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 6: Transacting a buyout
Our buyout blog series has covered the key areas to think about when deciding whether buyout may be right for your scheme, getting started with the process, preparing your portfolio and ensuring your investment decision-making is aligned with this goal. So, you should be all set, right? Unfortunately, things don’t always go exactly to plan. So this final instalment of our series outlines the important actions to consider in those last few months before you transact.
Managing risk in the transition to your price-lock portfolio
Until now, you’ll likely have been managing your investment strategy in a similar fashion to ‘normal’; having an objective in mind (i.e. buyout in the near future) that gives a targeted level of return whilst managing volatility along the way.
By your transaction date, you’ll need to have transitioned your assets to the ‘price-lock portfolio’ agreed with your insurer – this is the portfolio that the buyout premium will track, likely consisting of gilts and/or cash, and sometimes some investment grade credit. Some considerations for setting a transition plan to complete the required trades include:
- Have markets moved before a trade such that the value of the assets you need to sell has fallen and/or the value of the assets you need to buy has risen?
- Are any single large trades in your transition causing an imbalance to supply and demand of certain assets, resulting in adverse movements against your scheme (this is only likely if you’re undertaking a very large trade and/or you hold a meaningful proportion of a less liquid fund)?
- Have markets moved adversely during the period between selling your existing assets and buying the new assets?
- Where sponsor contributions form part of the buyout, at what point should these be transitioned to the price-lock portfolio and should this be within the schemes’ assets or managed separately?
These considerations are noticeably similar to those within the majority of large transitions; therefore, a well-structured transition plan, with involvement from all stakeholders, helps to manage potential risks. Additionally, having sufficient time and asset buffers in place helps to make the process run more smoothly – as discussed in Step 5, making buyout-aligned investment decisions and monitoring progress can ensure such buffers are achieved.
What can you do if you’re still holding illiquid assets?
Sometimes, as we’ve seen recently in both 2020 and 2022, market circumstances can lead to an increased demand for liquidity and, consequently, increased difficulties in exiting or selling (e.g. through the secondary markets) illiquid assets. While this may be a stumbling block, it doesn’t have to halt your plans to transact. Some insurers are open to deferring a proportion of the premium until a later date – this, of course, comes at a cost (similar to charging interest) – allowing additional time for the illiquids to run off. As with many buyout activities, the sooner you can highlight this to your chosen insurer, the better. This allows for an appropriate plan to be put in place.
How should your investment consultant support you at this stage?
Though your portfolio will likely be relatively simple by the time you’ve reached this stage (just a few months from transacting with your insurer), with the focus being on the transition to the price-lock portfolio, your investment consultant should be able to support in some important tasks, such as:
- Monitoring key investment metrics to ensure your scheme remains on track at the final hurdle.
- Structuring your asset transition plan to minimise exposure to the risks outlined above.
- Advising on the sale of illiquid assets or negotiation of a partial premium deferral with your insurer.
- Advising on any unexpected investment-related issues that might occur.
- Following up on post-transaction investment queries.
A buyout represents a major landmark in keeping the promises made to pension scheme members. Over the last five years, we’ve supported 18 pension schemes in achieving a buyout or buy-in to help them progress on their journey to securing member benefits, and will continue to help many more on our journey to helping make 100 million people financially secure – for the benefit of people and planet.
Here’s what our most recently transacted client has to say:
We started working with Redington in early 2019, and their advice on the Trust’s de-risking journey and work on streamlining the Trust’s very complex and illiquid LDI portfolio has been invaluable in helping us reach our target of a full scheme buy-in 3 years ahead of plan.
In particular, the framework we had in place helped add enormous value through the credit market volatility in 2020, and we were able to fully disinvest our buy and maintain credit portfolio at the end of 2021, enabling us to approach the insurance market in the best possible shape to transact.
Jeremy Stone, Chairman, WHSmith Pension Trustee
If you’d like any support on the investment aspects of your journey to buyout (or buy-in) – from assessing the feasibility to implementing a buyout-ready portfolio – please get in touch.
Please note, we don’t offer buyout broking services so you can rest assured that any advice we give is solely in your members’ best interests.
Unless indicated, these are the views of the author and may differ from those of the firm.