Fiduciary management during the UK gilt market crisis | 17 October

I am writing on Friday 14 October, in the midst of what could turn out to be the largest financial crisis ever to hit UK Defined Benefit (DB) pension funds. 

No doubt much of what has been reported in mainstream media to date has been poorly informed hyperbole – well managed pension schemes are not and have never been on the verge of insolvency – but the ramifications of unprecedented volatility in UK gilt markets will be far reaching.

There will be lessons to learn for all stakeholders in UK DB pensions. For fiduciary managers the time will come for a post-mortem, where their ability to maintain hedging exposures and portfolio liquidity will come under the spotlight. But that time is not now. 

Instead, the immediate focus for pension funds using fiduciary management (FM) should be on their manager’s investment mandate and guidelines. 

Changing circumstances

Fiduciary managers’ guidelines were set in a very different market environment, in which recent levels of volatility in gilt yields was almost unimaginable, and in which liability hedging portfolios required less capital to function in line with their strategic objectives.

In this new environment, previous objectives and guidelines may no longer be appropriate, and will very likely need to be revised for the long term too – strategic changes are inevitable for many DB schemes.

The key questions for trustees to consider with their fiduciary managers are:

• How is your fiduciary manager managing the competing objectives of your guidelines? Importantly, is their focus on maintaining the return target, the hedging target, or trying to strike a balance between the two?
• Is this approach consistent with what you want your fiduciary manager to be doing?
• Are there any operational constraints which can be relaxed in the short term to ensure your fiduciary manager is taking the decisions which are in the best interests of your pension fund?
• What contingency arrangements do you have in place as trustees, should your fiduciary manager require a quick decision from you in how they manage to the guidelines over the weeks ahead?

We are seeing a mixed approach across managers on all of this. Some managers have broader guideline parameters than others, affording more flexibility. Others are requesting temporary guideline waivers.

There are also managers that are desperately trying to maintain the hedging target with whatever liquid assets they can lay their hands on, while other managers are accepting a much lower level of hedging to avoid disrupting the target return of the portfolio. Increasingly, we are seeing managers compromise on these extremes and land somewhere in the middle.

There is no right and wrong answer. It is very much dependent on an individual pension fund’s circumstances.

Clear communication

In all cases communication is key. This highlights the importance of the advisory function within a fiduciary manager’s service, particularly in times of crisis. In most cases we are seeing fiduciary managers do a good job at keeping pension funds informed of portfolio developments and engaged with clients on emerging risks.

We have however seen examples of managers making huge shifts to the risk profile of portfolios in order to comply with their guidelines, without the pension funds knowing until many days later – which, in the current market environment, is a very long time.

Insufficient communication creates an illusion of control. Yes, your fiduciary manager might be managing to their guidelines, but are these guidelines appropriate right now?

Think of your FM guidelines as a car’s satnav - your manager is the driver, your pension fund is the passenger. The satnav is programmed to guide you in the right way to your destination. Most of the good ones nowadays adjust the route, or give you the option to do so, if there is trouble ahead. They notify you about this with enough notice for you to respond. The inferior models fail to recognise what lies ahead and keep everyone on the same path as before. 

The best experiences are when your driver has the ability to override the mechanics of the satnav to apply their experience and judgement with the information they have available. They keep you informed and check that you are comfortable with the action being taken.

Please, if you are using a fiduciary manager, make sure that they are operating in a way which allows them to take decisions which are aligned with your views on what is right for your pension fund. Make sure your manager is in control and make sure their guidelines are not doing the driving for them.

For professional use only. The above is for information purposes only and should not be construed as investment/regulated advice. Please contact your Barnett Waddingham consultant if you would like to discuss any of the above topics in more detail.