Investment and risk management considerations

This code of practice applies to activities related to valuations with effective dates on and after 22 September 2024. For activities related to valuations with effective dates before 22 September 2024, refer to the 2014 DB funding code (PDF, 401kb, 51 pages).

Implementing an investment strategy

1. For the purposes of the funding and investment strategy, trustees must take into account the objective that scheme assets up to the minimum funding level will be invested in accordance with a low dependency investment allocation from the relevant date. This objective does not apply to any surplus on a low dependency funding basis. More detail on this is available in the low dependency investment allocation module of this code.
2. Trustees must also formulate a journey plan, which should consist of both a funding journey plan (formally a part of the funding and investment strategy) and an investment journey plan. More detail on this is available in the journey planning module of this code.
3. While the funding and investment strategy and the investment journey plan do not limit trustees’ discretion over actual investment matters, we expect that investment decisions by trustees (and fund managers to whom decision-making has been delegated) will generally be consistent with the planned evolution of the notional investment allocation.
4. That is because the rationale behind the requirements for the funding and investment strategy and the journey plan should also underpin trustees’ actual investment decisions. These are some examples of the kinds of considerations trustees should have:
   1. When the scheme is significantly mature, there is less time to make good investment losses. Therefore, a low-risk investment strategy would generally be appropriate to mitigate against sudden and unexpected investment volatility.
   2. Trustees need to plan how they would transition to that low-risk investment strategy over time, generally requiring consideration of de-risking strategies.
   3. Investment risk should be dependent on the extent to which the employer covenant can support downside risks on the path to significant maturity.
5. The funding and investment strategy must be reviewed and, if applicable, revised whenever an actuarial valuation is undertaken under Part 3 of the Pensions Act 2004¹. This is because actual investment decisions may differ from the funding and investment strategy or the investment journey plan over the short term. For example, opportunities in the markets might arise that would enable the trustees to accelerate their plans for de-risking and take advantage of advantageous market opportunities such as increased bond yields. More detail on this is available in the risk management and governance section of this module of the code.
6. Other circumstances where investment decisions may not mirror the funding and investment strategy include the following.
   1. An employer refuses to agree to changes to the investment strategy set out in the funding and investment strategy, despite the trustees considering it appropriate. Employer agreement is required for the funding and investment strategy² but not for the investment elements in Part 2 of the statement of strategy (where consultation with the employer is required)³. However, the power to take actual investment decisions lies with the trustees⁴ (subject to the scope of their powers in the scheme’s trust deed and rules). While we would expect trustees and employers to work collaboratively to agree the funding and investment strategy, where agreement cannot be reached, this does not inhibit the trustees in exercising their investment powers.
   2. A material surplus exists on a low dependency funding basis. The existence of the surplus may significantly reduce the risk of further employer contributions being required in the event of funding level volatility. Therefore, the trustees may be able to invest all scheme assets, not just the surplus, in a manner different from a low dependency investment allocation, without affecting low dependency on the employer. This could result in an overall greater allocation to growth assets, which may allow the trustees to meet their long-term objectives.
7. Although the examples set out above show that there might be good reasons for the actual investment allocation to differ from the notional investment allocation set out in the investment journey plan or the funding and investment strategy, our general expectation is that investment decisions by trustees (and fund managers to whom decision-making has been delegated) will be consistent with the investment journey plan and the funding and investment strategy.
8. Where this is not the case, trustees should recognise that material differences between the actual investment allocation and the notional investment allocation set out in the investment journey plan or the funding and investment strategy may result in additional risk. This may affect the scheme’s ability to successfully implement the funding and investment strategy. Trustees should consider as part of their effective system of governance whether this is a key risk and, if so, they should put in place an appropriate policy to manage it (see the risk management and governance section for more detail).
9. While the additional risk arising from differences between the actual and notional investment allocations may not feature in the assessment of supportable risk (as detailed in the journey planning module), we would generally expect that where this is material, trustees should ensure that it remains supportable by the covenant. However, this expectation is relaxed in the event of short-term employer stress (more detail is available in the short-term employer stress section below) or inability to comply with the principles for assessing supportable risk detailed in the journey planning module of this code. This is outlined further in the section of this module below on inability to support risk.

