Category: pensions

Why a Focus on Personality Matters for a Better Pensions Team

I really enjoyed this fantastic article which featured in the March issue of Harvard Business Review, and explores the Deloitte Business Chemistry model in relation to trying to understand differing work styles and team dynamics. I’d definitely recommend reading the article in full if you haven’t already.


It got me wondering – how might these insights apply to pensions? After all, taking decisions, making progress and enacting change within a DB pension fund involves a huge team effort between trustees, corporate sponsor, in house pensions teams and advisors. In many cases there can be big differences in style and approach between these groups and even individuals within the same group. These differences could derail effective decision making, or they could enhance it.

What is the Deloitte Business Chemistry model?

The Model is based around identifying four different personality styles relevant to teamwork. The purpose of this isn’t to “pigeonhole” individuals but rather to identify a common language that helps everyone understand the differences between them, and appreciate the potential sources of tension (both positive and negative). It also gives some actionable takeaways that you can start thinking about straight away.

I’d encourage you to read the whole article but here is a summary of the four styles:

Pioneers value possibilities, and they spark energy and imagination on their teams. They believe risks are worth taking and that it’s fine to go with your gut. Their focus is big-picture. They’re drawn to bold new ideas and creative approaches.
Guardians value stability, and they bring order and rigor. They’re pragmatic, and they hesitate to embrace risk. Data and facts are baseline requirements for them, and details matter. Guardians think it makes sense to learn from the past.
Drivers value challenge and generate momentum. Getting results and winning count most. Drivers tend to view issues as black-and-white and tackle problems head on, armed with logic and data.
Integrators value connection and draw teams together. Relationships and responsibility to the group are paramount. Integrators tend to believe that most things are relative. They’re diplomatic and focused on gaining consensus.

Source: Harvard Business Review


The challenge in allowing these diverse styles to work together most effectively are the big differences in what energises and alienates each group. For example integrators dislike conflict, but drivers love a solid debate. Also the style in which each group prefers to think and contribute varies greatly: a guardian is likely to want to step through a plan line by line, for a pioneer this might feel quite painful. This has real consequences for situations where differing styles interact.

You’ve probably already recognised elements of your colleagues’ styles in the descriptions above, but what might this mean for running a pension fund?

It’s easy to see how these differing styles might be present around the meeting room of a typical DB pension fund trustee board. Starting with trustees themselves – the connotation of the word “trustee” in English is similar to “guardian” – even though the role of the modern day trustee is much wider than that – and many trustees approach their role with the mindset and style of a guardian (for all the right reasons). They want to see data and facts before taking any decisions that might expose their members to risk, they want to see rigour and convincing arguments in the choices being made in the management of the assets.

All makes total sense – we’re dealing with members’ future financial security here in many cases after all – however contrast this with (say) a “driver” in the chairman’s seat: someone brought in to get things moving, passionate about making progress, changing things for the better, making members better off. It becomes easy to see how these differing styles might cause tension.

Let’s add in the corporate sponsor angle – perhaps a pioneer in the CFO or CEO seat. A natural risk taker who doesn’t like to hear the word “no”, drawn to bold and innovative approaches and focused on the big picture. Sound familiar?

Where are the advisors in all of this? 

The key advisors to the scheme (actuary, investment consultant, covenant advisor, lawyer) will also contribute to the team dynamic, perhaps significantly so, and might have a variety of styles – and this is one area actually where the model opens up some choice. The trustees can choose their advisors after all and if they are aware of the mix they naturally have around the table, then they might want to select their advisor to complement that. Perhaps an integrator to try and bring people together, or a driver to generate momentum alongside the chair. Perhaps it might even help to have different personalities in the advisors – a guardian to represent and appeal to the guardian types around the table alongside a driver.

Without wanting to generalise excessively, it’s my experience that actuarial-types are likely to often display guardian characteristics to some degree (having said that I do know plenty of pioneer and driver actuaries). In some ways this isn’t surprising: careful study, discipline and logic are what gets you through the exams (and probably attracts many people to the profession). Having guardians among your advisers may be good, but might not be the best choice if the trustee board is already guardian-heavy.

