1MOUNTAINS OFTHE MINDPension Funds’ Greatest Challenges in 2013
2At the end of March 2013, according to the Pension Protection Fund’s 7800 index, the aggregate deficit ofthe 6,316 comprising funds was £236.6 billion. Over 80% of those in the index were underfunded with theaverage funding ratio at 82.6%.The futures of these pension funds and the well being of their members rests firmly on the decisions of afew: what trustees feel are the key challenges facing UK defined benefit pension funds in the near future(3-5yrs) and over the longer time horizon (10-20yrs), will define the actions they take and the condition ofthe pension funds they manage. Similarly, the views and opinions of those advising and working withtrustees will affect the decisions they take; sponsors, advisors, pensions managers and members ofin-house pensions teams all play a vital role in shaping the future of pensions. In March 2013, Redingtoncreated an online survey to collect said views and opinions.This report collates the subsequent responses of these influential individuals, as well as investment banks,fund managers, media players, academics and other solutions providers to pension funds, to the questionof what the key challenges of the pensions industry are right now, and what factors they see becoming so inthe future. At the end of the report, challenges we feel are significant to pension funds, but were not listedby the respondents, are also noted.The results in this report are based on an online survey completed in March 2013, and comprise theanswers from 88 respondents covering influential pensions roles:Each respondent was asked to list the top three challenges in each of four categories over two timehorizons. That is, 24 answers were required from each respondent in total:• Strategic Challenges (Top 3 challenges over the medium and over the long term)• Financial and Economic Challenges (Top 3 challenges over the medium and over the long term)• Political and Regulatory Challenges (Top 3 challenges over the medium and over the long term)• Operational Challenges (Top 3 challenges over the medium and over the long term)The survey allowed open responses rather than selection of pre-set options, so similar descriptions havebeen grouped into themes and described in the summary (8). There was no weighting of the answer order,all three responses were considered similarly important. Results for each category on each time horizonhave been shown in two main graphs:• Graph 1. Based on total respondents, challenges listed shown as a percentage of total responses• Graph 2. Based on responses from trustees, corporate sponsor, pensions managers and advisorsonly. Votes to each challenge split by relative votes of respondents within each member group.About This Report
3About this report ...............................................................................2Contents ............................................................................................3Introduction .......................................................................................4Executive Summary ..........................................................................5Summary............................................................................................8Key Challenge Descriptions .............................................................8Summary of Responses ..................................................................10Spotlight: Where Trustees and Sponsors Diverge .........................12Below the Radar ..............................................................................14Contacts ...........................................................................................15Contents
4IntroductionRobert GardnerCo-CEO | Co-FounderPensions has always been a tricky business. But perhaps never more so than in 2013. The regulationchanges of the early 2000’s rewrote the rulebook for those running pension funds, and a survey of the keychallenges of that time would have produced, it seems logical to assume, a set of concerns aboutchanging regulations, accounting issues that accompany them, and governance.Today, the landscape has changed. Pension funds, on the whole, got to grips with those systemic changesin pension infrastructure only to be faced, in 2008 onwards, with the greatest seismic economic shift ofour lifetimes. It wasn’t just that markets plummeted and equities didn’t turn out to be