The Pensions Regulator recently published guidance aimed at trustees on setting investment strategies for defined benefit schemes. The Regulator maintains that a good investment strategy involves effective governance, delegation and monitoring.

What is the need for investment guidance?

This is part of the Regulator’s strategy to provide simpler guidance for occupational pension schemes. The guidance is intended to be read alongside the Regulator’s other guidance such as its guidance on scheme funding and integrated risk management and provides practical examples and factors for trustees to consider when setting an investment strategy. It is split into six sections.

Governance

This section is intended to assist trustees in setting up an appropriate governance structure for their scheme’s investments. It is important for trustees to be clear on what their obligations are and when to take professional advice. The Regulator recognises that the fundamental purpose of trustees’ investment powers is to generate returns so that the scheme can pay members’ benefits as they fall due. The guidance stresses the need for trustees to have effective investment governance arrangements in place and for these arrangements to be suitably documented.

Investing to fund defined benefits

In this section, there are considerations to help trustees to formulate, refine and revise their investment strategy. Setting an appropriate investment strategy “balances risk and return in light of evolving scheme circumstances and objectives over time”. The Regulator refers to guidance by the Law Commission on the legal obligations that trustees have when considering financial and non-financial factors when making investment decisions. There are a number of areas that trustees are encouraged to focus on including:

  • Investment beliefs
  • Financial and non-financial risks including environmental, social and governance issues
  • Sustainability
  • Setting an appropriate investment strategy
  • Journey planning
  • Understanding investment risks

Matching DB assets

The Regulator emphasises that trustees need to understand why their scheme invests in matching assets and understand at a “high level”, the principal characteristics of the liabilities or cash flows they’re trying to match. Trustees should consider the risks involved in using matching assets such as leverage issues, collateral management when using derivatives and concentration risks. The guidance also reminds trustees that it’s a legal requirement for scheme assets to be properly diversified.

Growth assets

The guidance points out that trustees may find it helpful to consider whether the return on the growth assets are contractual (e.g. a bond investment) or non-contractual (e.g. equity investment). Also, using a framework that considers the underlying drivers of return can help trustees to understand how their growth assets may perform in different economic and market environments. Some drivers for consideration include:

  • Equity market risks
  • Interest rate risks
  • Inflation risks
  • Currency risks
  • Liquidity risk

Implementation

This section highlights the need for trustees to consider operational risks, the security of scheme assets, asset transitions, liquidity and collateral management. Trustees should have a prioritised strategy in place to manage and mitigate operational risks. Trustees may also wish to consider the need for operational due diligence before appointing any third party involved in managing scheme’s assets.

Monitoring

Once an investment strategy is in place, the trustees must monitor its performance. The guidance points out that monitoring is most effective when it is prioritised, timely and actionable. To attain this, the Regulator encourages trustees to:

  • focus on the key drivers of funding level change and investment performance, monitor them in a timely manner, and take appropriate action when necessary;
  • identify the key information that is needed to do this and ensure it is presented clearly;
  • monitor the investment strategy; and
  • make arrangements to monitor and review investment managers’ performance.

What next?

Trustees may wish to use this guidance to review their existing practices. What may be helpful to trustees are the practical examples throughout the guidance. Setting an investment strategy is complex and the guidance highlights the importance of trustees taking the appropriate advice where necessary. The Regulator also refers to the trustee toolkit throughout the guidance for assistance. Whilst trustees are able to take advice, ultimately the responsibility for compliance lies with them.

The full guidance can be viewed here, or a summary of the guidance can be viewed here.

This blog post was written by Patricia Bailey. For further information, please contact:

Michael Collins, partner, Pensions

T: 0121 234 0236

E: Michael.Collins@gateleyplc.com


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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.