The picture is further complicated in those pension funds that might have significant internal teams involved in the management. Perhaps a bold portfolio manager with pioneering anti-consensus views. There might be an integrator in there, or more guardians.

So what?

So the model’s great, but what can we do with it? What actions can we take away in order to help our pensions teams work better together, harnessing the benefits of cognitive diversity rather than experiencing the tensions.

Well, firstly simply having a common language to understand the differing styles within teams I personally find hugely helpful. Being able to depersonalise by saying things like “look, the guardian in me is saying X”, or “the driver in the room would be saying Y” allows teams to lightheartedly explore the differences without things becoming personal or existential, and hopefully without battle lines being drawn.

But there is more than that.

Adjust your style

Once you are aware that you’re a guardian type, craving rigour and logic, working alongside a driver who is committed to progress and getting things done it becomes easier to recognise and adjust your style – perhaps that means going outside your comfort zone to try and get to a decision on a key issue with incomplete data,  being happy working with a bit of ambiguity in an area that can’t be pinned down, or being open to new types of solution that don’t necessarily fit into existing modes of thinking. On the flip side the driver might need to be patient in systematically exploring the data behind the decision to appease the guardians, stepping through details like by line when their instinct is to get it done and move on.

Recognise minority styles 

Making sure that minority groups are represented and have a voice is really important to be productive and is something that can be influenced – for example it’s possible to verbally acknowledge that a group is guardian-heavy and that they need to try and listen to – and be receptive to the perspective of –  the drivers. Rather than playing “devil’s advocate” in challenging ideas, it may be more helpful to “play driver” or guardian. Especially if that isn’t your natural style.

Add to the team carefully 

When there’s the opportunity or need to add to the team, the model gives a clear roadmap for exploring the fit between the needs of the team in terms of personality and potential candidates. In particular it highlights the need to bring integrators to the table, and potentially the need to bring more balance to the driver/guardian split.

Get close to your opposites 

It’ll often be in one-on-one relationships where the real differences emerge and pain-points become apparent. Knowing how those styles opposite to you will react, what energises them, and how they prefer to work will be really helpful. It might involve getting out of your own comfort zone and adapting your style (as mentioned above), but it must just increase the chance of progress being made.
Beware of cascades

Teams with lopsided composition can be vulnerable to decision making biases such as cascades – where the views of those first to speak become echoed by others and grow into a crescendo until they go unchallenged. The key to addressing this is to consciously “elevate” the minority styles on the team – perhaps making sure they are first to speak when it comes to decision making.

These are just some quick thoughts on how this powerful model could apply to pensions. Do tweet me with your thoughts.

Consulting firms reply to the WPSC Inquiry

The Work & Pensions Select Committee (WPSC) Pension Protection Fund and Pensions Regulator inquiry consultation certainly attracted a good number of responses. I count almost a hundred in that list and presumably not all are yet published!

Most of the major investment & actuarial advisory firms are represented there, as well as  PPF and The Pensions Regulator.

Reading through the submissions of all the investment advisory firms (yes, I really did!) I must admit was struck by the quality of the submissions, the level of thought that had clearly gone into them and the ordered and lucid way in which arguments were presented. I didn’t agree with everything that was said by our competitors (you’d expect that) but I was impressed with the quality.

I’ve tried to summarise each of them below, naturally these are through the lens of my own reading and interpretation. If you think I’ve got any of them wrong, please let me know!

At the end I’ve tried to draw out the questions on which that group of respondents are clearly divided.

I’ve ordered the summaries below on an approximate scale of suggested change level, from those that argued for least >> most


Big picture Hymans believe that the current regime is fine, there is not an issue with affordability subject to giving schemes and sponsors “time to heal”.

“Most schemes are well managed and should be able to pay benefits in full

Hymans would not propose any changes lest these have unintended consequences and damage the functioning of the majority of schemes. Floated the idea of conditional indexation in stressed situations but highlighted the need for “watertight safeguards”. On the regulator’s powers:

“The regulator has adequate power. It’s wrong to assume that committing more resource to the regulation of DB schemes will improve outcomes for pensioners. It might actually exacerbate the problem – because more onerous regulation could make DB provision more difficult for employers.

