Five-step process – the “Investment cycle”

We have a five-step process for improving defined benefit schemes’ investments. It is usually ideal to start with Step 1. However, we are flexible and can provide ad hoc reports or start from other steps as required.  

The 5-step “Investment Cycle”

Step 1: Setting Investment Objectives

In our experience this is key to developing a suitable strategy. Getting this right can pre-empt significant difficulties later on. In practice, investment objectives vary radically from scheme to scheme.

We look for answers to:

• What constitutes ‘risk’ for you?

• Which of the different approaches for valuing the liabilities are important?

• Is the funding position in percentage terms of assets compared with liabilities more critical than the size of the deficit in absolute £ terms?

• What is your appetite for risk?

• Are there any other factors that we should take into account when recommending a strategy?

Step 2: Setting Investment Strategy

• Do you know how much risk your scheme currently takes?

• Do you know which risks your scheme is exposed to?Understanding the implications of risk is vital when setting asset allocation.

We have developed a proprietary Asset Liability Model (ALM) to manage risks arising due to mismatches between assets and liabilities. Our ALM extends beyond the approach used by more traditional UK investment consultants by applying the risk management techniques used by fund managers to pension fund liabilities.

Our ALM gives you the advantage of comparing various potential investment strategies with regard to different aspects of risk, so you can understand the full implications of your decisions, particularly the risk / reward trade-off.

Usually we can find strategies that reduce risk at the same time as increasing the expected long-term return on the assets. We will make an unambiguous recommendation based on our understanding of your objectives. However, the ALM is an interactive tool. We encourage you to investigate alternative approaches to put you in a position to make an informed decision.

Step 3: Selecting fund managers

We try to avoid recommending fund manager selection exercises where necessary but to implement new asset allocation strategies with the existing managers if possible. However, there are circumstances where this is either not practical or not desirable. So we still take manager research seriously.

Our answer is to focus on five specific factors which can increase the likelihood of selecting a fund manager that will outperform in the future. These five factors are:

Philosophy

Process

People

Research

Risk controls

Our fund manager research programme covers well over 100 investment managers and our focus is on qualitative research where we believe our experience and background provides valuable insight.

Step 4: Implementation

This includes (where applicable):

• Advice on setting up a framework to deal with future cash inflows and outflows, as well as rebalancing.

• Drafting the Statement of Investment Principles (SIP), which defines the policy controlling how your pension fund invests. This is a legal requirement for most pension schemes.

• Overseeing the asset transfer process (to minimise cost, out-of-market risk and operational risk).

Step 5: Monitoring

Our investment monitoring product is flexible so that you can choose the frequency that is most suitable for your scheme.

In our view, the most important and useful aspect of monitoring is an estimate of the impact of investment markets on your funding position since your last formal valuation. Our analysis also quantifies and explains the main factors that caused the change.

The report is set out as questions that we would ask if we were trustees:

• What has happened to your assets?

• What is the likely impact on your funding position?

• How have your fund managers performed?

• How were your assets invested at the end of the quarter?

• What do we want to draw your attention to?

We also offer a quarterly check of interest rate and inflation hedges.

A sample monitoring report is available on request.