Following WTW's recent Small Scheme Seminars, we've been reflecting on the unique challenges and opportunities that smaller DB schemes face, particularly when it comes to investment strategy. While WTW is often known for advising some of the UK's largest pension schemes, over half of our investment advisory clients are under £100m in size [1]. With the right approach, these schemes can punch well above their weight.
Any snapshot of market conditions risks being out of date within days, but as of late May, we were experiencing heightened volatility, partly fuelled by geopolitical uncertainty. That said, markets had rallied through the month, and many schemes found themselves slightly ahead year-to-date despite the swings.
In this kind of environment, it's essential to take stock and review your investment strategy. For schemes that are only marginally in surplus, whether on a technical provisions or buyout basis, there is a risk that a market event wipes that surplus out. We've been helping clients use reverse stress testing as a pragmatic way to identify what scenarios would put their surplus at risk. It's a simple tool, but incredibly powerful in helping trustees focus on the risks that matter.
Another area covered at the event was liability-driven investment (LDI). With long-dated gilt yields continuing to rise, many schemes are facing collateral calls. The LDI crisis in 2022 highlighted the risks associated with leveraged LDI strategies, particularly pooled funds used by smaller pension schemes - something we must learn from.
In our work with clients, we emphasise the importance of robust collateral planning and regular reviews. Ensuring you have appropriate, liquid assets earmarked as collateral can make all the difference. Off the back of the BoE highlighting potential systemic risk, it’s important to review your collateral funds to ensure there is not a concentration of pension scheme investors, all with the same collateral waterfall plans!
For schemes in a low-risk strategy, to refine the hedge, we've also been working across actuarial and investment teams to tailor LDI benchmarks specifically for buyout objectives, using solvency cashflows and mortality assumptions aligned with insurer pricing. This can make a material difference to the level of interest rate and inflation exposure to target.
Buyout is an increasingly common goal for the schemes we work with. A growing part of our role involves helping schemes prepare their assets for buyout, investing in a way that mirrors insurer portfolios. This does two things: it helps hedge buyout pricing more effectively and signals to insurers that the scheme is serious and well-prepared.
As a large firm, we're able to draw on extensive data and insurer insight to calibrate credit and LDI portfolios appropriately. But it's also about being pragmatic. Rebalancing LDI portfolios shouldn't have material trading costs but for credit assets, the decision to rebalance depends heavily on your expected timescale to buyout.
One growing issue is illiquidity. We've seen several cases where a previously modest private markets allocation has become disproportionately large due to the shrinking size of LDI portfolios. For example, one client's allocation has rose from 15% to over 30% purely due to market movements.
When this happens, small schemes face similar decisions to their larger counterparts:
Each of these paths has trade-offs, but there are ways through if addressed early. It's been pleasing to see insurers offering deferred premiums even for small schemes, so you shouldn't discount this option just because you are a smaller scheme.
Cost management is critical for all schemes, but for smaller schemes, the impact of ongoing fees is particularly acute. In recent reviews, we've seen cases where investment strategies had become overly complex with multiple managers and numerous public and private market funds. This can result in increased costs and time required to adequately review performance and managers. And any rebalancing between funds when allocations become overweight can be a real pain point.
Where schemes are now better funded and reducing their investment return target, there is an opportunity to simplify the strategy and implementation approach, which can significantly reduce cost.
Depending on the circumstances, consolidating the scheme assets with a single manager can still deliver the full solution across all the key asset classes. This can reduce investment management costs but also reduce the burden on trustees who are often already time constrained. Having a single manager report with all the key performance metrics makes monitoring more straightforward, and any rebalancing over time much simpler. It also reduces the work involved when you come to buyout, as you only have assets to disinvest from one manager.
Smaller schemes may lack the scale of larger funds, but they are by no means limited in their ability to optimise outcomes. With the right advice, a pragmatic approach, and smarter implementation, they can operate more efficiently, de-risk effectively, and prepare for buyout with confidence.
We've seen first-hand how targeted changes in investment strategy, governance, and cost structure can make a meaningful difference. And if there's one takeaway from our Small Scheme Seminar, it's that size doesn't have to be a barrier to being bold, efficient, and ultimately achieving the endgame objective.
Towers Watson Limited (trading as Willis Towers Watson) (Head Office: Watson House, London Road, Reigate, Surrey, RH2 9PQ) is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA Register Firm Reference Number 432886, refer to the FCA register for further details) and incorporated in England and Wales with Company Number 05379716.
This material is based on information available to WTW at the date of this material or other date indicated and takes no account of developments after that date. In preparing this material we have relied upon data supplied to us or our affiliates by third parties. Whilst reasonable care has been taken to gauge the reliability of this data, we provide no guarantee as to the accuracy or completeness of this data and WTW and its affiliates and their respective directors, officers and employees accept no responsibility and will not be liable for any errors, omissions or misrepresentations by any third party in respect of such data.
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This material is intended for investors with long-term investment time horizons. The value of all investments and the income from them can go down as well as up. This means you could get back less than you invested. Past performance does not predict future returns.