the knight in shiningarmour pension funds had hoped and planned they would be; it was that the very foundations of moderneconomic markets changed. Everything we thought we knew about risk, return and the relationshipbetween the two, was called into question. Now, in 2013, we are all still acclimatising to our new normal.For those managing pension funds and guarding the well-being of their members’ retirement pots, the lastfive years have been no easy ride. The actions they have taken and will continue to take will determine thewell-being of our ageing population, and the challenges they perceive as the greatest ones will shape thoseactions. This report collates the answers to a survey that asks the pensions industry – those activelyrunning pension funds as well as those advising and providing services to them – what they consider thegreatest challenges they face today, in the medium and longer terms, in the categories of Strategicchallenges, Financial and Economic challenges, Political and Regulatory challenges and Operational ones.Each respondent listed the top three challenges in each of these categories as they saw it, and therebyprovided a rare and candid insight into those items that occupy the tops of their agendas.This report provides a glimpse into the minds of those influential people in the UK who hold the well-beingof the retiring population in their hands. I hope you find it interesting and informative, and that, if you areso inclined, you will use the contact details at the back of this report to reach out to us and continue theconversation. Above all, we hope this report acts as a conversation-starter within pensions, and that you,the reader, will use it to engage with others in the industry to question, analyse and discuss the challengesreported herein.“it’s not been the strongest of thespecies to survive, but the mostadaptive to change.” Darwin
5Executive SummaryMedium-term Risk Radar (3-5yr)This section provides a summary of all the survey’s results, shown as two Risk Radars which illustrate thegreatest challenges respondents identified in each of the four categories. The first radar displays the chal-lenges respondents identified in the medium term (3-5 years), and the second radar displays those listed inthe longer term (10-20 years).Each dot represents a challenge, and the size and position of the dot simultaneously signifies the totalrelative votes by respondents. The larger and closer the dot to the centre, the more times the challenge wasmentioned by respondents.STRATEGICCHALLENGESRISKFACTORFINANCIAL &ECONOMICCHALLENGESPOLITICAL ®ULATORYCHALLENGESOPERATIONALCHALLENGES%
6Long-term Risk Radar (10-20yr)STRATEGICCHALLENGESRISKFACTORFINANCIAL &ECONOMICCHALLENGESPOLITICAL ®ULATORYCHALLENGESOPERATIONALCHALLENGES%Wherever you see these icons throughout this reportyou can click on them to bring you back to ourmedium and long term Risk Radars.
7Key Challenge DescriptionsThis section describes some of the key challenges mentionedby respondents and provides a summary description of why itis categorised as such.INTEREST RATES / INFLATIONEUROZONE CRISISSPONSOR AND/OR BALANCE SHEETFor the majority of funds, exposure to real yields (falling interest rates and rising inflation) represents thesingle largest source of risk. With real yields plunging relentlessly lower in recent years, funds that haveopted not to hedge this risk face the dilemma of whether to do so now and lock in at current levels or tocontinue to expose their funds to further volatility. Some commentators are predicting a great rotation frombonds back into equities and a reversion of yields back to historical “norms”. However, the prospect offinancial repression, where governments deliberately target low or negative real yields to reduce their debtburdens, presents a particularly compelling counter argument. As one US researcher recently noted, anaverage negative real yield of 2% over the next 20 years would reduce debt to GDP from 100% to amanageable 60%. Even if rates do nothing, pension funds face the time-decay effects of rolldown andcarry, which become another strong argument for hedging interest rate risk no matter what.http://bit.ly/Yt35HPhttp://bit.ly/18hoKH8The Eurozone debt crisis has settled into an uneasy calm since Mario Draghi’s pledge to do “whatever ittakes” to save the single currency. Nevertheless, the toxic combination of high debt burdens, lowcompetitiveness, non-existent