That said, longer-dated US government bonds have been subject to federal asset purchase programmes which will have had an impact on longer dated yields.
Issues remain in the Chinese economy as the corporate and personal debt mountain grows. In Q3 2018, local corporate borrowers (mostly privately owned) defaulted on a record $6.6bn of loans while 58 businesses accepted government bailouts (Bloomberg). A key reason for these defaults is that the Chinese government made a commitment to try and control the ’shadow banking’ industry. While this makes sources of funding more transparent, it does mean availability of cash for corporates is reduced, and those companies that are unable to
access state banks may continue to struggle to remain solvent.
In summary, it doesn’t matter where you are, it’s likely that politics and economics will walk hand in hand throughout 2019. The events described above are likely to introduce volatility, and therefore drive change in scheme funding ratios and liability values. What remains unclear, is the potential size of market reactions to these changes, it seems that markets are pricing the middle ground, which is the only impossible outcome. In this case, it makes sense that your hedge is high enough to ensure your funding level is secured and your LDI solution is able to exploit any changes in relative value between gilts and swaps.
Development in investment solutions
We think there we will be two key investment themes in 2019, both of which certainly began to make headway in 2018:
- A continuation of ’end-game’ discussions for DB schemes that are on their way to 100% funded.
- How Environmental, Social and Governance (ESG) factors should be integrated into pension scheme investment decision making.
We have already published a lengthy white paper and thought pieces describing our optimum ‘end-game’ solution. In this outlook we will discuss the integration of ESG factors in client portfolios.
Integration of ‘ESG’ issues in investment solutions
In 2018, the policies of pension schemes surrounding ESG considerations were thrust into the spotlight. New regulations published by the Department for Work and Pensions (DWP) will require schemes with more than 100 members to state their policy on taking account of ’financially material‘ considerations. Those considerations make specific reference to ESG factors such as climate change. As a result, we expect there to be a considerable focus on the integration and reporting of ESG practices in investment solutions.
ESG can and should be imbedded in the day to day management of investment portfolios in two key areas. The first is through integration with the investment process whereby ESG factors are formally built into the research process to support investment decision making. This will often seek to score or quantify the current ESG credentials of a company as well as identify whether these are on an improving or deteriorating trend. Such an approach helps not only to identify robust well managed companies, but also to avoid investments where significant ESG related risks exist.
The second is through direct engagement with companies and through the exercise of voting rights. This work helps to improve both the financial prospects of the companies we invest in (or lend to), as well as helping to minimise downside risk. Engagement work is often prioritised towards companies with higher ESG risk scores and targets specific themes identified by our ESG specialists.
For schemes wishing to go one step further there are then a wide range of specialist ESG investment strategies available. These will often apply an initial screen to the investable universe based on factors such as ethical criteria, ESG standards and sustainability themes. They may then apply a positive investment selection process which targets assets with superior ESG characteristics.
ESG scoring and engagement are imbedded in our corporate bond investment process and so where clients combine LDI and traditional credit (e.g. our Credit Matching LDI strategy) they can take comfort from the fact that ESG issues are already taken fully into account. We also offer a green bond strategy which can sit alongside an LDI mandate for those clients looking for something more specialist. Where clients wish to combine synthetic equity exposure with LDI this equity exposure can incorporate ESG factors in a number of ways. Firstly, passive exposure can be created to a range of ESG indices using total return swaps. The index can be selected to reflect a broad range of ESG criteria or a more targeted set of criteria, as required. For clients who prefer active equity management we are able to replicate our Responsible Global Equity strategy via a total return swap.