As published in Pensions World, November 2009:  Investment markets have been volatile in the past 12 to 24 months revealing some attractive opportunities that pension scheme trustees may have missed; not necessarily because they didn’t know about them.  Perhaps there wasn’t the realisation that some profits could be banked and adverse risks reduced whilst still targeting a longer term funding objective; or an inability to make the right decisions in time; or time to execute was just too tight.  So how should trustees get ready for next time and not later have regrets?

Getting ready

To get ready you need to:

• Set out your strategy for achieving your long term objectives;
• Have the right knowledge and understanding;
• Adopt an appropriate decision making framework; and
• Deal with practical matters.

What are you getting ready for?

The first challenge is to understand and articulate what you’re aiming for.  In today’s DB climate the ultimate objective for both Trustees and Company may be to ensure members’ benefits are secure by ensuring that the Scheme becomes “self-sufficient”.

As this is likely to take 15 years or more, it is important that you have a long term strategy for your funding objectives.  As part of your planning, set a number of pre-determined trigger points which could spur you into action (e.g. switching from equities to bonds).  This will help determine when it might be advantageous to participate in any medium-term opportunities arising without adversely affecting the probability of achieving those longer term funding objectives.

Knowledge & understanding

You need the right knowledge and understanding to help formulate your objectives and strategy in the first place.  In partnering with the Company you need to know when is it appropriate to consult - as you are required to on the investment strategy - and when you need to ask - for example, if you are expecting the Company to cough up some cash in order to proceed with a previously agreed strategic transaction.

In order to set an effective long term plan you need to consider both your assets and your liabilities.  In fact, with decisions on strategy dominating both the expected risk and return of many funds, 80% to 90% of your time should in theory be spent looking at issues such as asset allocation - this will have a far greater impact on the funding level than any under- or out- performance of a particular investment manager.  It is also important to understand all the risks relevant to the chosen strategy and not just those familiar ones such as market volatility, inflation and bond yields.  As solutions become ever more technical, you need to understand aspects such as counterparty risk and execution risk.

Give yourself time to see what is on offer and decide what might be appropriate to your particular circumstances.  This will help you focus and avoid wasting time on inappropriate ‘solutions’ or the latest investment fashion trend which may have no practical application for your scheme.  Medium term opportunities may present themselves from time to time (e.g. the peak in funding levels in the summer of 2007 or the historic spike in yields on corporate bond yields during the recent credit crisis). 

Be sure that you have both the understanding and flexibility to be able to exploit these opportunities when they arise.  To exploit some of the more complex products and strategies on offer, as well as understanding what hedging, swaps, derivatives etc are all about you need to look at collateral arrangements, typical contract terms and what protections are there for you.  This all brings much more meaning to you and your advisors’ work on due diligence.

Decision making framework

When you have the requisite knowledge and understanding you are better placed to make decisions.  Strategic decisions normally remain with the Trustee Board that might only meet, say, four times a year.  However, medium term opportunities are likely to require quick decisions (sometimes with only 24-hours’ notice) and you need to have a clear decision making framework in place with the appropriate protocols.  These protocols must involve the sponsoring employer if you know you will either need to consult with them or ask them should they be party to a previously agreed transaction.  And clearly you need a process that allows you not only to take decisions quickly but enables you to execute your decisions in the required timeframes.

One way to effectively speed up decision making is to allow your investment committee to act within pre-agreed parameters; by providing it with clear terms of reference you can ensure that it operates effectively and does not overstep its powers.  Make sure that the right people are appointed to the investment committee and set the parameters so that the committee can, where appropriate, be empowered to exploit medium term opportunities and deal with all manager issues.  This will help the Trustee Board as a whole to focus on the key strategic issues.  You also need to ensure that the investment committee formally accounts for its actions to the Trustee Board.

Consider how urgent and/or ad hoc decisions will be dealt with, perhaps via conference calls, convening of a Chairman’s or emergency powers committee and determine whether decisions made within this forum can simply be minuted or whether a trustee resolution will be needed.  If the latter, look at how you will achieve this, particularly if trustee directors are widely spread geographically.

Even when the decision is made, you need to consider how it will be executed.  For example, the trustee could appoint an executive function perhaps enabling its chief operating officer to execute manager agreements provided that (s)he a) has no discretion, b) demonstrably has the power to act on behalf of the trustee and c) is subject to certain protocols such as checking that appropriate investment and legal advice has been received.

Practical matters

As well as having a formalised process agreed including final decision and execution protocols, more advanced planning and preparation is needed.  For example, you need your custodian on board to open appropriate accounts such as those needed for collateral arrangements and/or new managers; it may be possible for you to have an alternative manager in place ready to replace an existing manager if things go wrong and it’s sensible to work closely with your transition manager early on in the process particularly if the size of your transactions could alert the market to your intentions and therefore impact the terms on which you’re able to conduct business.

It may also be possible to have the appropriate agreements in place in advance so that there is little need for your legal and investment advisors to stay up half the night and run the risk of needlessly getting something wrong; not to mention raise the fees you will have to pay.  Make sure your legal advisors are familiar not only with your pension arrangements but also, where applicable, with corporate finance, investment banking or insurance matters.

With so many moving parts you need to ensure that you have an effective partnership between yourself, the sponsoring employer, your advisors and your managers.

Attend to the mundane such as data and communicating with members.  You don’t necessarily want your members learning in the press about a major transaction involving your pension scheme!  In any event, you may need to communicate with members if you want to enlist their help in making sure your data is fit-for-purpose.  You may still be relying on the sponsoring employer for some of your data needs; that’s hardly consistent with your desire to be “self-sufficient”.  Whilst your data may be in excellent shape for an ongoing scheme it may not be anywhere near good enough to remove uncertainty about transactions costs.  So while your sponsoring employer is still interested, work with them and take action now to cleanse data.

Other beneficial outcomes

As well as being ready, just having a proper focus on what you’re trying to achieve and putting in place these preparatory actions could result in lower operational costs through, for example, greater trustee focus, and a potential reduction in liabilities with fewer surprises through, for example, having better data.  Not least it shows a proper discharge of your duties as trustees and gives you the satisfaction of getting it right.

Key messages

To sum up:

• Set a clear long term strategy to meet your objectives;
• Allow some flexibility to grasp medium term opportunities when they appear;
• Ensure you have the right knowledge and understanding;
• Have clarity in your decision making structure with the right people making the right decisions at the right time;
• Attend to the practical and more detailed matters such as pre-agreed contracts, data cleansing and communication.

And start now – this is no longer just a waiting game. 

In a nutshell:

• Set a clear long term strategy to meet your objectives allowing some flexibility to grasp medium term opportunities;
• Ensure you have the right knowledge and understanding;
• Have clarity in your decision making structure and be ready to execute your decisions.

Article by Barry Mack FIA, Head of Governance & Plan Management, Hymans Robertson

Barry is responsible for developing and promoting the firm’s Governance and Plan Management services, including new business generation and firm-wide thought leadership, as well as delivering and consulting directly on key client assignments.