DB schemes should use 2020 crisis as a 'learning opportunity'

Bennett: Covid-19 should be seen as a learning opportunity for schemes

• Stephanie Baxter

There are many lessons to be learned from the March 2020 market volatility and liquidity squeeze as the Covid-19 pandemic escalated, Barnett Waddingham says.

While many defined benefit (DB) schemes ended the year with a flat or even slightly better funding position year after financial markets improved, the consultancy warned against complacency.

Speaking at Barnett Waddingham's Investment Conference on 20 January, principal Jude Bennett said: "Things are almost certainly brighter than they looked in March. Many schemes have therefore dodged a potentially adverse situation, but we can easily imagine what might have been and it's clearly important not to be complacent. 2020 could, and in our view should, be taken as a good learning opportunity."

When the Covid-19 crisis hit markets in March, DB schemes faced a large increase in the value of their liabilities, while at the same time their growth assets were struggling badly, leading to significant pressures on funding.

"However, towards the end of the year, global equities subsequently rebounded in Europe around 10% for the year to date, corporate bond markets have recovered, and even gilt yields have crept back up a much better position than [we] might have imagined in March," said Bennett.

He said schemes should do a post-mortem of the events and review their risk positioning and governance framework, in a "similar way to what an engineer or air crash investigator would do".

DB schemes should think about what would have helped in the worst part of the crisis.

He said: "Firstly the management of risks around the valuation of your liabilities in particular, and having a high level of hedging in place against interest rate risk to protect against falls in gilt yields, would have been an important factor in helping protect your position.

"The shift in yields once again illustrates the difficulty in predicting changes in long-term interest rates, and the usefulness of being able to use liability-driven investment and other hedging strategies to scale risk exposures to manageable levels."

Schemes also would have slept better if they were making progress along the de risking journey, and had already taken action to constraint volatility in the funding position, moving away from growth assets towards cashflow-matching liability hedging assets, he said.

"Finally, growth portfolios set up with an emphasis on capital preservation would have performed better in the worst parts of the crisis than those relying on conventional diversification."

He added that while diversification did help to protect capital in the market collapse, but was shown in 2008/2009 financial crisis, it is a reduced benefit when most asset classes are falling at the same time.

It is possible to set up growth strategies to manage funding volatility, and ultimately risks to member benefits security and adverse market conditions, according to Bennett.

"Given the recovery since March, we'd argue that it's a useful and important time to review your risk positioning and your plans to bring your scheme into a more resilient position in future," he said.

Given the extremity of the crisis actually threw up some challenges for trustees and pension scheme managers, it is a "good time" to take stock of how governance arrangements work and consider whether any changes are needed, Bennett concluded.