Short-term employer stress

10. In some situations, an employer might experience a sudden deterioration in covenant. An example of this for some employers was the COVID-19 pandemic. Trustees should consider whether the stress is likely to be short-term or permanent. If they think the deterioration is permanent, current investment allocations (both actual and notional) and the journey plan should be revised appropriately.
11. However, if they think the deterioration is likely to be short-term, trustees could decide to preserve their existing investment allocations (both actual and notional) and the journey plan. Trustees may choose to make this preservation contingent on the employer providing additional support to the scheme. Examples of this kind of support include:
    1. providing contingent assets and formalising wider group support
    2. ensuring the scheme is treated fairly
    3. putting in place protections against covenant leakage (for example, negative pledges)
    4. improving the insolvency priority of the scheme
12. Trustees should regularly monitor the employer covenant and if they form the view that the deterioration in covenant is not likely to be short-term, they should revise current investment allocations (both actual and notional) and the journey plan accordingly.
13. Where insolvency is considered highly likely in the short term, trustees should review their actual investment allocation and consider changes, where reasonable, to ensure that their existing funding position is protected.

Inability to support risk

14. We recognise that there are likely to be a limited number of schemes whose circumstances prevent them from complying with the principles for assessing supportable risk over the reliability period set out in the journey planning module. For these schemes, the level of risk which could be supported by the employer covenant is such that, if it were reflected in the scheme’s actual investment allocation, it would severely limit the chances of paying full benefits to members. This is because the covenant or the investment strategy would not be able to produce the necessary funds or returns to enable the scheme to reach full funding on a low dependency basis.
15. In these circumstances, we expect that the trustees will reflect only the supportable risk (limited as it may be) in the scheme’s notional investment allocation along the journey plan, consistent with the supportability principle described in paragraph 5 of the journey planning module of this code. Consequently, when setting the technical provisions (TPs), we expect the trustees to place low reliance on the employer and only reflect the scheme’s maturity. This means the difference between low dependency and TPs will be limited.
16. Nonetheless, trustees may find it appropriate to hold unsupported investment risk in the scheme’s actual investment allocation, since it has a potential reward for the members. In these circumstances, we would always expect the trustees to seek to maximise the covenant support to the scheme by seeking to:
    1. stop the flow of value away from the employer (for example, through restrictions on dividends and other forms of covenant leakage)
    2. prevent detriment to the scheme’s claim on the covenant caused by any employer debt financing and other corporate events
    3. improve the scheme’s security
    4. provide contingent assets and formalise wider group support
17. Other actions we expect the trustees to consider, in collaboration with the employer, include the following.
    1. Stopping accrual of future service benefits, subject to any restriction in the scheme rules. In these circumstances, we think it is unlikely to be appropriate to allow new, additional, liabilities to be built up when the level of security provided to the existing accrued liabilities is inadequate.
    2. Winding up the scheme. In certain circumstances, the trustees or the employer may consider this is the best option for protecting members’ benefits. This would involve taking appropriate advice and would require careful consideration of the extent to which the employer might be expected to continue in the longer term, which could allow the scheme more time to recover and members’ benefits to be provided in full.
18. If trustees take unsupported investment risk in this scenario, they should seek to strike an appropriate balance between taking enough risk to stand a reasonable chance of reaching full funding on a low dependency funding basis while ensuring that member security is not unnecessarily compromised. In general, our expectation is that trustees should take unsupported risk only when necessary to get from the current funding position to full funding on a low dependency funding basis at the relevant date.
19. In circumstances where the risk implied by this approach is unreasonable (for example, the scheme is poorly funded and only a few years away from significant maturity), we accept that trustees may conclude that it is in the best interests of members for them to continue to take unsupported risk in their actual investment allocation, potentially beyond the relevant date. If taking unsupported risk for any material length of time, we expect trustees to put in place a suitable de-risking framework to reduce the unsupported investment risk when opportunities arise.
20. Trustees should document their considerations and be able to justify their decisions as being in the best interest of members. When performing their duties under Part 3 of the Pensions Act 2004⁵, trustees should not take advantage of the existence of the Pension Protection Fund (PPF) as a justification for acting in a way which would otherwise be inconsistent with those duties.

