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Rolls-Royce might be a UK-based company, but it has outposts all around the world—and many of these outposts have pension liabilities to address.
After the implementation of an LDI strategy for the UK fund, it was time to roll it out to the next largest sources of pension risk: the United States and Canada. (Outside of these three countries, pension liabilities amount to around 1% of the UK’s total.) As noted, Rolls-Royce found itself in a difficult position after September 11, 2001, as a perfect storm of accounting changes and a collapse of confidence in the global equity markets—and in particular the aviation industry—hit the company. As a result, in 2001, Rolls-Royce saw itself facing a pension deficit larger than its market capitalization.
Mike Elliott, treasurer for Rolls-Royce North America, said: “Our positive experience in deploying LDI in the UK made us think hard about our long-term pension strategy for North America. Rolls-Royce is a long-term business—our engines are built to fly for 25 years or more—we have to be around to provide parts and services to the people who buy them. This means we have to take a very long-term view of our commitments and liabilities and we place a greater premium on certainty.
“In the US we started looking at LDI in 2009. Equity markets were down, but we felt we had the right endgame and looking back, we are happy with the results we achieved.
“It took until June 2011 to fully implement the LDI program. It took longer than we expected, but this gave us time to educate everyone involved and then roll out the change. We didn’t do it all on day one—we are still on a glide path with triggers in place to automatically de-risk as funding levels improve.
“In the pension world, many think they can predict what will happen next. This often means that they end up doing nothing, hoping things are about to improve. In our view, hope is not a strategy. It is better to begin the de-risking process today, even if it takes a long time to fully implement.
“The biggest change for the US fund is the reduced equities exposure, which has been a mainstay for 20 years. When we increase to fully-funded on a risk-free basis, our equity allocation will be less than 10% and all in an index—we don’t believe in alpha. When you average alpha managers’ returns, you end up with beta minus fees.
“We use only one manager for our LDI portfolio. People are often surprised by that, but it is much more efficient: maintenance is streamlined and it saves a lot in fees. Performance reports are simple and all we really worry about now is the tracking error. “LDI makes sense for Rolls-Royce—I find it difficult to imagine circumstances under which we would re-risk.”
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—EHP