growth, and the absence of a long-term political solution to the crisis meansthat it remains the dominant macroeconomic tail risk for financial markets (and therefore a key driver ofpension fund asset returns in the short to medium-term). The crisis also presents more direct risks for UKpension funds with the prospect of further safe haven demand driving down gilt yields.New accounting and regulatory requirements have rendered pension funds an increasingly visible partof corporate financial statements, with investors and credit rating agencies now far more attuned to therelationship between pension funds and wider balance sheet volatility. At the same time, rising pensionfund deficits have forced sponsors to divert scarce cash into the pension fund, reducing free cash flow andwithholding potential dividends for shareholders. From the Trustee’s perspective, the ability and willingnessof the sponsor to support the fund on an ongoing basis remains key to determining the risk appetite andsetting the long-term investment strategy.Scan this QR code with your smart phone orclick on the hyperlink below for a direct link to:REDVIEWSScan this QR code with your smart phone or click onthe hyperlink below for a direct link to:PENSION RISK TO THECORPORATE SPONSOR
8http://bit.ly/182zD20http://bit.ly/WuCZ2yFUNDING MANAGEMENTREGULATION / POLITICSINVESTMENT RETURNSIn negotiating any deficit recovery plan, sponsors and trustees must strike the optimal balance betweencash contributions from the company and reliance on investment returns. Set contributions too high, andpension funds and sponsors risk diverting cash that could have been used to grow the business into thepension fund, ultimately weakening the company (and therefore the sponsor covenant). Set contributionstoo low and expected returns too high, and the fund becomes reliant on an overly risky investment strategy,potentially resulting in much higher deficit contributions in future years. Some sponsors and their fundshave squared this circle by agreeing innovative non-cash funding strategies whereby the company providesthe fund with secure or collateralised assets while retaining cash for investment in the business.In January, the Consumer Price Advisory Committee (CPAC) announced, following months of speculation to thecontrary, that it would maintain the existing approach for calculating RPI inflation rather than align the measurewith CPI inflation. The move resulted in a sharp upward move in market inflation and a corresponding increasein UK pension liabilities. Two months later, UK Chancellor George Osborne announced that the government hadrejected a proposal to allow smoothing in the valuation of pension assets and liabilities, a move that could haveallowed some companies to sharply reduce deficit contributions. These “moving goalposts” erode the trust thatthe government and regulators have funds’ or members’wellbeing at heart. Ongoing developments emphasise that political and regulatory uncertainty will remain akey challenge for pension funds in the years ahead.With major central banks committed to keeping interest rates low for the foreseeable future, investors havebeen encouraged to “reach for yield”, driving down returns on riskier fixed income (such as high yield) tonear historic lows. Equities no longer appear the obvious solution: in a recent study, researchers at LondonBusiness School revised down their estimate of the historical equity risk premium to a meagre 3.0%-3.5%,reflecting poor performance over the past decade and more accurate adjustment for “survivorship bias”.Given the bleak outlook for conventional asset classes, pension funds have shown increasing interest in arange of illiquid alternatives that offer a rare combination of secure and attractive real returns (for example,infrastructure debt).Governance bandwidth is a perennial challenge for UK pension funds. In recent years, the already limitedresources of trustee boards and investment committees have been further strained by an increasingly wideand complex array of available asset classes and strategies, as well as greater volatility in financial marketsmore generally. This makes it ever more important for funds to have in place clear strategic framework toevaluate opportunities against the fund’s objectives and to focus governance resources on the areas ofgreatest potential value add to the fund. Those funds that have spent time and resource in building a robustgovernance framework have been repaid handsomely.GOVERNANCE / DECISION-MAKINGScan this QR code with your smart phone or clickon the hyperlink below for a direct link to:Journal #33 (The Pensions Risk ManagmentFramework)Scan this QR code with your smart phone or clickon the hyperlink below for a direct link to:RED-BLOGESTIMATING THE EQUITY RISK PREMIUM
