Investment guidance for trustees and advisers running schemes that offer defined benefits.
Issued: March 2017
Last updated: September 2019
19 September 2019
Updates to reflect changes arising from The Occupational Pension Schemes (Investment and Disclosure) (Amendment) Regulations 2018.
The update involved significant rewriting of various sections throughout the Investment Governance and Investing to Fund DB Schemes portions of the guidance; you may, therefore, find it useful to re-acquaint yourself with the guidance as a whole.
Updated information on investment decisions and your statement of investment principles, stewardship, reporting, sustainability and financial and non-financial factors may be of particular relevance.
1 August 2019
We have made some small updates to this guide to reflect the fact that an industry led body: The Cost Transparency Initiative, has produced standardised templates which we encourage trustees to use to obtain information about costs and charges from their provider.
Other minor changes have been made including minor editorial changes.
30 March 2017
Using this guidance
This guidance is for trustees of occupational pension schemes providing defined benefits (DB), and will therefore also be of interest to advisers and sponsoring employers. It is set out in six sections:
- Investing to fund defined benefits
- Matching assets
- Growth assets
You can also read a summary of the DB investment guidance.
Our code of practice 3: Funding defined benefits (the DB funding code) sets out the standards we expect you to meet when complying with the law and this guidance provides information on how you might meet these standards in practice. You should read the code before you read this guide.
This guidance aims to provide you with practical information, examples of approaches you could take and factors to consider when investing scheme assets to fund defined benefits. Often the methods and approaches you choose to adopt will depend on the nature of your scheme.
We have used the phrases ‘you should’ and ‘you need to’ to indicate good practice approaches. This contracts with legislative requirements (which are identified as such), and language such as ‘we would encourage you to’ and ‘you may wish to’, which indicate matters you may find it helpful to consider.
Some of the text in this guidance is highlighted to emphasise key principles and questions for consideration. Examples are used to illustrate concepts and provide practical guidance.
If your scheme has multiple benefit types, eg DB with a defined contribution (DC) additional voluntary contribution section, then you’ll also need to read our guidance on DC investment management.
Trustees of some schemes, such as those with fewer than 100 members, wholly-insured schemes or small self-administered schemes are subject to different requirements in some respects. If you think that this could apply to your scheme, you should obtain legal advice on the applicable requirements.
What other publications could be useful?
- Code of practice 9: Internal controls
- Integrated risk management (IRM) guidance
- Assessing and monitoring the employer covenant guidance
- Conflicts of interest guidance
- Record-keeping guidance
- The trustee board guide (this guide has been prepared for schemes with money purchase benefits, however other trustees may find it useful)
- Scheme management skills guide (this guide has been prepared for schemes with money purchase benefits, however other trustees may find it useful)
- The Law Commission guidance on pension trustees’ duties when setting an investment strategy (PDF, 123kb, 6 pages)
- Myners Principles for institutional investment decision-making (PDF, 504kb, 30 pages)
Links to the Trustee toolkit
Throughout the guidance, we’ve referred to the relevant modules and tutorials of the Trustee toolkit - our free, online learning programme.
You should sign up for a Trustee toolkit account if you do not already have one.
Alternatively, if you have a Trustee toolkit account you can log in. You will then have access to all the materials, including downloadable resources, interactive sections, case studies and quizzes. You can also save your progress and download and share a record of your achievements.
Understanding your legal duties
Purpose of investment
The fundamental purpose of trustees’ investment powers is to generate returns in order to enable the scheme to pay promised benefits as they fall due.
When exercising investment powers, the law requires you to act in the best financial interests of scheme members and beneficiaries.
As a trustee, you benefit from a statutory power to make any kind of investment. However, this broad power is subject to a number of restrictions.
A scheme’s governing documentation might limit the scope of the trustees’ discretion. For example, a scheme’s trust deed and rules might prohibit investment in certain asset classes. You need to check your scheme’s governing documentation for restrictions. Note that restrictions cannot be placed on trustees by requiring them to obtain the consent of the employer in relation to investment.
Employer-related investment (ERI) is restricted or prohibited, depending on the form of investment. ERI is not covered in this guidance, so you need to ensure you understand the scope of these restrictions and how they might apply to your scheme.