Hyman’s noted that the PPF has been managed in a sustainable way and indeed provides a good risk management model for all pension funds.


Provided a timely reminder that the PPF itself is both necessary and stable – with a growth in assets to £23bn but a funding level of 116%, and total benefits paid out to members of £2.4bn.

Much of the response concerned considerations regarding the future level of the levy, describing enhancements to the models used and refinements based on data gained, particularly in taking a different approach to small companies compared to large ones. Improving predictiveness of models, using different variables.

The PPF indicated a belief that sponsoring employers have sufficient cash and financial strength to shorten recovery periods, and discussed their aggregate modelling of the number of schemes predicted to enter the PPF:

“. Indeed our modelling projections would indicate that given the strength of employers in the median case the vast majority of schemes should be sufficiently funded to pose little risk of making a claim on the PPF by 2030 (with less than 700 schemes falling into the PPF in in the median case by that time as against around 850 to date).

The PPF would support a more interventionist role from TPR, for certain categories of scheme, with the goal of tackling risks to member benefits. In particular PPF believe that for stronger sponsors shorter recovery periods should be targeted (interesting, this is the one area where the PPF appear at odds with TPR, with TPR indicating their willingness for more flexible terms for strong sponsors). PPF believe restrictions on recovery periods and “back-end loading” of contributions would be appropriate.

For stressed schemes – the PPF  suggests intensive scrutiny and consideration of the options for restructuring the scheme. They made a case for TPR to have the broad power to trigger the wind-up of schemes with request of PPF or the trustee. In transactions PPF believes avoidance powers could be enhanced by better targeting and faster implementation. Duties placed upon employers and trustees to engage with TPR would be appropriate.

PPF noted that options for scheme consolidation should be considered. Highlighted their concern at the suggestion of new business models that might allow a scheme to continue without a sponsor.


The Pensions Regulator (TPR)

TPR believe the current regime is operating as intended and most pension schemes are affordable for the majority of employers (backed up by data on ratio of contributions to dividends). Made some suggestions on how TPR could be changed with the benefit of experience: more powers to compel individuals and organisations to give TPR information and submit to scrutiny (including civil powers). More timely actuarial valuation information (narrowing the 15 month window in acknowledgement of technological enhancements). Powers to be more prescriptive on the overall funding and investment outcome, rather than focusing on individual parameters such as length. Shifting the burden of proof to schemes to justify long recovery periods etc. Mandatory clearance of corporate transactions could be considered (the current system being voluntary), which could extend to all actions that potentially weaken the standing of a pension scheme (eg dividends, share buybacks). Suggested enhanced whistle-blowing procedures could also be considered.


We stressed the importance of considering all this from the member perspective, and emphasised the benefits to schemes of enhanced governance (which many UK schemes are of insufficient scale to deliver). We also highlighted the existence of a number of success stories around the industry that we believe through better knowledge-sharing of best practice. We acknowledged the tricky balance that regulation must strike between security for members and sustainability of firms, noting that it is usually in the best interests of pensioners to continue to have an ongoing firm backing the scheme. We argued for small-scale changes to existing regulation to strengthen the hand of trustees in funding negotiations, provide more guidance on parameters and shift the responsibility to sponsors to offer additional security in the case of lengthened recovery plans.


LCP’s response took things back to the highest context level, highlighting the key tensions and spelling out the fact that there aren’t any easy political choices. LCP believe a “significant minority” of schemes will be unable to pay full benefits. Resolution will require political change now which may be painful in the short term, but carry long term benefits for security of pensioners. Setting out the three different political options facing the government LCP described the broad choices as (1) leaving the balance between DB members and employers broadly the same (2) shifting the balance in favor of member security at the possible risk of “significant negative impact” on corporate sponsors and (3) shifting the balance to soften the pension promise, creating “welcome easement” to firms at the expense of reducing the value of pensions paid to members. Beyond that point LCP said they broadly agreed with the response of the ACA (summarised below). LCP believe that small changes (to regulation) are unlikely to have a positive impact:

“We think it unlikely that small changes to the current pension regulatory environment will have a major positive impact, and they may have negative unintended consequences. We strongly recommend that you do not propose changes to Government in order to be “seen to do something” in response to BHS.

