The long-term impact of Covid-19 on covenant is more concerning than that on current funding levels, and preparation was key in weathering the March crisis – but not just on a portfolio level. Here is what panellists have been discussing at a recent mallowstreet event. 

 

For schemes that are more derisked, the pandemic has not made as significant a dent into funding levels as feared at the start of the market downturn. But while some have not had to worry much about funding, other concerns have intensified. 

 

At a Fixed Income Indaba event organised by mallowstreet on Tuesday, one pension trustee said that on his schemes, the response to the crisis had been very calm. “This has not been a crisis from the point of view of the pension schemes that I work with,” he observed; in fact, funding levels have even improved somewhat over the period. he said. 

 

However, he added: “The thing that worries me most in the longer term is what it’s done to the quality of the covenant.” 

 

Some sectors have already been negatively affected by Covid-19; others are expected to be feeling the pain over coming months or even years. There are also employers whose business was never sustainable in the longer term regardless of coronavirus. 

 

This increased concern about sponsor covenant has reinforced the desire to transfer the liabilities to an insurer, he said, while for schemes that have been running more investment risk, the focus “has shifted heavily to worrying about cash flow risk". But ultimately, “crises come and go, but the world keeps going on", therefore it’s important not to overreact, he said. 

 

 

From a CIO perspective, how well investments did depended partly on preparation – not just around the portfolio and managers, but also in terms of stakeholder management. One scheme CIO said the in-house investment process is deeply predicated in looking for when assets are relatively cheap or expensive, and so the team wanted to invest when markets went into crisis mode – but it needed the consent of trustees who may have been spooked by the selloff. 

 

“One of the intellectual arguments you have to bring out is that risk models are useful for setting a loose framework, but you have to recognise their limitations. When assets are cheaper, traditional risk models and assumptions don’t hold true,” he said. “That's the thing we had to explain to our committee to make sure we had decisions taken in the midst of a crisis, which from an emotional point of view is very difficult.” 

 

Thinking through what to say to a board to ensure it makes decisions at the point of hysteria of financial markets was important in weathering the situation, he said. 

 

Preparation also allowed the scheme deploy new managers to take advantage of market dislocations, as it keeps a bench of managers ready to go; out of three that were funded, contracts were already in place with two, while the third had previously been identified. 

 

 

Another CIO noted that while markets were very volatile, the scheme followed its derisking journey plan as before, all the while ensuring there is adequate liquidity. Risk models can offer a framework, he agreed, but can’t be blindly relied on. 

 

With yields currently at extreme lows and little prospect of a change, he said “a test of good portfolio management is how well you can immunise the portfolio”. He recommended to “try to hedge as much as possible”, using both physical and derivative assets. 

 

Offering three simple lessons for investors, he said: “Don’t bet against the Fed, never underestimate the enthusiasm of lemmings, [and] supporting your team can enable you to deal with really adverse circumstances.”