9CONFLICTS WITH AGENTSDEATH OF DBMANAGING THE END GAMERISK MANAGEMENTEMPLOYEE BENEFITGood help can be hard to find. There are those who believe they are receiving “poor advice from consult-ants” and others that feel there may be a “misalignment between the objectives of the trustees with theiragents”. However, while funds battle service costs and drive to push for lower management and advisoryfees, this begs the question: can one expect the best service from the lowest bidder? Pension fundscontinue to fight this battle of needing good advice like never before, but needing the costs to bemanageable and, perhaps, linked to performance of the pension fund.Members of Generation Y would be lucky to get into a defined benefit fund (if they are even offered a jobfirst). Final Salary funds are no longer widely viewed as an effective reward tool to attract and retain toptalent. While some believe the challenge lies in “making people understand pensions are affordable”, othersbelieve the legacy is “just a burden to be managed”. In the face of closing funds, maturing membership andnegative cashflows, the challenge lies in managing ways to meet the liabilities as funds walk the green mile.In managing the transition to the End Game, funds face a complex marketplace of solutions ranging fromlongevity swaps to synthetic “buy-ins” to full buy-out. However, some respondents ask a more fundamentalquestion: “what is the end game”? The finishing line lies at buy-out for some pension funds, and in self suf-ficiency – meeting benefit payments without reliance on investment returns or sponsor contributions – forothers. The challenge rests in managing the fund’s journey to arriving at their respective destinations.Pension funds face a myriad of risks and hurdles; first to full funding and then at full funding. Some risksare rewarded (assets), some are unrewarded (interest rate and inflation), and pension funds are having todevise increasingly complex strategies to address these risks. And then there are operational (governance)risks too. Finally, risk management is not unidirectional: funds should have an effective framework tore-risk, as necessary, in response to funding level declines.As an employee benefit and reward tool, it is important to ensure “members appreciate the value of thebenefit” defined within defined benefits. Between “demands for higher payouts” and “integration withnon-equal benefits needed for employee recruitment”, funds face the challenge of “changing or loweringmember expectations should present promises prove unsustainable due to changed economic and demo-graphic circumstances”.SUMMARY OF RESPONSESMany of the risks described above were chosen as respondents’ top three risks in each of the fourcategories over the medium and longer terms. Below is a summary of responses for the greatest riskswithin each of the four categories of challenges: Strategic challenges, Financial and Economic challenges,Political and Regulatory challenges and Operational ones.Results for each category on each time horizon have been shown in two main graphs:• Graph 1. Based on total respondents, challenges listed shown as a percentage of total responses• Graph 2. Based on responses from trustees, corporate sponsors, pensions managers and advisorsonly. Votes to each challenge split by relative votes of respondents within each member group.“Not my problem, I hope to haveretired or died” Respondent Quote
