Despite recent market volatility, a combination of strong long-term returns across growth assets, company contributions and, latterly, real interest rate increases have resulted in improvements across the funding levels of many defined benefit pension schemes on an endgame basis. With the endgame now in sight, trustees have begun to turn their attention to what a suitable target might be and how to get there.
For lots of schemes, buyout is seen as the ultimate endgame objective. But how do you decide whether it’s right for your scheme and what the next steps are once you have? In this blog series, we’ll be guiding you through the six steps to buyout to help you navigate your journey. If you need any support along the way, please get in touch.
Step 4: Getting your portfolio buyout-ready: growth assets
As we mentioned in our earlier blog, the first hurdle in preparing your growth assets for buyout is managing any illiquid holdings, but there are some considerations for your liquid growth assets too. In this blog, we discuss how to restructure your growth assets.
Does it matter if you hold illiquid assets?
Typically, yes. To transact a full scheme buyout, a pension scheme will require sufficient liquid assets to meet all the pension scheme liabilities. We’ve not seen any cases where an insurer gave a better buyout price for a non-cash asset allocation, and holding illiquids can limit your choice of insurers. Whilst some insurers may offer a deferral to a proportion of the buyout premium to allow for illiquid assets, this is usually relatively small as a proportion of assets transferring, so should only be used as a tool to manage existing illiquid holdings in the case that buyout becomes affordable sooner than expected, rather than as a tool to allow for new illiquid investments.
What should you do with your illiquids?
First things first, if you’re getting close to buyout, don’t commit to any additional illiquid investments. If you’ve still got a way to go, make sure you’re planning ahead to try to naturally run off your closed-ended illiquid assets and redeem in good time from open-ended illiquid funds as you’re approaching buyout. You’ll (most likely) need to continue funding any existing commitments, but it’s worthwhile discussing an exit plan for these with the investment manager; selling up early can be more viable than you might think.
Now let’s suppose you’re in, or almost in, a position for buyout, but you have some illiquid assets. The first thing to do is to understand from the investment manager the expected timelines for all locked-up capital to be distributed. For longer-dated assets which you expect could be a barrier to buyout, such as assets held in a private equity style vehicle, sales on the secondary market, including to the asset managers’ other investors, could be considered.
With your illiquids sorted, we move on to your liquid assets
You’ll be pleased to know that getting your liquid growth assets in order is more straightforward – but you should still have a plan in place for managing them. At the point of transferring your assets and liabilities to an insurer, it’ll likely be a portfolio consisting of gilts or cash (or a combination of the two and sometimes an element of investment grade credit depending on the insurer). Typically, we’d recommend liquidating all other growth assets into this ‘insurance portfolio’ once you’ve locked in a buyout price. It’s possible to stagger the execution of this to diversify the risk of adverse market movements on a single day and, for larger schemes, to avoid moving the market with substantial sales.
There are a lot of moving parts here, so how can you monitor your progress?
In our second blog of this series, we mentioned our ‘Buyout Risk Management Framework’ (BRMF), a one-page dashboard setting out the key metrics that define your progress towards buyout. In our next blog, we’ll outline this in greater detail and explain how it can help you continue to make buyout-aligned decisions and measure success clearly and robustly.
Unless indicated, these are the views of the author and may differ from those of the firm.
