private equity opt for the equally expensive fund of funds route.
For some reason, LDI has been labelled costly and complex by investors who probably know little else about it. The investment industry will have to work very hard to win over these doubters.
Henry Smith, editor
henry.smith@ft.com