LCP also commented that the exit from the European Union might present opportunities to change legislation.


On the issue of regulating the effect on pensions of corporate action, Mercer believed the onus could be moved to the other relevant regulators (such as the FRC, PRA or takeoever panel), to take into account pensions issues in the context of corporate activity, rather than the “single issue” pensions regulator becoming involved in corporate activity. Mercer suggested that advisers themselves could be an enhanced source of regulation by increased use of “whistleblowing” type activity and an enhanced focus on the need for members of professionally regulated bodies to do this.

On the question of TPR’s powers, Mercer made the point that before considering new powers the way TPR exercises it’s current powers should be evaluated, as it is possible the current powers are sufficient, but not being fully utilized. New powers would not necessarily reduce the risks faced by pension schemes. Making TPR more interventionist would not guarantee better outcomes, and might impose additional costs on trustees for no gain.

On the question of whether the current market conditions warranted an exceptional approach:

“Unfortunately, it is not possible to tell if the current environment is exceptional, and so difficult to say it warrants an exceptional approach.

“Our view is that the purpose of a valuation is to impose some controls over the future expected cost of providing the scheme and the pace at which that cost is met. The statutory funding regime achieves that. If a non-market related approach were introduced, the results might be different, but they would also have no context, be virtually meaningless (for example, they might not give appropriate signals to inform investment strategy), and inevitably short lived.

Association of Consulting Actuaries

Made some very similar points to Mercer in the role that other regulators could play with regard to pensions, and much of the wording in other areas also bears a lot of similarity, suggesting there was a lot of common input.

In particular the ACA highlighted a possible role for other regulators:

“Consider the role of all regulators that could possibly have authority over actions that might affect pension scheme outcomes, and how they could use their powers to influence good governance in relation to decisions and advice affecting workplace pension provision.

Gave examples of the Takeover Panel, PRA and FRC, noting that the TPR itself does not regulate the way companies are run, and how they balance the demands of DB pension provision against other things.

“…corporate responsibility for balancing the security of company pension schemes with their other priorities seems a matter for other regulators, such as the FRC or PRA, with responsibility for good corporate management and governance.

Believe making TPR more interventionist, from it’s current supervisory and guidance stance is not a guarantee of better outcomes, not helped by the TPR’s internally inconsistent and conflicting objectives.

On the TPR’s powers the ACA response (again similarly to Mercer) emphasis the belief that existing powers have perhaps been underused or in practice are “illusory”

TPR has seldom used those of its powers that would directly impact company decisions, which has perhaps led many to view that its powers are illusory (for example, because the hurdles to cross before they can be used are too onerous). It is possible that the threat of using them has always proved sufficient, but that is not obvious to many in the industry. TPR has to produce reports about when it does use its powers; some clarification around situations where it chooses not to might also be helpful.

The ACA noted that TPR’s objective to minimize claims against the PPF skews it’s focus (towards larger schemes, even if they are at lower risk of default) in a way that is not necessarily optimal for the functioning of the system as a whole.

The ACA suggest a statutory override to RPI benefits (moving them to CPI) in the context of generating inter-generationally fair outcomes in relation to money purchase pension recipients. ACA note that the intention of trust law probably wasn’t to hardwire benefit increases to a particular index and also that mandatory indexation was enshrined by the Pensions Act 1995, suggesting that it is appropriate for the government to legislate to overcome problems created by previous legislation.

Mentions consolidation relatively briefly, makes the point that benefit complexity is one barrier to this happening, suggests that introduction of a facility whereby historic benefits can be converted to a single standard would facilitate this.


Aon believe that the inquiry into DB should be considered in the context of DC – money spent on DB  can’t be spent on DC. Aon believe that an intermediate solution should be available to some schemes between full benefits and PPF levels. Focusing more on bigger regulatory changes rather than tweaks AON made some quite developed suggestions in regard to intermediate solutions, for workable changes to the existing regime. Broadly these suggetions were in favor of an intermediate benefit solution based on conditional indexation and moving to more of a “with-profits” style system with  regard to pension increases (pay increases conditional on the performance of growth assets). Aon suggested that a change to a with-profits system (including within the PPF) might make it easier to push for consolidation of schemes without subsidy.