You should not take account of the potential for the Pension Protection Fund (PPF) to provide compensation to members when exercising your investment powers.
Delegation to fund managers
The trustee board has ultimate responsibility for the scheme’s investments. However, in practice, the role played by trustees will generally be constrained by the Financial Services and Markets Act 2000 (FSMA). You need to familiarise yourself with FSMA so you understand what activities the trustee board (or a sub-committee of trustees) can take. This guidance should be read with the restrictions of FSMA in mind.
In summary, FSMA requires that ‘regulated activities’ are only carried out by persons who are authorised or exempt. Most day-to-day investment activities carried out on behalf of an occupational pension scheme are regulated activities. In practice, this means these decisions will generally need to be delegated to an investment manager who is appropriately authorised under FSMA.
Where activities have been delegated, it is important that you monitor the fund manager’s performance. This is because as a trustee you may be responsible for the actions of the fund manager unless you:
- satisfy yourself that they have the appropriate knowledge and experience for managing the scheme's investments, and
- monitor them to check they are carrying out their work competently and complying with applicable statutory requirements
It’s also important that the terms of contractual arrangements and fund documents in place with investment managers and advisers are reviewed (including legal review) and negotiated to ensure this is achieved.
Trustees who are not appropriately authorised or exempt are generally restricted to making strategic decisions. These include decisions about:
- the statement of investment principles (SIP)
- formulating asset allocation policy
- the balance between generating income (eg from interest) and capital growth
- the use of risk mitigations such as liability hedging
- appointing investment managers
- the purchase of units in collective investment vehicles
In this guidance, we’ve indicated some additional circumstances where you may consider it appropriate to seek professional advice to support your decision-making in relation to investment issues. If you are unsure about your duties and the legal requirements in relation to investments, you need to undertake relevant trustee training and/or obtain appropriate legal advice.
Further information on ensuring your trustee board has the right governance, skills and knowledge to work together and with scheme advisers can be found in our conflicts of interest guidance and scheme management skills guide (this guide has been prepared for schemes with money purchase benefits, however other trustees may also find it helpful).
Your duty to obtain advice
There are two circumstances in which you are required by law to obtain and consider investment advice:
- Before preparing or revising your SIP.
- Before investing in any manner. In most cases, you will not be taking this kind of day-to-day decision due to the requirements of FSMA. However, FSMA does allow unauthorised trustees to take a limited number of day-to-day investment decisions, for example purchasing units in a collective investment scheme. Before doing so, the law requires you to obtain investment advice, and renew that advice periodically.
You need to be satisfied that your advisers are suitably skilled and professionally qualified (and, where relevant, appropriately authorised under FSMA) to provide the advice they’re giving.
Footnotes for this section
-  Regulation 4(2) Occupational Pension Schemes (Investment) Regulations 2005 (the ‘Investment Regulations’).
-  Section 34 Pensions Act 1995.
-  Section 35(5) Pensions Act 1995.
-  Section 40 Pensions Act 1995.
-  The Financial Conduct Authority’s perimeter guidance provides guidance on activities in relation to pension schemes at Chapter 10 and the FCA’s Handbook is the principal guide to roles and responsibilities under FSMA and FCA regulation.
-  Section 34(6) Pensions Act 1995.
-  Article 4 of the Financial Services and Markets Act 2000 (Carrying on Regulated Activities by Way of Business) Order 2001.
-  Section 36(3) and (4) Pensions Act 1995. This advice is sometimes called 'Section 36' advice.
Conflicts of interest that arise where one party (the agent) is expected to act in another’s (the principal’s) best interests and where the interests of principal and agent are not fully aligned.
Asset liability modelling
Modelling that involves projections of a pension scheme’s assets and liabilities into the future; typically the projections allow for random variation in outcomes (known as stochastic modelling) and are used to show the potential rewards and risks of different investment strategies.
The risk that an asset used for hedging a liability responds differently to changes in market conditions from the liability that it is hedging. For example, when an asset based on interest rate swaps is used to hedge a gilt based liability valuation.
'Buy and maintain' strategy
Bonds purchased with a view to holding them to maturity unless the probability of default for a particular bond held rises to unacceptable levels. If this occurs, the bond would be sold and a replacement purchased.
