MNOPF derisks as more schemes hit triggers, but is a credit supply squeeze looming?

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The Merchant Navy Officers Pension Fund has derisked its investments further after hitting a fourth funding trigger since Q1 last year and reaching a funding level of 102%. What role did journey planning play in how the scheme got there? 

‘Journey plan is the most critical thing’ 

The £3.5bn MNOPF hit the headlines in 2020 when it revealed it had bought in liabilities with Pension Insurance Corporation for £1.6bn, but the scheme’s trustee board has not been sitting back since. 
The fully closed scheme covering more than 30,000 members is following a journey plan that could potentially result in a full buyout and windup and was one of the first to adopt fiduciary management, provided by Willis Towers Watson, said trustee chair Rory Murphy. 
“The journey plan is the most critical thing we do as a trustee board,” he said. Having a fiduciary manager in place allows the board to focus on the strategy and governance, he said. 
The strategy includes downside and upside triggers, which are however not automatic and still need the board’s approval. “If we hit an upside trigger it allows the board to decide if we derisk, so we hit one recently,” he said. The trigger in question was about the scheme reaching a funding level of 102% on a technical provisions basis, not a mean feat considering that about a decade ago, it still had a deficit of roughly £1bn. 
Murphy attributed the success to the disciplined approach of the trustee board, saying that having a clear strategy and and “sticking to it” has been key. “I see many schemes that have a plan but if something happens, they change it a bit,” he noted. 
The scheme will hit its peak outflow in 2026, and Murphy hinted that at that point or before, the board – half of whom are trade union representatives – could decide whether the scheme should continue. 

MNOPF participated in 2020 rebound 

The rise in funding level at MNOPF was down to timely investment choices and the significant buy-in completed in the first quarter of last year. Pieter Steyn, head of delegated solutions UK at WTW, said the manager introduced equity option protection in February 2020 – just before the stock market rout – which meant the funding level only fell by 1% for investment reasons, and rose thanks to the buy-in. 
“We saw an opportunity at the end of 2019 to protect funding levels through an allocation to US treasuries. They went up in value massively up to February 2020, so much so that we didn’t see any further protection from holding US treasuries,” he explained. “We didn’t predict what happened subsequently,” he admitted, but the significant market fall in March meant the equity options delivered an outsized positive return. 
“Because of that and because it already had a low equity allocation anyway, the MNOPF’s funding level was very significantly protected in the falls of March. It allowed us to rebalance back into equities," as the outlook improved, he added, and with its greater than previous equity allocation, the fund participated in the 2020 rally that followed. The equity allocation is now slightly under 5% of total assets. 
Apart from the equities and the significant insurance assets, the fund’s portfolio “looks like a traditional very diversified fiduciary management portfolio”, he observed, making use of liability-driven investment but also credit, as well as hedge funds and some illiquid assets, although the latter two are "in payback mode” in line with the scheme’s journey plan.  
Asked about a potential conflict of interest between fiduciary management and buyout, Steyn highlighted that his unit had seen £2.6bn of insurance settlement transactions last year. “It's not our decision. It's the client’s decision whether you settle or not. The fiduciary manager takes instruction on that,” he said.   

LTO has focused minds on derisking 

The MNOPF is not the only one to have profited from recent market movements. “I have one scheme that’s hit a 95% funding trigger and we had agreed to derisk," said Keith Scott, a trustee director at LawDeb Pension Trustees. 
“It's been quite a good six months or so for schemes. Not only has the stock market done well, but interest rates have gone up a bit and funding levels have improved quite a bit,” he added. With a number of schemes now having pre-agreed derisking triggers in place, this means many have been selling growth assets and moving further into matching assets.   
Schemes hitting triggers and derisking demonstrates the advantage of having triggers in place, he said. “In the past pension funds haven’t necessarily agreed what they would do if funding improved,” he said, and by the time they had come to a decision, markets might have gone back down.  
Scott attributed the growing use of journey plans to incoming regulations requiring schemes to have a long-term objective. “That's focused the minds for a lot of schemes,” he said, as having an end point helps trustees to focus on where the scheme is today and what steps will get it to the long-term target. 

Credit market situation is not looking rosy

The equity market rally and supportive fiscal and monetary environment means risk assets have posted high returns. Arif Saad, senior investment strategist at Kempen Capital Management, said a number of the firm’s pension fund clients have hit derisking triggers as a result. 
This has meant that the move into UK government and corporate bonds “has become even more pronounced”, he said, as schemes race to achieve full funding before they reach peak cash outflow, pushing up prices. 
“Analysis of the UK corporate bond market does not paint a rosy picture,” said Saad. The race to purchase high quality credit has already begun, he said, leaving pension schemes who are looking to buy credit later with potentially lower quality credit or lower yielding assets. He said this is evident in pension scheme’s share in BBB credit, which has increased in recent years. “Although there has been much greater issuance of bonds and brand new issuers in the market, the quality of marginal issuance relative to debt outstanding is worsening,” he observed. 
This means that in future, derisking may not just be funding level led but capital market led, he argued, as opportunities to purchase those assets in such high demand intensifies. 

Has your scheme been derisking recently? Are you concerned about the supply of high quality credit? 

Pieter Steyn
Keith Scott

*This article has been updated to more accurately reflect the fund's investment changes and the corporate bond market situation