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Pension Funds

It’s all coming together for U.K.’s PPF investment leader

Pension Protection Fund’s Barry Kenneth: ‘We have to have a competitive advantage and it has to be something we are likely to be invested in for the long term.’

The Pension Protection Fund is "seven-eighths of the way" toward achieving CIO Barry Kenneth's vision when it comes to bringing certain assets of the lifeboat fund in-house.

It has taken years of work and investment to get this far — all the while keeping in mind the enormity of the PPF's role in the retirement of millions of participants, as it takes on the role of paying pensions if eligible sponsoring employers go bust.

Along the way the fund has hired a number of new staff, with high-profile roles filled in recent years, as well as a move for the investment team to the City of London from Croydon — a London borough in the south of England where the PPF has retained an office.

It also has seen the fund evolve to managing some of its own assets.

When Mr. Kenneth joined the PPF five years ago as chief investment officer, he had a vision of how the lifeboat fund should look. He was tasked with building a money management capability, insourcing parts of the PPF's now 29.9 billion ($39.3 billion) assets where it made sense.

Speaking at the PPF's new offices, Mr. Kenneth said: "Part of the move up to London was to recruit the right people. It also provides a good challenge for the team — it is important to be in the city, to understand what is going on."

The location is also more efficient for PPF executives when it comes to visiting money managers and banks. "And if we are insourcing (money management), when banks do roadshows for corporate bonds they are not going to come down to Croydon. We have gone from an asset owner to a part asset manager — that is the evolution."

Big decisions

The insourcing of assets has meant a series of big decisions, which always come back to several principles for Mr. Kenneth.

"We have to have a competitive advantage and it has to be something we are likely to be invested in for the long term. From 2030 onward, should we be successful, we are more likely to look like an annuity fund, so we don't want to bring in teams to do private equity because it would take a couple of years to build up, then a 10- to 20-year cycle to invest. We are ultimately looking to bring in (assets) that would be relevant and cost effective, and that means hiring people and having the right expertise," he said.

The insourcing journey began in 2015 with the appointment of Trevor Welsh as head of liability-driven investment.

"The LDI side is probably the biggest risk pool in the fund. They are low-risk assets, but the biggest risk in terms of management. ... If we get something wrong there, it would have a far bigger impact than anything that could happen to a single asset," said Mr. Kenneth. The fund hedges 100% of its liabilities using funded gilts and unfunded derivative instruments including swaps and repos. Liabilities are around 30 billion, made up of the PPF's own liabilities and those of the pension funds under PPF assessment.

"I believe our approach to LDI is one of the most sophisticated in the city, as we are actively managing (consumer price index) liabilities including caps and floors, with (retail price index) and nominal assets, rebalancing real-time," said Mr. Kenneth, referring to different measures of inflation. The insourcing of the LDI portfolio was completed in July 2017.

Next on the list was its new allocation to cash. "We didn't really have a cash allocation before, but we want to be at the front end should we ever move to cleared derivatives" under European legislation, Mr. Kenneth said. The strategic allocation to cash is 6%.

And next month, executives are set to complete the insourcing of part of the PPF's hybrids allocation, which houses illiquid assets that have hedging characteristics and carries a 12.5% strategic allocation of the portfolio.

Bringing in-house part of this portfolio "enhances our control on our U.K.-based investments. None of these things have been insourced for financial gain — that is there, but it's not the key reason. Given the risks posed to the PPF by the U.K. corporate sector, we might want to have more control on what companies and sectors we invest in," said Mr. Kenneth. "We are on track to insource part of that in September — we are creating a structure at the moment."

On the list of potentials for future insourcing is foreign exchange, owing to the fund's large exposure to overseas investments. The fund has a "pretty standard FX hedge" in place. "It is not particularly complex, just big. It would be cost effective to insource that. It's not on the agenda for now though," Mr. Kenneth said. Executives could not disclose overseas exposure.

Mr. Kenneth wants the PPF's investment team to be ready for anything that might affect its assets and operations.

"We are very much at the forefront of what's going on in regulation, and are very conscious of what's happening whether it's Brexit or the global economy," he said.

And the investment team can deviate from the PPF's strategic asset allocation. "We took some decisions in the last three months of the (financial) year, to reduce equity risk and preserve capital in the portfolio, which assisted in making our target returns," Mr. Kenneth said.

According to the fund's 2017-'18 annual report, it has a three-year rolling target return of 1.8% above the London interbank offered rate, and exceeded this target with a return of 2.7% annually.

"We now have experienced investment professionals who have the experience and capability to make such investment decisions, especially in volatile times, whereas five years ago we did not have that level of capability and expertise," he said.

But when deviations from the strategic asset allocation happen, there is a risk-controlled framework in place. "We use a RAG (red, amber, green) framework to ensure risk control for any position the team take away from the strategic asset allocation, ensuring transaction discipline," said Mr. Kenneth.

Should a transaction hit an amber level, which is the fund's profit taking or loss limit, "then we make a decision to continue, adjust or cut the position. However, if pre-set (red) profit targets or stop limits are hit, then the transaction is automatically closed," Mr. Kenneth said.

And the more sophisticated investment process came with more efficient governance — although not at the expense of risk assessment.

"We are looking to try and build up the co-investment program in private markets. One of the major things I did early on was create a governance process that means we can make decisions quickly — if we say no, we do so within 24 hours, and if we say yes we make sure we don't go through lots of layers," he said.

Looking ahead

One of the next items on the PPF's to-do list is enhancing their attention to ESG factors. To that end, the fund hired Claire Curtin in May as head of environmental, social and corporate governance.

"The PPF has spent a lot of time on ESG in the past, and integrated it in our manager selection program. We still have a robust way of looking at ESG but we want to make sure we understand what's important out there, make sure our policies and processes link into what's important for our board and members. And we are going through a hard look at what we need to do, what we need to add on top of what is already there and what works to make ourselves more at the front end of the debate than the back end," he said.

Other things on Mr. Kenneth's mind include markets — "generally when you come out of a recession you get high interest rates to provide a buffer; this time around that is not going to happen" — and where to park new assets.

"It is difficult to find value in markets, which is why we need to work hard to find opportunities, so we can deploy new money. We have the biggest quantum of schemes in assessment since I got here, in terms of assets and liabilities," Mr. Kenneth said.