DIY buyout – for the many, not the few

October 16, 2014 Categories: Investment Strategy


With the party conference season upon us, you may well be groaning at being forced to listen to hackneyed phrases such as: “For hardworking families”; “Forward not backward”; “One nation”; “Britain can deliver”; and so on and so on.

However, listening to one of these phrases, “For the many, not the few”, got me thinking about my real passion in life: pensions, and the topic of DIY buyout. OK, I might be exaggerating a bit about pensions being my real passion in life, but before you suggest I get out a bit more, you might like to hear me out. In short, it’s often been suggested that DIY buyout is only for sophisticated funds: for the few. Well actually, I think this approach is for the many, not the few.

What is a DIY Buyout?

“DIY buyout” describes a situation whereby instead of handing assets over to an insurer as an endgame solution, the suggestion is that the most sophisticated funds look to replicate what an insurer would do on their behalf. Such an approach doesn’t get the liability off a sponsor’s balance sheet or benefit from the pooling of certain risks such as mortality, but it does save funds from paying an insurer’s profit margin and may be associated with greater investment freedoms from a less stringent regulatory regime. In turn, funds may also like to change their portfolios today to prepare for this future set-up thereby benefitting from “early mover advantage” as other funds cotton on to setting themselves up in this way in the future. In this sense the term DIY buyout not only describes a way of investing in the future, it also describes a way of investing today.

So should all funds change their current investment approach to something akin to a DIY buyout approach?

Before answering this question in the affirmative, it’s helpful to be a bit more specific about what buyout providers do and to understand why such an approach is suddenly coming to the fore. Among other things, buyout providers:

  1. Ensure liability related risks associated with interest rate and inflation movements are hedged – they may also look to hedge out the risk of pensioners and their spouses living longer than expected, longevity risk, although this is a more nascent market.
  2. Ensure there’s a suitable capital reserve in place by targeting a premium in excess of the liabilities – this is done by maintaining investments in credit as well as gilts, and bearing a suitable level of illiquidity to benefit from an illiquidity premium.
  3. Ensure an administrator is in place to make pension payments when they fall due…

Interest in DIY buyout approaches is coming to the fore now as, following the recent equity bull market. Some schemes are now either at, or approaching full funding on their Technical Provisions and therefore need a new target for their journey. While that could be full buyout with a gilts negative basis, that may be too expensive a basis to target leading to consideration of a gilts flat or even a slightly positive basis to discount the liabilities. In other words a basis that is more consistent with a DIY buyout solution which doesn’t involve the payment of an insurance premium!

So should the many not just the few be adopting elements of a DIY buyout solution?

Well, yes, they should be because there’s little reason that smaller funds cannot gain access to the various elements of a DIY buyout solution today. As I see it, the three main reasons are these:

  1. It doesn’t make sense simply to disinvest into unnecessarily liquid gilts; it makes more sense also to derisk into credit, including the less liquid credit associated with the shadow banking sector. This is likely to lead to a more efficient investment portfolio for a given level of return and a variety of pooled fund vehicles are springing up to allow smaller funds to invest in this area.
  2. It also makes sense to consider hedging out interest rate and inflation risk using leverage as opposed to physical investments, and there is an increasing array of leverage levels available within pooled hedging vehicles today. Clients may consider substantially increasing their hedge ratios if there is:
    • no expectation that rates will mean revert back up by significantly more than the market already anticipates;
    • a feeling that the risk budget is more efficiently spent (in risk/return terms) on other sources of return; and
    • a belief that the current size of this “bet” is too large in relation to other risks being run relative to the potential rewards.
  3. Finally, and very importantly, it also turns out that adopting the various elements of a DIY buyout approach will make your asset portfolio more attractive to an insurer in any case. So while you might not think you can afford full buyout now, if things change in the future you’ll be in a great position to take advantage of your new circumstances.

So there it is. DIY buyout may genuinely be one of those things in life that is for the many not the few! Now much as I like it when things are for the many, not the few, where’s my table booking at the Chiltern Firehouse…

Lloyd Raynor, Associate Director, Pension Solutions Group

Russell Investments blog - Lloyd Raynor


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