Risk management and governance

21. Good governance, including risk management, is a central tenet of managing a scheme.
22. Trustees must consider the main risks to implementing the funding and investment strategy successfully and how they plan to mitigate these risks. This includes material differences between actual investments and the investment journey plan or the low dependency investment allocation from which the low dependency funding basis in the funding and investment strategy is derived. As the scheme progresses towards the relevant date, trustees should identify and monitor any such differences and consider the risks these may pose to their ability to successfully implement the funding and investment strategy, and consider whether corrective action is appropriate.
23. Trustees will be required to outline the key risks to the scheme and how these are being managed in the statement of strategy. The amount of detail we require will depend on the scheme’s circumstances and the level and complexity of the risk being taken. More detail can be found in the statement of strategy module of this code.
24. The general code of practice sets out the expectation for defined benefit (DB) trustees to have written policies on their risk management, the necessary governance to embed them into their decision-making, to carry out regular reviews to assess their effectiveness, and to take remedial action as necessary. More specifically, all schemes are required to have an effective system of governance⁶ and, for schemes with 100 or more members, to carry out an own risk assessment. More detail can be found in the general code of practice.
25. The trustees’ strategy for delivering member benefits in the long term is a key aspect of scheme governance and is covered by the requirements of the general code. The expectations set out in this code will help trustees focus on the risks from a funding perspective and assist them in complying with the governance and documentation requirements of the general code. More detail on this is available in the general code modules on systems of governance and own risk assessment.

Integrated risk management (IRM)

26. Trustees should adopt a proportionate integrated approach to risk management when developing an appropriate scheme funding solution. The resources committed to this should be commensurate with the benefits the approach is expected to deliver for the scheme and employer.
27. Schemes face many risks to achieving their funding plans. Although interconnected, the risks broadly fall into three categories.
    1. Employer covenant related. This includes the risk that the employer covenant supporting the scheme deteriorates over time (or, in extreme scenarios, disappears due to the employer’s insolvency), resulting in the employer being unable to provide sufficient support to the scheme when it is needed.
    2. Investment related. This includes the risk that the investments do not provide the returns expected.
    3. Funding related. This includes the risk that the scheme experience is materially different to that assumed, for example, in relation to inflation or mortality.
28. Trustees should understand the risks across each of these categories and, as required by the general code, assess which are key risks and define acceptable parameters within which they seek to manage them. In doing so, they should recognise the inter-connectedness of risks across the three categories. For example, scenario analysis of alternative economic conditions should consider not just the impact on the key risks to the scheme’s assets and liabilities, but also on the support available from the employer covenant. They should also consider events that could lead to significant losses, even though their likelihood may be small (these are known as tail risks).
29. Trustees should then put in place appropriate policies to mitigate and manage all the key risks. These can include contingency plans, which should set out specific actions for employers, trustees, or both to take. Contingency plans may also include requirements to:
    1. provide additional funding to the scheme
    2. improve the support provided by the employer covenant (for example, improving access to employer assets or through legally binding support)
    3. realign investment risk for consistency with the support available from the employer
    4. realign other elements of the funding and investment strategy
30. Trustees should regularly monitor the key risks they have identified and ensure that their funding and investment strategy remains appropriate.
31. We expect trustees to develop suitable risk metrics to monitor, agree the frequency with which they will monitor them, and decide on appropriate thresholds and triggers for action. Trustees may find it helpful to develop a dashboard showing the performance of the key metrics against their risk thresholds. They may want to discuss these regularly at trustee meetings or with individuals and committees to whom appropriate decision-making has been delegated.
32. Trustees should also carry out an own risk assessment, which is a requirement for most schemes but encouraged for all, to test the effectiveness of their risk management policies and document the learnings.
33. This process should enable effective decision-making and will help the chair of trustees obtain the necessary assurances about how the key risks are being managed, as well as the quality of the governance they have in place to accomplish this. This should include statements about what the key risks are and how they have been factored into the scheme’s monitoring systems, including:
    1. what trustees do with the monitoring reports
    2. who is responsible for them
    3. how trustees determine their responses to the risks