Of the consulting firms Aon came closest to advocating changes to the funding approach- articulating the benefits of a cashflow and probability of success measurement regime as opposed to a present value and funding level, however overall Aon reflected a balanced view here, arguing for a “wider range” of approaches, including both present value and cashflow approaches, rather than a replacement of the present value approach.

“A present value approach is not wrong. It encapsulates the valuation in a single figure, which probably does reflect where the scheme is trying to get to in the long-term. It also tends to encourage more immediate action in response to changing circumstances, although this means reducing deficit contributions when deficits reduce, as well as increasing deficit contributions when deficits increase. However, the present value approach does have a number of disadvantages which are becoming more apparent in the current low yielding and volatile environment

Aon suggest giving company directors a responsibility to consider the funding level of the pension scheme when deciding upon dividends.

AON “called out” the practical challenges associated with consolidation – namely that it’s tricky to do it in a way that both avoids cross-subsidies between schemes AND achieves the enhanced governance objectives of consolidation. This is important as the concept of consolidation seems an easy one to agree upon, but much harder to find workable ways to achieve it in reality.


Cardano believe that the regime should be changed to engender (1) greater prevention – by focusing on the economic value of the liabilites (rather than the technical provisions basis which allows for asset returns) and (2) more flexibility – with the ability for trustees to negotiate with employer to get to an intermediate solution between full benefits and PPF benefits, in advance of a full corporate insolvency process. Cardano believe that there is a systemic affordability issue that government needs to address.  Cardano believe that the current system of Technical Provisions gives a false sense of security, they also referred to the increased cashflow negativity of schemes and path dependency issues this creates as schemes pay out full benefits while being substantially underfunded on a full economic basis.

Cardano are critical of the Technical Provisions as a measure of scheme health and believe this has not fostered the best decision making:

“The recovery plans, approved by The Pensions Regulator (TPR), have also been sliding. As schemes have become more severely underfunded, longer recovery periods and higher future return expectations have been accepted. So a fuzzy measure of the health of the pension fund (Technical Provisions) contributed to poor risk management on behalf of trustees, which led to deteriorating funding positions, and that has been met, broadly, by TPR simply relaxing the parameters, and tacitly accepting the new status quo.


What are the key questions that divide the respondents?

I think you can boil it down to the following subjective questions with the above respondents divided on pretty much all of these points

  1. Is large-scale reform of the DB system needed (to generate better and more optimal outcomes for members and sponsors)
  2. Are small-scale tweaks to existing regulations worth considering
  3. Should an intermediate solution between full benefits and PPF levels be investigated
  4. Should there be consolidation among schemes
  5. Would additional interventionist powers in TPR be overall helpful to pension security

What common themes were there among the responses?

I think there was broad agreement on what the key challenges are – namely balancing security for members with sustainability for employers. This question seems to frame the debate at the right level for government consideration, rather than getting too absorbed in the particular details.

I think there was general agreement that changes to the funding regime, particularly moving the basis on which the liabilities away from one which references bond yields are not warranted.

Scheme consolidation and conditional benefit indexation were two frequently occurring suggestions that while not universally agreed upon, would appear in my view to have enough advocates for further investigation.

A considerable number of suggestions were made regarding smaller incremental improvements to current legislation, although there was disagreement on the question of whether incremental improvements is in itself worthwhile or beneficial or wholesale reform needed. Again that question seems framed at the right level for government consideration.

There seemed to be agreement that the current system is not set up to deliver inter-generationally fair outcomes, given that younger employees (particularly in the private sector) have no access to DB provision and are likely to receive lower pensions in relative terms than previous generations. There were several suggestions that the DB reforms should be considered in the context of/alongside the DC system in the knowledge that imposing increased costs on the DB side will impact DC.

So there you have my take on the consulting community responses to the WPSC BHS pensions inquiry. Do let me know your thoughts.

Mind the gap – funding levels fall as market volatility hits assets

The PPF today published its monthly estimates of scheme funding position for the schemes in the PPF 7800 index.

Not surprisingly, given the market moves over September 2015, and over the third quarter generally we saw a 5% decline in funded status over the quarter due to both declining asset values and increasing liabilities.