10Graph 2. Top Strategic Challenges by Member Group - Medium-Term (3-5yr)0% 5% 10% 15% 20% 25% 30% Sponsor and Balance Sheet Funding Regula;on & Poli;cs Investment Returns and the Economy Interest Rates Risk Management Death of DB Managing the End Game Conﬂicts with Agents Governance and Decision Making Employee Beneﬁt Trustees Sponsor Advisor Pensions Manager 18% 14% 11% 11% 9% 7% 7% 7% 6% 5% 3% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Sponsor and Balance Sheet Funding Governance and Decision Making Investment Returns and the Economy Death of DB Risk Management Interest Rates RegulaJon & PoliJcs Managing the End Game Employee Beneﬁt Conﬂicts with Agents Strategic Challenges (3-‐5yr) Graph 1. Top Strategic Challenges by Total Votes - Medium-Term (3-5yr)Respondents identified Sponsor and Balance Sheet related issues as their number one medium-termchallenge (18%) closely followed by Funding issues (14%) Governance (11%) and Investment Returns (11%).Surprisingly, Risk Management (7%) appears relatively low on the medium-term agenda for respondents.The majority of respondents identified the Sponsor and it’s Balance Sheet as the main concern in themedium-term. Trustees also listed Funding as a key issue while Sponsors, Advisors and Pensions Managerscollectively listed Governance and Decision Making.Over a longer-term horizon, Managing the End Game (29%) is unsurprisingly viewed as the dominantconcern. The Sponsor and its Balance Sheet remains a key issue (15%) while Funding follows once more inthird place (11%).29% 15% 11% 8% 8% 8% 7% 6% 4% 2% 1% 0% 5% 10% 15% 20% 25% 30% Managing the End Game Sponsor and Balance Sheet Funding Investment Returns and the Economy Death of DB Interest Rates RegulaHon & PoliHcs Governance Employee Beneﬁt Risk Management Conﬂicts with Agents Strategic Challenges (10-‐20yr) STRATEGICCHALLENGESGraph 3. Top Strategic Challenges by Total Votes - Long-Term (10-20yr)
11Graph 4. Top Strategic Challenges by Member Group - Long-Term (10-20yr)Similarly, the majority of the groups believe Managing the End Game is the main concern in the long-term.While the Sponsor and it’s Balance Sheet remains a top concern for Trustees, Sponsors on the other handare more concerned about the Death of DB and the challenges associated with structural changes as fundsclose.Respondents identified Investment Returns (26%) and Deficit Funding (26%) as the joint top financial andeconomic challenges over the next 3-5 years, followed by Interest Rates (18%). This may suggest that theemphasis is now on strategies to close funding deficits rather than de-risking to avoid further volatility.“Is the market big enough to cope ifall private sector DB funds try to windup?” Respondent Quote0% 5% 10% 15% 20% 25% 30% 35% 40% Managing the End Game Sponsor and Balance Sheet Funding Interest Rates Investment Returns and the Economy RegulaCon & PoliCcs Death of DB Governance Risk Management Employee Beneﬁt Conﬂicts with Agents Trustees Sponsor Advisor Pensions Manager FINANCIAL ANDECONOMIC26% 26% 18% 14% 9% 7% 0% 5% 10% 15% 20% 25% 30% Deﬁcit Funding / Management Returns Interest Rates & Inﬂa@on Eurozone & UK Growth Sponsor Solvency Economic Policy Financial and Economic Challenges (3-‐5yr) Graph 5. Top Financial & Economic Challenges by Total Votes - Medium-Term (3-5yr)
1221% 19% 19% 13% 12% 10% 4% 0% 5% 10% 15% 20% 25% Deﬁcit Funding / Management Returns Eurozone & Global Growth Interest Rates & InﬂaFon Longevity and Buy-‐out Sponsor Solvency Economic Policy Financial and Economic Challenges (10-‐20yr) 0% 5% 10% 15% 20% 25% 30% 35% Returns Eurozone & Global Growth Interest Rates & Inﬂa;on Longevity and Buy-‐out Deﬁcit Funding / Management Sponsor Solvency Economic Policy Trustees Sponsor Advisor Pensions Manager Graph 6. Top Financial and Economic Challenges by Member Group - Medium-Term (3-5yr)Graph 7. Top Financial and Economic Challenges by Total Votes - Long-Term (10-20yr)Graph 8. Top Financial and Economic Challenges by Member Group - Long-Term (10-20yr)0% 5% 10% 15% 20% 25% 30% 35% 40% Deﬁcit Funding / Management Returns Eurozone & UK Growth Interest Rates & InﬂaFon Sponsor Solvency Economic Policy Trustees Sponsor Advisor Pensions Manager Collectively, the group consensus on the key Financial and Economic challenge appears to be DeficitFunding / Management. However, more specifically, advisors listed Returns as the top challenge faced byfunds.Over the long-term, respondents were more evenly balanced in their distribution of challenges withDeficit Funding (21%), Investment Returns (19%) and the Eurozone Crisis/Global Growth (19%) stillfeaturing strongly while interest rates and inflation (13%) still remain a concern.Sponsors, Advisors and Pensions Managers maintain that Deficit Funding / Management is the topchallenge facing funds, while trustees cite Returns as the top challenge in the long-term. Trustees and advi-sors broadly agree on the level of significance of the challenges posed by the Eurozone and Global Growthand Economic Policy, while these did not register at all with Sponsors and Pensions Managers.
