Statement of investment principles in respect of the default investment strategy for the DC section – September 2019
1.1 The Trustees of the Plan have drawn up this Statement of Investment Principles (“the Statement”) to comply with the requirements of the Occupational Pension Schemes (Investment) Regulations 2005 and subsequent legislation, relating to provision of information specific to default investments, referred to as the “Default Arrangement”. This should be read in conjunction with the main Statement.
1.2 The Default Arrangement covered by this Statement is as follows:
- the Lifestyle Investment Programming Option
2.1 The Trustees recognise that many members do not consider themselves competent to take investment decisions. As such, the Trustees have made available a default arrangement. Unless members make a specific request for their accounts to be invested in a different manner, the Trustees implement the default arrangement.
2.2 The default investment arrangement, which is the Lifestyle Investment Programming option (the “Lifestyle Strategy”), adopts a pre-set investment strategy. This strategy has two phases: the accumulation phase and the consolidation phase. When a member is younger, their account is invested in funds that aim for long-term growth (accumulation phase) in excess of inflation. As the member approaches retirement, their account is switched automatically into lower-risk, lower-growth funds (consolidation phase) that aim to provide greater stability by targeting the purchase of an inflation-linked annuity and the withdrawal of tax free cash.
3. Default Arrangement
3.1 The aims of the default arrangement and the ways in which the Trustees seek to achieve these aims are detailed below:
– To generate returns in excess of inflation during the accumulation phase of the strategy whilst managing downside risk.
The default arrangement’s accumulation phase invests 100% of members’ accounts in a fund comprised mainly of global equities, but which also has a small allocation to bonds and cash. This fund is expected to provide long term growth in excess of inflation but with greater downside protection than investing purely in equities.
– To provide a strategy that reduces investment risk for members as they approach retirement.
As a member’s account grows, investment risk will have a greater impact on outcomes at retirement. Therefore, the Trustees believe that a strategy that seeks to reduce investment risk as the member approaches retirement is appropriate. Moreover, as members approach retirement, the Trustees believe the primary aim should be to provide protection against a mismatch between asset values and the expected costs of retirement benefits.
The Lifestyle Strategy therefore aims to reduce volatility near retirement via automated switches over a 16 year period to a member’s selected retirement date. Investments are gradually switched from a growth oriented fund (the Multi-Asset Fund), initially into a lower risk / return fund (the Blended Fund) and finally into a combination of an Index-Linked Gilt Fund (to broadly match short-term changes in the price of Inflation-linked annuities) and to a cash fund for capital preservation purposes.
– To provide exposure at retirement to assets that are broadly appropriate for an individual planning to use their savings in the Plan to buy an inflation-linked annuity and to take a 25% tax-free cash lump sum at retirement.
At the member’s selected retirement date, 75% of the member’s assets will be invested in an index-linked gilt fund and 25% in a cash fund.
Policies in relation to the default arrangement
3.2 The Trustees’ policies in relation to the default arrangement are:
– The default arrangement manages investment risks through a diversified strategic asset allocation consisting of traditional assets i.e. equities, bonds and cash. Risk is not considered in isolation, but in conjunction with expected investment returns and outcomes for members. Section 4 provides further information on the Trustees’ risk policies in relation to the default arrangement.
– In designing the default arrangement, the Trustees have explicitly considered the trade-off between expected risk and return.
– The Trustees have also taken into account the needs of members with regards to security, quality, liquidity and profitability of a member’s portfolio as a whole. The Trustees have designed the default arrangement taking account of the assets in the default.
– If members wish to, they can opt to choose their own investment options at any time. Members are supported by clear communications in the form of a members’ booklet regarding the aims of the default arrangement and the access to alternative funds, albeit the Trustees will not provide advice to members on their individual choice of investment options.
– Assets in the default arrangement are invested in daily traded pooled funds which hold highly liquid assets. The pooled funds are commingled investment vehicles, which are managed by Legal & General Investment Management (“LGIM”). The selection, retention and realisation of assets within the pooled funds are delegated to LGIM in line with the mandates of the funds. Likewise, LGIM have full discretion (within the constraints of their mandates) on the extent to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments.
– Within the default arrangement, units across the underlying pooled funds are bought and sold according to the table below:
Taking into account the demographics of the Plan’s membership and the Trustees’ views of how the membership will behave at retirement, the Trustees believe that the balance between asset classes within the default option is appropriate and will continue to review this over time, at least triennially, or after significant changes to the Plan’s demographics, if sooner.
In selecting assets, the Trustees consider the liquidity of the investments in the context of the likely needs of members. All assets are daily dealing and therefore should be realisable based on member demand.
The Trustees have considered risks from a number of perspectives. The list below is not exhaustive but covers the main risks that the Trustees consider and how they are managed.
How it is managed
How it is measured
The real value (i.e. post inflation) value of members’ accounts decreases.
The Trustees provide members with a range of funds, across various asset classes, with the majority expected to keep pace with inflation (with the exception of the money market and fixed interest bond funds).
Members are able to set their own investment allocations, in line with their risk tolerances.
The Trustees consider the real returns (i.e. return above inflation) of the funds, with positive values indicating returns that have kept pace with inflation.
Pension Conversion Risk
Members’ investments do not match how they would like to use their pots in retirement.