It’s been a bumpy ride for pension schemes over the last year as the liability side of pension scheme balance sheets have been impacted by volatile and falling gilt yields, while the asset side has now been hit by the equity market volatility we’ve seen through August and September.

Both the funding position (79.9%) and deficit (at £311.7bn) are close to the January 2015 positions, which were the worst in the 10-year history of the dataset.

PPF (12)

What does this mean for most pension funds?

The major impact this will have on a pension fund will be the Required Return they need to become fully funded over the target investment horizon of the scheme (which will vary).

Roughly speaking a 5% worsening in funding level might equate to a 0.5% per annum increase in required return over, say, a 15 year investment horizon. It would mean a significantly higher increase in required return over a short time horizon of 10 years or less (see figure 1)

If the expected returns from the assets are held constant then a 5% fall in funding level would push the full funding date out by around 5 years (see figure 3).

Figure 1: Required returns to different full funding dates
Figure 2: quarterly funding level changes of PPF 7800 index
figure 3: Projected scheme full funding dates for various starting funding levels & future excess returns
figure 3: Projected scheme full funding dates for various starting funding levels & future excess returns

Following these falls, what should pension schemes do? 

  • Revisit their funding goals, and ask whether these are still achievable;
  • Check the investment strategy is on track to meet the returns they need;
  • Avoid knee-jerk reactions by sticking to a decision making framework.

Live Long & Hedge?

In the longevity-hedging space, 2015 is on track to match 2014 as a record year for the total volume of hedging deals, highlighting the significance of this area within the pensions space.


Following the Scottish & Newcastle deal in September 2015, the widely followed blog listed c£30bn of liabilties hedged so far in 2015 compared to £40bn in 2014 (which included the mammoth £16bn BT scheme deal).

Other significant developments in the longevity hedging in 2015 included:

  • Advisors turn providers: Towers Watson (Longevity Direct) and Mercer (with Zurich, for smaller schemes), two of the most successful deal advisors to date launched vehicles to allow schemes to access longevity hedges
  • Guernsey is the place to be: the offshore dis-intermediated structure pioneered by the BT deal in 2014 continued to be a popular approach in 2015. some of the details of this are pretty arcane but needless to say there are advantages and disadvantages to the structure some of which I mentioned here
  • Experience turns against trends: analysis by the institute of actuaries CMI, and covered in the Actuary magazine shows that mortality experience between 2010-2015 suggests a slower rate of improvement than that implied by the previous decade, opening the debate on assumptions that should be used in the future. A further piece in the actuary magazine highlighted the role that falling smoking rates could have.

In fact, research produced by the Institute of Actuaries in September 2015 stated that 2015 may well show the lowest mortality improvements in the 40 years of data used to calibrate the CMI model. Taking 2015 by itself of course could be regarded as a blip, but improvements were also low in 2012 and 2013 – bringing into focus the question of when this becomes a trend that should factor into the model.

We at Redington firmly believe that longevity risks can, and should, be considered alongside the other asset and liability investment risks within a pension scheme. We’ve developed a framework for assessing when, and how much longevity hedging makes sense for our clients, which can be simplified to a 5-point rule of thumb assessment:

  • Are interest rate risks hedged to the funding ratio?
  • Are risk seeking assets less than 25% of the portfolio?
  • Are you more than 80% funded on an economic basis?
  • Is pricing relatively attractive?
  • Do you have the time and governance bandwidth to commit to the deal process?

Meanwhile, demand for longevity hedging looks set to continue at roughly the current rate of £40bn per year, which is equivalent to 2-3% of total UK pension liabilities. The total amount hedged to date is c£100bn or 4-5% of total liabilities.

Tail Risks, LTCM & Constant Volatility … notes from a lunch with Myron Scholes

I had the very great privilege of taking part in a roundtable lunch with Myron Scholes last week, thanks to Janus Capital (see unashamed photo below) –

IMG_4149 (2)

hosted in the Fenchurch Brasserie in the well-known “walkie-talkie” building in London the views were pretty good as well (see below).