1329% 20% 17% 10% 10% 6% 6% 2% 0% 5% 10% 15% 20% 25% 30% Valua-on and Repor-ng Regulatory Burden Capital Requirements Uncertain / Unfair Poli-cal Interferance The Pension Protec-on Fund Monetary Policy Central Clearing The Pensions Regulator Poli,cal and Regulatory Challenges (3-‐5yr) Graph 10. Top Political and Regulatory Challenges by Member Group - Medium-Term (3-5yr)Respondents identified Valuation and Reporting (29%) as the number one medium-term political/regulatoryrisk, perhaps reflecting concern about upcoming triennial valuations. Regulatory Burden (20%) and CapitalRequirements (17%) were identified as the next greatest challenges.“Trying to prevent the TPR frombeing any more painful andunhelpful” Respondent Quote0% 5% 10% 15% 20% 25% 30% 35% 40% Valua-on and Repor-ng Capital Requirements Regulatory Burden Uncertain / Unfair Poli-cal Interferance The Pension Protec-on Fund Central Clearing The Pensions Regulator Monetary Policy Trustees Sponsor Advisor Pensions Manager Graph 9. Top Political and Regulatory Challenges by Total Votes - Medium-Term (3-5yr)POLITICAL ANDREGULATORY CHALLENGESSponsors see the implications associated with Capital Requirements as the top Political and Regulatorychallenge to their funds in the medium-term, while Trustees, Advisors and Pensions Managers togetherbelieve Valuation and Reporting will be the biggest challenge. Collectively, all member groups agree thatRegulatory Burden in general will be a key challenge for pension funds.Unsurprisingly given the recent debate around smoothing of liabilities and potential changes to RPIinflation, respondents identified Uncertain or Unfair Political Influence (37%) as the key long-termpolitical and regulatory challenge. Also featuring strongly was the Death of DB funds (17%), RegulatoryBurden (15%) and Capital Requirements (15%).
1427% 17% 14% 13% 13% 9% 5% 2% 0% 5% 10% 15% 20% 25% 30% Governance and decision making Costs & Eﬃciency Admin Regulatory Burden Strategy ImplementaEon and Monitoring Lack of Quality Providers Auto-‐Enrolment Member CommunicaEon Opera,onal Challenges (3-‐5yr) 37% 17% 15% 15% 8% 3% 2% 2% 0% 5% 10% 15% 20% 25% 30% 35% 40% Uncertain / Unfair Poli7cal Interference Death of DB Capital Requirements Regulatory Burden Who knows? The Pensions Regulator Monetary Policy The Pension Protec7on Fund Poli+cal and Regulatory Challenges (10-‐20yr) The member groups agree that Uncertain / Unfair Political Interference poses the greatest challenge in thelong-term. In a similar response to Strategic challenges, sponsors view the implications associated with theDeath of DB funds as a key challenge. Regulatory entities in the industry also feature as a challenge:some trustees believe The Pension Protection Fund will be a long-term issue, some advisors are lookingmore pointedly at The Pensions Regulator.Graph 11. Top Political and Regulatory Challenges by Total Votes - Long-Term (10-20yr)Graph 12. Top Political and Regulatory Challenges by Member Group - Long-Term (10-20yr)Graph 13. Top Operational Challenges by Total Votes - Medium-Term (3-5yr)0% 5% 10% 15% 20% 25% 30% 35% 40% Managing the End Game Sponsor and Balance Sheet Funding Interest Rates Investment Returns and the Economy RegulaCon & PoliCcs Death of DB Governance Risk Management Employee Beneﬁt Conﬂicts with Agents Trustees Sponsor Advisor Pensions Manager Governance (27%) is viewed as the key medium-term operational challenge facing funds as trustees grapplewith the question of how to spread scare resource across an ever more complex investment environment.Costs and Efficiency (17%) and Administration (14%) are viewed as the next most significant challenges inthis category.“Most overestimate their ability tomanage complexity” Respondent QuoteOPERATIONALCHALLENGES
