Watch your language with trustees

“The reality of trying to talk about investment strategy is that the decision makers are trustees,” said Dr. Marlene Puffer, managing director of Twist Financial, speaking at last week’s CPBI conference. “With your typical fund, the trustee is not an investment expert. This is the reality of who is setting policy and decisions.”

She points out that investment experts tend to speak in terms that confuse the typical plan trustee. At best, this can make meetings tedious, but at worst trustees might not fully comprehend their fiduciary duty.

“If you are a trustee and your main fiduciary duty is to live up to the pension’s promises, how on earth can it be possible to say you do something other than liability driven investing? I don’t understand how anyone can have [the trustee] hat on, and say we’re not going to consider the liabilities in our investment policy.”

She suspects that people are confusing LDI with “some kind of specific investment strategy,” rather than an approach to risk management.

The problem is that liabilities are not a fixed target. The trustee needs to understand what the plan’s liabilities are and how they might be affected by trends in labour demographics and economic conditions.

“Liabilities can move for a whole bunch of reasons, not just because interest rates went up, or inflation rates go up,” said Puffer. “It’s not just something that can be measured in the financial markets; you have all these other variables.”

Some of the risks—such as actuarial risk—are obvious: if the workforce is demographically lopsided, with too many workers retiring simultaneously, the plan could be overstretched. Others are less so, such as regulatory risk.

“The question really is not ‘do you want to do liability driven investment,’ but ‘how much risk do you want to have in your portfolio, and why?'” said Puffer. “That question is really, really hard. All the risk questionnaires in the world do not really answer that question very well.”

The reason for this is that the answer depends on such a wide range of details that vary from plan to plan.

Most trustees would jump at the chance to keep their plan’s expected return constant, while decreasing risk, explained Puffer.

“If you stop thinking about your assets as assets only, and start thinking about your assets relative to the liability, and you change your risk measure from absolute volatility to volatility relative to liability, you can get there.”

Unfortunately, the tools required to get there have names that tend to leave trustees scratching their heads: derivatives, leverage, alpha transport, etc. But in many cases, there are simpler options, such as increasing the duration of the bond portfolio, or adding real-return bonds.

“The key to helping real plans and real companies make basic decisions, is to simplify the language, and really help people move in the right direction, which for most plans is to decrease risk, manage risk, and choose risks that they are comfortable with,” she said.

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