RPMI Railpen moves on new track to power up fixed-income portfolio

RPMI RailPen is turning its attention to fixed income in the latest move to take greater control of costs and investment decision-making in the £21 billion ($32.1 billion) Railways Pension Scheme, London.

Work on equities and some alternative assets has been completed, but with investment returns globally likely to remain constrained and interest rates stubbornly low, the pension fund's leadership determined that changes in investment strategy and the management of assets was necessary.

With an ambitious target for the growth part of its asset allocation pegged to the retail price index plus four percentage points, the pension fund needs risk in its portfolio. But RPMI executives also want a good handle on exposures and investment decisions, and that has meant internalizing control and investment allocation decision-making. “If it goes wrong, it's our fault,” said Craig Heron, investment manager at RPMI RailPen, the in-house manager for the Railways plan, in London. “We know what (the portfolio) should look like, and what it does look like.”

As Pensions & Investments went to press, RPMI was in the process of completing its latest internalization project: moving management of the approximately £2 billion government bond portfolio in-house. Previously run by two external money managers that were not identified, the move is probably one of the most significant changes executives have made in the past six months.

“The government bond fund we will run internally in a very straightforward way. We are basically going to own gilts,” said Mr. Heron.

It was a classic case of “It's not you, it's us,” said Mr. Heron, with a rationale that even the incumbent money managers could not discredit. With yields compressed across fixed income, holding a portfolio of gilts rather than a government bond fund that needed managing and hedging back to sterling makes sense. “We are not sacrificing anything in yield, credit quality and currency. And it means we don't have to govern external managers, we don't have to pay fees. The cost saving, given where equities are at moment, is quite significant,” he said.

But executives are willing to be flexible. “That is what it is now; should the world change, we will change,” said Mr. Heron. While he doesn't see a move back to an active government bond fund managed against an index, “if it turned out that being fixed to the U.K. gilt market is not a great thing for shareholders, we would adapt. We would be foolish to say "This is it.'”

Another change underway involves the pension fund's global £625 million investment-grade bond portfolio moving to a buy-and-maintain credit strategy. Mr. Heron said executives expect to save 50 to 60 basis points just by removing trading costs associated with the portfolio.

The fund doesn't want to be forced to sell or trade bonds unless holdings face significant downgrades, and the portfolio has a duration range of five to seven years. The idea is to hold a straightforward portfolio with minimal use of derivatives. “If there is big concern about a name, then the use of short (credit default swaps) is fine but the message is, it is intended to be a simple (portfolio), almost what fixed income was 20 years ago,” said Mr. Heron.

The pension fund had benefited from “pretty keen” fee structures when it came to credit in the past, but the cost saving from reduced management fees and portfolio churn is still significant.

Mr. Heron said assets were moved Nov. 17 to one manager, which executives at the pension fund declined to name. “We are not in a tearing hurry. The transition will take, we expect, maybe a fortnight — that is the nature of credit markets: it may be done quickly, or over two weeks,” he said.

The change also has meant RPMI executives needed a new way to measure their buy-and-maintain money manager to ensure it is doing a good job. While a Barclays Aggregate Bond index can be used for comparison and is a barometer for returns from the credit universe, Mr. Heron said instead of measuring the manager against a benchmark at all, the firm has put a series of key performance indicators in place. The manager will be asked to report on these indicators, which include transaction costs, turnover and credit management.

RPMI has been taking more control over the assets it runs for the Railways pension fund under its investment transformation program, which kicked off two years ago and altered investment structures.

“We overhauled the pooled fund range, analyzing investments in terms of risk premia rather than asset class,” said Ciaran Barr, investment director at RPMI, during a meeting in September. One requirement was to create a new pooled fund range with a focus on simplicity, so executives created four types of strategies within its default offering: growth, illiquid growth, a long-term income fund and a derisking platform. The first two are viewed as return-seeking, and the others as defensive.

The weighting of these four strategies will vary across the more than 100 sections of the Railways Pension Scheme, depending on return, risk and liquidity requirements.

About 75% of the equity portfolio is invested in alternative risk premiums across five buckets: value, income, low volatility, quality and momentum. “We decide how to implement those distinct ARPs. We get access through off-the-shelf indices,” said Mr. Heron. The “vast majority” of the remaining 25% of equity allocation is invested internally, mostly through passive exposures to countries and country indexes. A framework for individual country investment allows the fund to capture “quite a lot of GDP growth as well.” Executives are looking to take more active allocation decisions, including individual country weightings in the emerging markets, said Mr. Heron.

The pension fund's previous £1 billion or so allocation to hedge funds also has been reduced to almost zero, said Mr. Heron. “We wanted to get away from an "always on' allocation to hedge funds,” he said. Executives realized they were achieving beta returns for 2-and-20 fees. “We can make those allocations to traditional beta ourselves.”

Investments were not the only overhaul that came under the investment transformation program. “One of the things I'm most chuffed about is the way we are organized as a team,” said Mr. Barr. “We broke the "let's organize by asset class'” model, which was necessary because most of the scheme holds multiasset investments. Rather, the team is organized by function, covering areas including investment, portfolio implementation and risk premiums. RPMI also created a chief investment office, rather than having one chief investment officer.

The reorganization has meant a rethink on the back- and middle-office plumbing that supports RPMI's work. Julian Cripps was brought on board this summer as chief operating officer, investments — a new role. And the firm outsources its trading desk activities to BNP Paribas Dealing Services.

But RPMI is not designed to be an “all-singing, all-dancing asset manager,” stressed Mr. Barr. “Our ambition is to be a world-class asset owner.”