Secrets of a top pension fund

Dinner Dialogue with Antony Barker, Santander UK

At a recent dinner engagement in Sandton, Sanlam Investments hosted leading international keynote speaker, Antony Barker, Managing Director and Chief Pensions Officer at Santander UK. Santander UK is a leading financial services provider with a multi-award winning UK pension scheme, one of the largest pension funds in the UK. Antony has been instrumental in Santander winning a number of awards, including Best European Corporate Pension Fund Investor 2015 (Investment & Pensions Europe), Best Investment Strategy 2013 and 2014 (Professional Pensions), Best Investment Strategy 2014 (Engaged Investor), Most Innovative Large Pension Fund 2014 (Asset International), and Institutional Investor’s Best Real Assets Manager of 2015.

How did he do it? What are the valuable lessons he can share with us? Antony explained how he differentiated Santander’s pension fund investment strategy so distinctly from its peers:

We embrace fear and uncertainty. We see it as an opportunity.

There was a time when we had large deficits on our book and would need net returns of 7 – 8% pa consistently over the next ten years just to remain self-sufficient. Near-zero interest rates, negative real rates on long bonds and geopolitical uncertainty were making it tough to navigate a way forward. At every corner, there were new issues causing fear and uncertainty.

We saw the positive in it and asked ourselves what we had to do to change what we did and how we did it.

We had to run our pension fund as though it were a business.

The crucial change was that we had to redefine for ourselves what a pension fund was. We realised we had to run our pension fund as though it were a business. We had to drive down costs, generate much better returns, improve governance and generate profits. We had to put in place the same kind of principles as any banking institution would, with strong governance leading to a much better and faster way of making decisions.

Says Barker, the proverbial opportunity of a lifetime only lasts for the lifetime of that opportunity. So unless you seize it then, it’s gone. Act fast. Speed of execution has been our clear differentiator in the last year.

Good governance is critical.

We put in place an expedient governance process on both the company and the trustee side and some very experienced and expert individuals participating on those trustee boards to enable improved, more informed decision making.

Says Barker, “For smaller funds, the ‘outsourced CIO’ model is definitely the way forward. Recognise that pension risk is the single biggest risk the company faces. It’s not about intellect. It’s about experience. Mostly you get it by acquiring it the hard way, through trial and error. Good experience comes from making those important judgement calls, and sometimes getting it wrong – that’s the learning. The move to outsourced CIO or delegating the investment management process is a definite trend to counter this risk of getting it wrong, and the way forward to guide the roles of trustees. You must have the right skills in place, effective and useful governance and monitoring, as well as investment professionals you can partner with and trust.

We had to build a new business model.

Beyond the traditional risk/return asset management model of today, we had to put in place a proper transactional focus. We had to build in cash flow, accounting and the capital implications of different investment strategies into our model.

What we’ve since created with our new model is greater security for fund members, a much more robust decision-making framework and excellent returns of 8 – 12% per annum.

Be open to new ideas and doing things differently.

We needed to encourage our fund trustees to think innovatively and be open to doing things differently. We had to have a source of ideas and a clear, planned strategy. Trustees were prepared to give the company airtime simply because we had ideas, a clear strategy in place and there was a clear need for change.

We only saw risk in two ways: there was unrewarded risk and rewarded risk. What our new business model allowed us to show trustees and investment committee members, was that it was possible to put in place an investment strategy so that by hedging the unrewarded risks, you could take the risk budget and apply it to the rewarded risks instead, like private markets and real assets. This way you could generate a utopian state where you generate higher returns while lowering risk.

By doing this we took away the unrewarded risks such as duration risk and volatility. Our thesis was simple: we would have a target, but be benchmark light. Strategy is the greatest long-term driver of returns, but how you implement that strategy is ever more crucial in an increasingly low-return environment.

When it came to pension fund investment management, we realised we had to change.

A ‘risk-on” investment strategy
We’d inherited a relatively conservative investment portfolio of passive equity, index-linked gilts, and other conventional bonds. We needed to fundamentally change the way trustees thought about investments and risk. We overhauled our investment strategy dramatically and decided a diverse, risk-on investment strategy was the only way forward. We realised we could do things differently, that pension funds could become the long-term capital investors that they were designed to be.

How did Santander reinvent its investment strategy? We changed what we were going to do and how we were going to do it:

1. We pooled our assets into a common investment fund for scale and muscle. We also accelerated the level of collaboration between sponsors, scheme actuaries and trustees. As a result, we saw greater operational and cost efficiencies and an improved risk framework. There was greater consistency in our investment strategy, and much better governance committees.
2. We increased our exposure to illiquid assets as we had a long-term outlook (7-10 year window), and we realised we could manage our immediate liquidity requirements well in a 10-year window. We looked for opportunities where there was genuine embedded value, recognised that we needed patience to realise the long-term investment returns and the stamina to stick it out. We needed high conviction and genuine active management to release the value.
3. We focused on the ‘next big idea’. We like simple stories. Technology, global interconnectivity, urbanisation, digitisation…that’s what interests us. We looked at the demographics and rapid urbanisation of emerging markets and the opportunities to be found there. For instance, we like Africa; it’s a simple story. Africa represents an astounding 12% of the global population who are becoming digitally enabled, while Nigeria is the seventh biggest holder of telecoms. We also invested in infrastructure developments to own the transactional platforms that bring people together (consumers and suppliers) and leverage off the end to end value chain.
4. We collaborated opportunistically. We partnered a lot with third-party asset managers, even taking an equity stake in the asset manager in some instances to ensure that interests were completely aligned; the idea was to share revenue rather than take fee discounts. Big pension funds must talk to each other; we can harness each other’s strengths, relationships and networks. We developed overarching relationships and partnerships with private equity firms, which facilitated a fertilisation and cross-pollination of ideas. It’s very simple “Take people away from their restrictive compliance model and they focus on why they joined the investment industry in the first place”.

With regard to its pension fund investment strategy, Santander UK has employed a highly differentiated and successful approach to exceeding expected returns for its retirement fund members. In summary, there are rewarded risks and unrewarded risks. Barker redefined the strategy to the board by enabling the hedging of the unrewarded risk and thereby allowing them to be more aggressive in the rewarded risk category. This allowed Santander’s Pension Fund to get up to a 35% allocation to alternatives, thanks to its good governance and speedy execution processes.

In addition, they embraced uncertainty – saw the opportunity in it. They ran their pension fund as though it were a business, and had a clear plan and sound strategy in place. And most importantly, they collaborated widely, innovated often and were open to new ideas.

“If you do what you’ve always done, you’ll always get the same results and, to date, for most fiduciaries and sponsors, that hasn’t been enough”, says Barker.

It’s that simple.