The UK’s Pension Protection Fund (PPF) has shaken up its strategic investment principles to adapt to its growing asset pool and a new financial regulatory climate.
The PPF, the lifeboat for bankrupt company defined benefit pensions, is to reduce exposure to cash and bonds—from 70% to 58%—and move the capital to a newly created “hybrid” assets division.
This new allocation, which will amount to 12.5% of the £21 billion portfolio, will invest in assets that fulfil established risk-factor based criteria and match the fund’s liability needs rather than adhering to a set “class”.
“People have been talking about risk factor-investing for years—now we are doing it.” – Barry Kenneth, CIO, PPF.
PPF CIO Barry Kenneth told Chief Investment Officer (CIO) that the move was in line with his work to reconstruct the portfolio since his arrival a year ago. The construction of this new line should take around three years.
“We are growing at £2 billion a year so we looked at what challenges that might appear on the horizon,” he said. “Regulatory changes to the banking sector such as centralised clearing, Basel III, and the Volker Rule will all impact our derivatives usage, mainly by increasing the cost.”
The PPF uses a range of derivatives on its large fixed income and cash portfolio. Kenneth said he and the team had decided to access the factors they had accessed through these derivatives in actual assets instead.
“We want to act more like insurance companies,” he said, “which means having less reliance on derivatives markets. If we keep piling into them our costs are likely to move into the tens of basis points rather than the single basis point figure today.”
Kenneth and his team have already begun putting this new plan into action.
“We have awarded a few mandates to asset managers—mainly to those that have attached annuity businesses as we will be going for the same deals as them—and some risk factor mandates,” said Kenneth. “For these, we don’t care what the assets are, but we want to take advantage of the illiquidity and duration premia.”
The PPF is also making investments through its in-house team. Kenneth told CIO about a commercial property in Manchester that was one of its first purchases.
“We co-bid on building in the business district with an insurer worth £330 million,” he said. “It is on a 23.5 year lease—we wanted the regular cash flows rather than looking at the resale value.”
The tenant is UK bank RBS.
“We are focusing on UK assets at the moment—foreign assets and cash flow would require derivatives to look after currency changes, which would defeat the object—but that’s not to say we are not looking further afield for the future.”
Kenneth and the team have visited China and New York on their hunt for new assets.
“If an asset is too expensive, despite having all the right characteristics, we will walk away.” – Barry Kenneth CIO, PPF.
“We will be recruiting,” he said. “We cannot be passive in this space and have to hunt out good assets. We will not overpay, however. If it is too expensive, despite having all the right characteristics, we will walk away.”
Having the right team and governance structure has also been crucial for Kenneth to establish—and already execute—this new set-up.
“We were not the highest bidder on the Manchester property—in fact it was the opposite—but we could get the deal done,” said Kenneth. “It was completed in a matter of weeks rather than months. We couldn’t have done this last year.”
For the moment risk-factor investing will be confined to just this one bucket, but the team will increasingly use these return drivers to select what goes in the rest of the portfolio.
“People have been talking about risk factor-investing for years—now we are doing it,” he concluded.
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