The Trustees make available a lifestyle strategy for DC members, targeting members taking their DC assets 75% as a pension increasing in payment with inflation and 25% as a tax-free cash lump sum.
The lifestyle strategy automatically switches member assets as they approach retirement into investments that are expected to be less volatile relative to how they wish to access their pension savings. The lifestyle strategy increases the proportion of assets that more closely match the chosen retirement destination as members approach retirement. This aims to reduce the risk of a substantial fall in the purchasing power of their accumulated savings near retirement.
The Trustees considering the returns of the funds used within the switching phase of the lifestyle strategy relative to changes in annuity prices.
The value of securities, including equities and interest bearing assets, can go down as well as up.
The default investment strategy is set with the intention of diversifying this risk to reach a level of risk deemed appropriate for the relevant members by the Trustees.
The Trustees monitors the performance of external investment funds on a quarterly basis.
A counterparty, either an underlying holding or pooled arrangement, cannot meet its obligation.
Delegated to external investment manager.
The Trustees monitor the performance of external investment funds on a quarterly basis.
The value of an investment in members’ base currency may change as a result of fluctuating foreign exchange rates.
The main sources of currency risk within the default investment strategy are the allocations to the Multi-Asset and Blended Funds.
The management of currency risk within the Multi-Asset Fund is delegated to the investment manager. Within the Blended Fund, currency risk is managed by hedging 50% of the developed market overseas equity exposure back to Sterling.
The Trustees monitor the performance of external investment funds on a quarterly basis.
The Trustees consider the movements in foreign currencies relative to pound sterling.
A lack of robust internal proceses, people and systems.
In line with the main DC assets.
The Trustees consider the ratings of investment strategies from their Investment Consultant and monitor these on a quarterly basis.
Assets may not be readily marketable when required.
The Trustees access daily dealt and daily priced pooled funds through a unit-linked insurance contract from LGIM.
The Trustees consider the pricing and dealing terms of the funds underlying the unit-linked insurance contract.
The value of an illiquid asset is based on a valuer’s opinion, realised value upon sale may differ from this valuation.
The multi-asset fund may hold illiquid assets. In such cases, the management of valuation risk is delegated to the external investment manager.
The majority of the default lifestyle strategy’s assets are invested solely in liquid quoted assets.
The Trustees monitor the performance of funds on a quarterly basis, and where relevant delegate the monitoring of valuation risk to the Investment Consultant.
Environmental, Social and Governance Risk
ESG factors can have a significant effect on the performance of the investments held by the Plan e.g. extreme weather events, poor governance.
In line with the main DC assets as set out in the main Statement of Investment Principles.
The Trustees review their external investment managers’ policies and actions in relation to this on a regular basis.
Manager Skill / Alpha Risk
Returns from active investment management may not meet expectations, leading to lower than expected returns to members.
The only exposure to active management within the default lifestyle investment stratregy is within the Multi-Asset Fund.The Fund is highly rated by the Trustees’ Investment Consultant, based on forward-looking expectations of meeting objectives.
The Trustees consider the ratings of investment strategies from their Investment Consultant during the selection process.
The Trustees monitor performance and rating of funds on an ongoing basis relative to the fund’s benchmark and stated targets/objective.
The items listed above are in relation to what the Trustees consider ‘financially material considerations’. The Trustees believe the appropriate time horizon over which to assess these considerations should be viewed at a member level. This will be dependent on the member’s age and their Selected Retirement Age.
5. Suitability of Default Investment Strategy
5.1 Based on their understanding of the Plan’s membership, the Trustees believe that the above objectives and policies reflect members’ best interests. The rationale underpinning this belief is as follows:
- A defined benefit underpin applies to many members. The underpin requires that the majority of members’ benefits should be taken as a pension which increases in payment in line with inflation.
- In addition, the Trustees believe that most members save into a pension plan to achieve a stable income in retirement that is protected at least partially from inflation. The targeting of an annuity purchase at retirement during the consolidation phase is aligned with that objective.
- The default arrangement is aimed largely at members who do not feel capable of taking investment decisions. Again, the Trustees believe that an annuity purchase which provides a secure income at retirement is likely to be the preferred course for many such members, as opposed to say income drawdown which requires more intensive investment governance during retirement.
- Almost all members withdraw tax free cash at retirement. The use of the Sterling Liquidity Fund within the default addresses that requirement.
- Members seeking an adequate income in retirement will likely need to achieve real investment returns for most of their period as pension savers. The use of a fund with significant weightings in global equities during the accumulation phase addresses that requirement.
5.2 The Trustees are aware that fund sizes for members approaching retirement are often small and this may disincline members towards annuity purchase at retirement. However, members will likely have other savings that can be consolidated with their Plan savings.
5.3 The Trustees intend to monitor members’ decisions and other inputs from time to time to ensure that the default arrangement remains suited to their needs. They will also review the investment choices available to members to ensure that those who regard the default arrangement as unsuited to their needs have suitable alternative investment funds to select from.
6. Review of this Statement
6.1 The Trustees will review this Statement at least once every three years and without delay after any significant change in investment policy. Any change to this Statement will only be made after having obtained and considered the written advice of someone who the Trustees reasonably believe to be qualified by their ability in and practical experience of financial matters and to have the appropriate knowledge and experience of the management of pension scheme investments.