Security, quality, liquidity and profitability

34. The Investment Regulations⁷ require trustees to exercise their powers of investment to ensure the security, quality, liquidity and profitability of the portfolio as a whole.
35. An appropriate investment strategy should balance the investment risk (security and quality) and return (profitability), considering the scheme circumstances and objectives and how these evolve over time.
36. The key considerations in how trustees should approach this balance are discussed in the sections of this code on implementing an investment strategy, short-term employer stress and inability to support risk. These sections highlight our expectation that trustees’ investment decisions will generally follow their funding and investment strategy and the expectations set out in this code for a scheme’s journey plan and low dependency investment allocation.
37. It is also important to consider liquidity as a separate (although related) consideration. Below are the key aspects we expect trustees to consider in relation to liquidity. Trustees should take into account the expectations set out in the remaining sub- sections of this module when considering how the scheme assets comply with the principle of being invested with sufficient liquidity to enable the scheme to meet expected cash flow requirements and make reasonable allowance for unexpected cash flow requirements.

Benefit payments and collateral requirements

38. It is important that trustees ensure there are appropriate levels of liquidity to meet their expected benefit and expense payments, including pensions in payment and cash commutation lump sums on retirement. They should also keep an appropriate amount of liquidity for more unpredictable cash flows, for example, the payment of cash equivalent transfers values (CETVs), lump sum payments on death, or collateral calls for derivative instruments.
39. These issues will be more prevalent for more mature schemes as benefit payments increase where members approach retirement age and start to take their pensions or consider their options.
40. Trustees should undertake forecast cash flow needs over at least three to six months, including an allowance for new retirees and transfer value requests. The cash flow forecast should make allowance for contributions to the scheme and investment income paid to the scheme (as opposed to being reinvested). As cash flow experience may differ from forecasts, adequate governance arrangements should be in place to ensure that trustees (and fund managers to whom decision-making has been delegated) are informed of liquidity needs as soon as they are known.
41. In smaller schemes, the trustees should be aware of the idiosyncratic risks where a few members might account for a significant proportion of the liabilities and assets. For these schemes, understanding the retirement plans for these few members will be key in cash flow planning.
42. Liquidity issues can vary depending on scheme maturity. As schemes mature, the predictability of outgoing cash flows may increase (as the number of deferred members decrease), while the size of such cash flows increases in relation to the size of the scheme. The trustees will need to balance these factors carefully when assessing suitable levels of liquidity for their scheme. Conversely, more immature schemes may have less need for liquidity as the majority of their benefit cash flows are further into the future. However, trustees should be aware that cash flows may be accelerated where members may exercise the option to transfer out or, depending on the scheme rules, retire early.
43. More immature schemes may, on balance, have greater scope to invest in illiquid assets. However, more mature schemes can also invest in illiquid assets as they can, for example, be a useful investment to cash flow match the expected benefit payments. Trustees will have to manage these issues closely to minimise the risk of needing to sell illiquid assets to raise cash if events cause an unexpectedly high number of transfers out or early retirements.
44. Immature schemes might have greater exposure to leveraged liability-driven investment (LDI) funds as they seek to manage their interest rate and inflation risks in relation to the longer duration of their liabilities. The use of leveraged LDI will bring additional liquidity risks and requirements due to the nature of collateral demands over short periods when interest rates change.
45. Trustees should ensure there is sufficient liquidity to meet margin payments and cash calls following re-collateralisation events in relation to their allocation to leveraged LDI funds, or other leveraged investments. Concurrently, trustees should ensure that adequate governance arrangements exist to deliver this liquidity within the timelines required by their fund managers.
46. In ensuring sufficient liquidity, trustees should consider the impact of changes in key variables such as real and nominal interest rates, currency and credit spreads. They should ensure that their leveraged investments are suitably resilient to sharp changes in these variables. We may issue guidance on relevant benchmarks as appropriate.

Interaction with schemes’ long-term objectives

47. A scheme’s long-term objective will also impact on the appropriate asset mix and balance of liquid and illiquid investments.
48. For example, a scheme with a long-term objective to buy out will likely need to start to better match their asset portfolio with that of an insurer as they approach their planned date or timeframe for transacting with an insurer. This can put them in a better position both in terms of being a more attractive prospect for the insurance company (since the assets they own will be desirable to the insurer) and to better hedge the buy-out price to limit significant differences due to market movements leading up to the transaction.
49. Schemes with high allocations to illiquid assets, which are not desirable for insurance companies, may find that they need to unwind their position earlier than planned if they had not factored in these issues within their planning.
50. These issues are also prevalent when considering a transfer to a DB consolidation vehicle, including a master trust or superfund, although these vehicles may have differing requirements or preferences to those of an insurer when it comes to the investment strategy and asset portfolio of a scheme transferring.
51. For schemes planning to run on, their focus should align with the cash flow requirements of the benefits payable under the scheme.