Despite his fame, Myron still clearly thinks deeply about markets on a day-to-day basis and made some well-argued and thoughtful points, principally around the interaction of  risk management and long-term asset management including –

  • The incidence of Tail Risks is very damaging to returns, even over long periods of time
  • Beware “convexity costs”: the fact that large positive and negative return swings will tend to drag down compound average returns over time *
  • As well as diversifying across asset classes investors should logically diversify across time also, by trying to ensure their portfolio is equally exposed to risk in different time periods
  • Fixed allocations while appealing do not naturally have this property, dynamic allocations to assets are required to keep risk constant
  • The options market, by it’s “Darwinian” nature may contain useful information on tail risks, which most investors do not or are not able to use

And on LTCM…

  • Myron suggested that he was highlighting the nature of the large tail risks in the fund to the managers going into 1998

On the Black-Scholes equation …

  • Myron suggested that they spent several years in the early 1970’s attempting to arrive at a formulation that allowed variables like volatility and interest rates to vary over different time-periods, but the maths was too difficult to work so Fischer Black made the suggestion to keep them constant, which greatly simplified the mathematics allowing them to publish

Here are some of my previous thoughts around approaches to tail risk hedging in practice. Click here to download a paper examining different practical approaches to tail risk hedging for UK pension funds.

* for a simple illustration of the convexity cost point imagine a gamble that creates an equal chance of a 20% gain or a 20% loss. On a single-run basis the expected profit or loss is zero, however simple compound maths shows that a 20% gain followed by a 20% loss (or vice versa) in fact creates a loss of 4%. Running the same gamble over and over again results in a substantial loss through time on a compound basis.


Changing Times – 50 Years of UK Pensions

A lot has changed since 1962, particularly in the world of finance and pensions.

UBS recently published a weighty tome containing some fascinating data on global markets and pension funds:

A long-term perspective on pension fund investment

Worth a read, one thing I found particularly interesting was the long-term data going back 50 years on the asset allocation and aggregate asset returns of UK pension funds.


How things change: asset allocation among UK pension funds 1962-2014

How things change

Lots of interesting trends to draw out of this data, including-

  • Back in the 1960’s the allocations were very UK centric, split roughly equally between equities and bonds (in terms of liability-relative risk, this was probably a much better-hedged position than pension funds held for the majority of the next few decades).
  • Interestingly, the split between equity and non-equity assets is pretty similar today as it was in 1962, with just over 40% of assets in equities.
  • The peak of equity allocations occurred in the early to mid 1990s where close to 80% of pension fund assets were in equities, the majority of this being in the UK. This probably marks the highest level of risk that pension funds ran over this period.
  • Real estate was actually a very significant part of portfolios in the early 1980’s, up to 20%. It has since shrank and stabilised around a 5% allocation.
  • Since index-linked gilts were first issued in the early 1980s these have, not suprisingly, comprised an increasing proportion of bond portfolios compared to conventional gilts.
  • One trend that this data doesn’t capture of course is the duration of the fixed income portfolios, which one has to assume has lengthened considerably in recent years with longer dated gilts and the use of LDI 
  • UK equities have seen a big decline in allocations, relative to overseas equities. This was initially offset somewhat by higher overall allocations to equity, but the decline manifested itself particularly in the years since 2000, when overall allocations to equities also began declining heavily.

Based on this data, UBS have also calculated that the average returns generated by UK pension funds over this timeframe was 10.2% annualized. Impressive, you might think, but compare this to annualized returns on gilts of 8.9% p.a. and cash of 7.5% p.a. suggests that:

  • Over 50 years pension funds on average generated returns of gilts + 1.3%
  • Over 50 years pension funds on average generated returns of cash + 2.7%

Pretty important to bear this in mind in the context of setting expectations for future returns. If you are involved in a pension fund and are expecting relative returns to gilts or cash far in excess of these it might make sense to question whether this is reasonable.

Of course, past performance is not a guide to the future, but in an industry which frequently draws conclusions or sets assumptions based on statistically very insignificant data sets (performance of a few years, say) a 50-year data set has to be respected.

If you liked this blog on UK pensions you might also like:

What can pension schemes learn from the PPF

Snakes, Ladders & Pension Scheme Deficits