Four reasons LGPS need to adopt bespoke approach to equity protection
Local Government Pension Schemes (LGPS) cannot afford to ignore equity protection in the current environment amid a surge in the value of investment markets, River and Mercantile Derivatives has said.
Schemes have switched to focus more closely on equity protection for portions of their assets in recent months, according to Mark Davies, managing director at River and Mercantile Derivatives, as LGPS question whether the time is right to protect relatively strong asset values.
With this trend expected to continue throughout 2018, Davies said it was understandable more schemes were considering equity protection. However, he said rather than buying “off the shelf” products, it is critical they focus on tailored solutions which meet schemes’ specific needs..
“With the 2019 actuarial valuation fast approaching, and following strong market performance and an improvement in schemes’ funding positons, it is understandable that equity protection is being considered more and more by LGPS’,” he said.
“However, a one-size-fits-all solution is not practical when it comes to providing that protection.”
As interest grows among LGPS, so too have the amount of providers entering this space. However, Davies said it is not just a question of “having equity protection”. Whilst a passive strategy, once in place, may vary in terms of scheme design, seeing equity protection as a passive execution only strategy runs the risk of there being a lack of tailoring to meet objectives for scheme members.
Davies added that equity protection requires a specialist skillset and requires providers to use those skills to work with consultants, officers and committees to ensure the approach is appropriate.
Below he highlights four key reasons why a bespoke approach is therefore so important when it comes to protecting schemes’ gains.
The initial design of the equity protection mandate is of vital importance as it will set the tone for the performance to follow. Only by engaging with schemes and getting under the skin of their goals and objectives – and building bespoke mandates to meet them – can schemes really achieve what they set out to do.
Many of the strategies on offer are not what could be called unique, with lots of broad similarities. Part of the key determiner of the performance delivered comes down to what derivatives can be bought in the market at implementation.
Education is critical
Derivatives, structured equity, and the concept of sacrificing returns at the outset in order to provide a degree of protection can seem like it is complex. However, with a skilled provider at the helm, these solutions can be instigated for schemes as easily as a passive solution. – The key is to ensure that education is delivered simply and effectively to officers and members.
Few in the market have the experience of building and running such mandates for schemes across a full market cycle. Protecting from market falls is just a small part of what we call Structured Equity can do. Over 15 years of clients using Structured Equity it has also been used for return generation and diversification, as well as meeting cashflows. It is one thing to build and launch a series of products with inflexible mandates at one stage of the market, but it is quite another to consider whether such an approach will still deliver the right results for a scheme when the market environment changes, especially if they have not operated in a different environment. Longevity counts, and therefore trustees and their consultants need to consider carefully how much experience the manager they pick actually has.