1530% 16% 11% 11% 11% 11% 4% 4% 2% 2% 0% 5% 10% 15% 20% 25% 30% 35% Governance and decision making Admin Costs & Eﬃciency Wind-‐up and declining membership Strategy ImplementaGon and Monitoring Technology and member engagement Regulatory Burden Who knows? Auto-‐Enrollment Lack of Quality Providers Opera,onal Challenges (10-‐20yr) Sponsor concerns over operational challenges were fairly evenly spread across those listed. Trusteesdistinctly view Governance and Decision Making as the key challenge, while pension managers discerniblyregard Costs and Efficiency as a key matter. Together, pension managers and trustees were the only groupswho listed Member Communication.The picture is similar over the longer-term, with Governance (30%) listed as the primary burden, followingwhich concerns were more evenly distributed across Administration (16%), Costs and Efficiency (11%),Strategy Implementation and Monitoring (11%),Technology and Member engagement (11%) and Wind-Upand Declining Membership (11%), the latter of which is a new concern.Graph 14. Top Operational Challenges by Member Group - Medium-Term (3-5yr)Graph 15. Top Operational Challenges by Total Votes - Long-Term (10-20yr)Graph 16. Top Operational Challenges by Member Group - Long-Term (10-20yr)0% 5% 10% 15% 20% 25% 30% 35% 40% Governance and decision making Admin Regulatory Burden Lack of Quality Providers Strategy ImplementaEon and Monitoring Costs & Eﬃciency Auto-‐Enrolment Member CommunicaEon Trustees Sponsor Advisor Pensions Manager 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Governance and decision making Admin Wind-‐up and declining membership Technology and member engagement Costs & Eﬃciency Lack of Quality Providers Who knows? Strategy ImplementaNon and Monitoring Auto-‐Enrollment Regulatory Burden Trustees Sponsor Advisor Pensions Manager The concerns appear fairly similar across the listed challenges, although trustees do not appear to viewStrategy Implementation and Monitoring as a long-term concern. Collectively, the groups show similarlevels of interest in Wind-Up and Declining Membership and Technology and Member Engagement.Some trustees and advisors pragmatically suggest, “Who Knows?”
1625% 22% 11% 13% 13% 13% 13% 13% 0% 5% 10% 15% 20% 25% 30% Sponsor and Balance Sheet Funding Regula;on & Poli;cs Risk Management Governance and Decision Making Conﬂicts with Agents Sponsor and Balance Sheet Trustee Sponsor 31% 31% 12% 12% 36% 27% 18% 0% 5% 10% 15% 20% 25% 30% 35% 40% Managing the End Game Sponsor and Balance Sheet Funding Interest Rates Death of DB Governance Trustee Sponsor Graph 18. Top Strategic Challenges by Trustees and Sponsors – Long-Term (10-20yr)Graph 19. Top Financial and Economic Challenges by Trustees and Sponsors - Medium-Term(3-5yr)Graph 17. Top Strategic Challenges by Trustees and Sponsors - Medium-Term (3-5yr)25% 20% 20% 36% 14% 14% 14% 14% 0% 5% 10% 15% 20% 25% 30% 35% 40% Deﬁcit Funding / Management Returns Eurozone & UK Growth Interest Rates & InﬂaGon Sponsor Solvency Trustee Sponsor STRATEGICCHALLENGESFINANCIAL ANDECONOMIC CHALLENGES
1741% 18% 12% 12% 12% 30% 20% 40% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Uncertain / Unfair Poli7cal Interference Capital Requirements Death of DB Regulatory Burden Who knows? Trustee Sponsor 29% 24% 18% 22% 33% 22% 0% 5% 10% 15% 20% 25% 30% 35% Returns Eurozone & Global Growth Interest Rates & Inﬂa>on Deﬁcit Funding / Management Longevity and Buy-‐out Trustee Sponsor Graph 20. Top Financial and Economic Challenges by Trustees and Sponsors - Long-Term (10-20yr)Graph 21. Top Political and Regulatory Challenges by Trustees and Sponsors - Medium-Term (3-5yr)Graph 22. Top Political and Regulatory Challenges by Trustees and Sponsors - Long-Term (10-20yr)36% 18% 18% 36% 21% 14% 0% 5% 10% 15% 20% 25% 30% 35% 40% Valua/on and Repor/ng Capital Requirements Regulatory Burden Monetary Policy Trustee Sponsor POLITICAL AND REGULATORYCHALLENGES
