According to JP Morgan Asset Management head of pensions solutions and advisory EMEA, Sorca Kelly-Scholte, schemes should consider assets that deliver long-dated secure cashflows.
“Certainly high credit quality government debt is one of those,” adds Kelly-Scholte, “but that extends through to credit and then to spread sectors like emerging market debt, a lot of which is actually investment grade-rated, and goes through to high quality loans and private credit.
“It extends to real assets which are defensive in nature such as core real estate and infrastructure, ground lease rent, and other forms of secure income streams that are inflation-linked.”
ILLIQUID, PRIVATE ASSETS
The Church of England Pensions Board (CEPB) is one scheme looking to base its liability measure on the assets it holds in the portfolio and as such is moving into illiquid private market assets.
Speaking to PI recently, CEPB chief investment officer Pierre Jameson said instead of the gilts-plus method the fund was starting to base the portfolio on real return contractual income from assets such as US corporate loans and infrastructure where there is no direct mark-to-market.
Earlier this year, the scheme invested £80m in US private debt with Audax Senior Loans, an asset manager that invests in the debt securities of middle market companies backed by private equity sponsors.
Jameson said: “[Calculating liabilities] could be based around the anticipated return from the portfolio and the more confidence you can have in the return from the portfolio, the more likely you are to be able to use that as your discount rate.
“That’s a big difference from using something like gilts plus 1.3%. If you could have confidence you were going to generate something like RPI plus 3% or 4%, which is actually quite possible through some of the things we have in the portfolio, it could transform the calculation of liabilities.”
FLEXIBILITY
Moving into cashflow generating assets makes sense, but JLT’s Wright urges schemes to think carefully before tinkering with their long-term investment strategy. He argues employers will save more money in the long run by getting their investment strategy right up front rather than moving to an alternative discount rate later on.
“People are too reliant on the assumptions side of things,” he explains. “The assumptions we set as actuaries do not really change anything other than the timing of when you are paying for the pension scheme. Moving from equities to cash will affect the cost of the scheme to the company, but using different actuarial assumptions does not change the actual pounds and pence cost you have to pay in over the period – the members’ benefits are unchanged.”
In terms of illiquid assets, Wright says they get schemes to a point where they can use a higher discount rate, but they don’t actually do as well relative to the liabilities over the long run and will actually cost more money.
He adds: “Let’s say you have an alternative illiquid asset and a listed equity; if you think that listed equity is actually going to do better over the long run then would you move into that lower return asset just because you can measure it slightly differently? People have to tread very carefully with this.”
NONE OF THE ABOVE
But BrightonRock head of research, and PI columnist, Con Keating believes measuring liabilities on either a gilts-plus basis or a return on asset basis is wrong.
Keating is surprised discount rates of any kind appear in the valuation of pension liabilities because, he argues, they do not figure in determination of the pension payments promised and projected, whereas longevity, wages and earnings do.