Liquidity governance

52. Trustees should keep aside a bank float to meet benefit payments. A bank float has an opportunity cost and is exposed to credit risk (especially where bank floats exceed any applicable deposit insurance scheme). However, too little cash also creates operational risks of not being able to meet payments as they fall due. Therefore, trustees should consider how much float is kept in the bank account, for example, three months of pension payments plus any allowance for other expected payments such as cash commutation lump sums or CETVs.
53. Where liquidity needs change at short notice, for example, due to changing interest rates leading to collateral demands, trustees should also consider the protocols to meet cash demands.
54. These protocols can be documented in the statement of investment principles (SIP). The protocols can cover the order in which assets need to be sold to meet cash needs, whether the trustees have pre-agreed or not to meet cash demands, how long it would take to sell the investments for cash and if the cash call process is different to the cash distribution process.
55. As part of this process, it will be necessary for trustees to assess the liquidity of their investments.
56. If trustees use third parties such as fiduciary managers, outsourced chief investment officers or investment platforms, they should regularly review the operational processes for meeting the required cash demands. These operational processes can include ensuring the SIP is up to date, the level of delegation is appropriate, signatory lists are up to date, and signatory processes are understood. Trustees should ensure that compliance with service standards relating to these processes is addressed in the service contracts, with appropriate measures for breaches.

Assessing liquidity

57. Ongoing monitoring is an important part of trustees’ assessment of the liquidity of scheme assets. This can be done in several ways and will depend on the importance of liquidity for the pension scheme, including their long-term objective and level of investment in leveraged LDI or other exposures involving collateral. In their assessment, the trustees should be careful to consider the possible mismatch between the liquidity of an asset class, and the liquidity of the investment vehicle (for example, a pooled fund) with which they access said asset class. The trustees may find it beneficial to receive advice (including legal advice) on liquidity risks pertaining specifically to their chosen investment vehicles.
58. Trustees should quantify the supply of liquidity under normal and adverse market conditions, noting that stressed market conditions change both the speed and cost of liquidating assets, including assets that would normally be considered very liquid. For example, trustees can carry out scenario testing of their portfolio’s liquidity under a variety of stresses, including considerations of how the behaviour of other DB pension schemes may affect the liquidity of their assets. Under adverse market conditions, some investments are likely to become less liquid and asset valuations may deteriorate. By quantifying liquidity in normal and adverse market conditions, trustees can assess the resilience of the investments to meet cash flow demands from, for example, benefit payments, margin payments, and re-collateralisation events in LDI funds.
59. An example of this is in relation to property funds. In normal market conditions, property funds may deal monthly. However, under adverse market conditions, property fund managers can stop withdrawal of investments if the demand for disinvestment is significantly higher than expected. In such situations, it will take longer to obtain cash for the investments as the investment manager will need to use discretion and liquidation processes to meet investor demands.

Legal references

¹ Part IV of The Pensions (Northern Ireland) Order 2005

² Section 229(1)(za) of the Pensions Act 2004 [Article 208(1)(za) of The Pensions (Northern Ireland) Order 2005]

³ Section 221B(5) of the Pensions Act 2004 [Article 200B(5) of The Pensions (Northern Ireland) Order 2005

⁴ Section 34(1) of the Pensions Act 1995 [Article 34(1) of The Pensions (Northern Ireland) Order 1995]

⁵ Part IV of The Pensions (Northern Ireland) Order 2005

⁶ Section 249A of the Pensions Act 2004 [Article 226A of The Pensions (Northern Ireland) Order 2005]

⁷ Regulation 4(3) of The Occupational Pension Schemes (Investment) Regulations 2005 (SI 2005/3378) [Regulation 4(3) of The Occupational Pension Schemes (Investment) Regulations (Northern Ireland) 2005 (SR 2005/569)]. This requirement does not apply to schemes with fewer than 100 members.