1838% 19% 13% 13% 40% 10% 10% 10% 20% 10% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Governance and decision making Admin Wind-‐up and declining membership Technology and member engagement Strategy ImplementaFon and Monitoring Costs & Eﬃciency Trustee Sponsor Graph 23. Top Operational Challenges by Trustees and Sponsors - Medium-Term (3-5yr)Graph 24. Top Operational Challenges by Trustees and Sponsors - Long-Term (10-20yr)38% 16% 13% 23% 15% 15% 15% 15% 0% 5% 10% 15% 20% 25% 30% 35% 40% Governance and decision making Admin Regulatory Burden Lack of Quality Providers Costs & Eﬃciency Strategy ImplementaKon and Monitoring Trustee Sponsor OPERATIONALCHALLENGES
19The results of the survey, illustrated and discussed in the previous pages, provide a rare insight into thekey challenges that those running pension funds currently face, or perceive that they face. As investmentconsultants, however, we at Redington see a slightly different perspective. Some key challenges that weexpected would feature strongly in the survey results, did not. We have identified, in the course of our workwith a range of clients representing over £270bn in assets and eleven of the largest 30 UK pension funds,some more challenges that we stand with our clients to face and that, we believe, might be some of themost important and serious ones on the horizon. A summary of those key challenges are described belowfor consideration and debate.STRATEGIC: ROLL DOWN AND CARRYRoll down and carry presents a more subtle – and perhaps less appreciated - variation on the interest ratechallenge. This is the impact on pension fund liabilities assuming nothing changes except for thepassage of time. The current interest rate curve is upward sloping because the market expects rates torise in the future. These expectations are similarly reflected in the valuation of pension liabilities. Given thecurrent shape of the curve, this means that a typical pension fund liability profile can be expected to growby around 2.5% per year if interest rates merely remain unchanged. This presents an interesting twist forfunds unwilling to hedge because they view today’s low rates as unattractive: can they afford to the pay theprice if the expected rise in rates fails to materialise?FINANCIAL AND ECONOMIC: REINVESTMENT RISKFor well funded funds nearing the End Game, high quality credit allocations can form a key part of theportfolio. These allocations offer a relatively secure return over Gilts while also providing predictable cashflows to help meet benefit payments. For funds in this position, falling credit spreads (and the associatedrisk that coupon payments will be reinvested at lower rates of return) can present a significant challenge totheir funding objectives.POLITICAL AND REGULATORY: CENTRAL CLEARINGNew 2013 OTC derivative regulations present complex challenges for UK pension funds. Should existingswaps be kept out or moved to central clearing? Should funds make use of the 2015 / 2018 exemption fornew trades or move to clearing immediately? How funds respond to these questions will have importantimplications for areas like counterparty credit risk, collateral efficiency, eligible collateral and, ultimately,the strategic asset allocation. As the impact will vary depending on fund’s unique circumstances, a carefulcost/benefit assessment, soon, is crucial.OPERATIONAL: LIQUIDITYWhile pension funds have the benefit over other institutional investors of being able to take advantageof longer investment horizons, liquidity is nevertheless a key operational challenge. Funds need to retainenough cash both to pay benefits as they fall due and meet potential margin calls on derivative positions.As this can have important implications for the investment strategy, careful monitoring and stress testing isessential.Below the Radarhttp://bit.ly/16NvAHhhttp://bit.ly/Yt35HPScan this QR code with your smart phone or clickon the hyperlink below for a direct link to:REDVIEWSScan this QR code with your smart phone or clickon the hyperlink below for a direct link to:REDVIEWS