The additional contributions that would be required in order to achieve the scheme funding objective without changing the time horizon if a significant downside event occurred; often considered together with the corresponding VaR.
Assets available to compensate an investor in the event of the other party to an obligation defaulting on their obligation.
Posting collateral or receiving collateral in respect of an arrangement where collateral is required to manage credit risks; typically found, for example, in connection with LDI arrangements. See section 2: cash flow and liquidity risks.
Plans setting out actions that will be undertaken in certain circumstances to limit the impact of risks that materialise or to introduce additional risk capacity. See section 2: contingency plans.
The extent to which values of different types of investments tend to move in tandem with one another in response to changing economic and market conditions.
The extent of the employer’s legal obligation and financial ability to support the scheme now and in the future.
An arrangement or product (such as a future, option, or warrant) with a value derived from and dependent on the value of an underlying asset, such as a commodity, currency, or security.
Average discounted term of the liability payments.
Efficient portfolio management
Ways of investing which relate to transferable securities and approved money-market instruments and which fulfil the following criteria:
- they are cost effective
- they are entered into because of:
- reduction of risk
- reduction of cost
- generation of additional capital or income for the scheme with a risk level consistent with the risk profile of the scheme and the risk diversification rules
Governance model where a potentially significant amount of decision-making is delegated to a third party. See section 1: fiduciary management.
A driver of return in insurance-linked securities and similar investments where the investor is effectively writing insurance and receiving premiums for this, but is exposed to the risk the insured event may occur.
An agreed, transparent and consistent way of thinking about financial markets in the specific context of a given investor, based on research and experience. See section 2: investment beliefs.
The structures and processes which enable trustees to have sufficient and flexible oversight of the scheme’s investments. See section 1: investment governance structures.
Investment management agreement
Formal arrangement stipulating the terms under which the manager is authorised to act on behalf of the investor to manage the assets listed in the agreement. The agreement establishes the extent to which the adviser may act in a discretionary capacity to make investment decisions based on a prescribed strategy.
Liability driven investment; a strategy designed to manage scheme liability risks. See section 3: LDI.
The degree to which an asset or security can be quickly bought or sold in the market with minimum price disturbance. See section 2: cash flow and liquidity risks.
Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. See section 5: operational risk.
Collective investment schemes where funds from multiple asset owners are aggregated for the purposes of investment.
Risk that future coupons from a bond will not be reinvested at the prevailing interest rate from when the bond was initially purchased.
Risk in a hedging strategy using short term derivative contracts that it may not be possible to renew the contracts, either at all or at an acceptable price.
The trustees’ or employer’s (as appropriate) readiness to accept a given level of risk. See section 2: risk appetite.
the scheme’s ability to absorb or support risks. This will be largely contingent on the ability of the scheme’s covenant to absorb or support risks. See section 2: risk capacity.
The return in excess of the risk-free rate of return an investment is expected to yield.
Analysing possible events that can take place in the future by estimating the expected value of a portfolio (such as a scheme’s assets and liabilities) after a given period of time, assuming specific changes in the values of variables that may have an impact on the value of the portfolio.
The trustees’ objective to pay benefits promised as and when they fall due.
Segregated mandate / portfolio
A fund run exclusively for the pension scheme where the portfolio is tailored specifically for the needs of the scheme.
Investment strategy where the investor sells shares of borrowed stock in the open market, hoping to buy them back for a profit after their price has fallen.
The exercise of ownership rights, including engagement and voting, to protect and enhance the long-term value of investments. See section 1: stewardship.
Identifying variables that affect the finances of the scheme or employer, changing the values of those variables, and seeing what effect this has. This helps identify which variables are most important, through their impact on covenant, funding and investment.
Sustainability / sustainable investment
Meeting present and future needs through the management of long-term risks and opportunities, which involves considering ESG issues and wider societal impacts. See section 2: sustainability.
Tail risk hedging strategy
A risk mitigation technique intended to reduce an investor’s exposure to significant market falls, for example using suitable derivative strategies.
A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over a specific time frame and with a given probability.
This is a measure of the variation in the value of a liability, investment, market or parameter. This is commonly used as an indicator of risk.