Identifying and communicating the information you require to effectively monitor your scheme’s investments and funding level.
Issued: March 2017
Last updated: August 2019
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
What you need to do
- Focus on the key drivers of funding level change and investment performance, monitor them in a timely manner, and take appropriate action when necessary.
- Identify the key information you require to do this, and ensure that this is presented clearly so that you can make effective well-informed decisions.
- Monitor the investment strategy to help you assess whether investment returns and risk levels are within acceptable ranges and whether your objectives and any triggers remain appropriate.
- Make arrangements to monitor and review your investment managers’ performance.
Monitoring your scheme investments is a key part of integrated risk management (IRM). You should monitor scheme investments in the context of monitoring the employer covenant and funding level, and consider the results together. Our IRM guidance provides practical help on a proportionate and integrated approach to risk management.
Monitoring is most effective when it is prioritised, timely and actionable.
Prioritise monitoring those things that matter most to your scheme’s investments and funding level.
You may find it helpful to refer to section 1: DB investment governance, which suggests a generic order of priority of investment decisions based on their likely impact on future outcomes.
Your scheme’s investment strategy is likely to have a far greater overall impact than the investment managers’ performance relative to their targets.
You should bear this in mind when allocating monitoring time and resources between investment strategy and investment managers. In this guidance, we have accordingly placed greater emphasis on monitoring investment strategy.
When deciding how closely to monitor specific risks you may find it helpful to consider how likely they are to occur, and their potential impact, so you can focus on more likely risks with significant impacts.
It’s important to monitor your scheme’s investments and funding level regularly and ensure monitoring information is prepared and considered in a timely manner.
How often you monitor will depend on your scheme’s circumstances. More frequent monitoring may be appropriate if your scheme is poorly funded, is close to breaching any triggers or where there is a high-risk investment strategy. Some risks may need more frequent monitoring than others.
You need to actively consider whether to take action in response to your review. Some information might require action immediately. Other information may indicate a need for future action, for example at the next actuarial valuation or formal investment strategy review. Some information may form part of a contingency plan or trigger framework where the actions are pre-agreed.
It’s important to identify what information you require to effectively monitor your scheme’s investments and funding level. Your advisers can help you prioritise the available information. You may also wish to receive help and training on how to interpret the information received, for example from your advisers or investment managers.
Your main sources of monitoring information are likely to be your scheme actuary (for reports on the scheme’s funding) and your investment adviser and investment managers (for reports on the scheme’s investments). Their reports need to contain enough data and commentary for you to understand developments since the previous report and over the long-term, as well as the reasons for this, any views expressed regarding future developments and any significant assumptions underlying the report. If any report is not clear enough, we encourage you to discuss this with the report provider and seek improvements.
Monitoring is easier if the information is presented in a digestible, visually appealing form. For example, graphs can be easier to understand than tables of numbers. ‘Traffic light’ graphics can quickly highlight when monitoring statistics are outside tolerances. The balance between summary and detail in monitoring reports should be appropriate for their intended readership and purpose.
You may find it helpful to put together a dashboard to help your monitoring. This is a short overview of key monitoring statistics. It should help you understand your scheme’s finances at a high level and highlight key potential risks. It can also help you identify areas where you need to review additional data and drill down into particular topics.
You could incorporate key elements of this dashboard into a higher-level IRM monitoring dashboard.
The content to include on your dashboard will depend on your scheme and the dashboard’s intended readership, and is likely to change as circumstances evolve.
Monitoring dashboard: examples of areas to consider
Scheme funding level
- funding level and surplus / deficit, change since last report and last valuation
- funding level relative to any triggers for action
- action taken if triggers have been met
- progression of funding level compared with valuation objectives
- breakdown of change into key drivers
- projections of future funding levels
- required future return on scheme assets to meet scheme objectives
- expected future return on scheme assets
Key risks and contingency plan
- statistics on which the contingency plans are based
- Value at Risk (VaR)
- Contributions at Risk (CaR)
- risk decomposition (eg rates, inflation, equity, credit, manager)
- stress and scenario tests
Investment performance net of fees, over long-term and short-term
- performance of overall assets relative to benchmark
- contribution from asset class performance
- contribution from investment manager performance
- hedge ratios for interest rates and inflation
- bond market statistics relative to any triggers for action
- action taken if triggers have been met
- performance of the hedging assets relative to liabilities hedged
- breakdown of exposures by counterparty
- counterparty credit ratings
- distribution by asset class relative to benchmark and change since last report
- allocation of cash flows since last report
- distribution by investment manager
- contributions received
- investment income received
- benefits and expenses paid out
Liquidity and collateral
- allocation to illiquid assets
- leverage ratio in matching asset portfolio
- collateral required and available
- stress tests of the required and available collateral
Investment manager review
- performance of investment managers relative to objectives and benchmarks
- any organisational change at the investment manager firm
- investment adviser’s view of managers’ likely future performance
- dates of last and next meetings with the managers
Charges and fees
- investment manager / fiduciary manager fees and fee benchmarks
- investment advisory fees and fee benchmarks
- transaction costs and benchmarks
- manager report on approach and actions taken to incorporate environmental, social and governance (ESG) issues into investment analysis and decision-making
- any ESG events / issues and any material changes to the ESG risks and opportunities in the portfolio
- manager report on social impact of investments
- voting activity summary
- engagement summary
The Cost Transparency Initiative (CTI) is a partnership initiative between the Pensions and Lifetime Savings Association (PLSA), the Investment Association (IA), and the Local Government Pension Scheme (LGPS) Advisory Board. With an increasing focus on cost transparency across all financial universes, the CTI has produced a suite of voluntary templates and guidance designed to help trustees understand and compare the costs of their investment services by using a standardised reporting format. These templates can be used to request charges information.
Monitoring dashboard: management information and indicators
It’s important to keep your dashboard focused. When considering statistics to include, or remove, you might find it helpful to ask the following questions:
- Does this information tell you something useful that the statistics already on the dashboard don’t? Will it be missed if you remove it?
- What are you going to do with the information? If you cannot or will not act on it, is it worth monitoring?
- If this statistic needs to be calculated just for the dashboard, is the cost justified, or can other already-available statistics be used instead?
Example 16: developing a dashboard
The trustees of a small scheme recognise that the monitoring they receive does not help them assess progress against the scheme objectives or help inform their decision-making. At present, each of the scheme’s investment managers send quarterly performance reports to the trustees and they only receive an annual funding update. Furthermore, the trustees only meet their investment adviser once a year, although their scheme actuary attends each quarterly meeting.
The trustees discuss with their advisers how they could improve their monitoring without incurring significant additional costs. While the scheme is running risks supportable by the covenant, the trustees wish to better understand its progression towards the objectives and identify emerging risks that would require action.
Following discussion, the trustees decide to introduce a dashboard to review at each quarterly meeting, setting out the following:
- Overall scheme asset performance over the quarter and since the valuation. This is then monitored against the return anticipated under the scheme’s funding strategy.
- A proxy of how the liabilities have changed since the last valuation/actuarial update. This is calculated approximately based on the difference in market conditions since then.
- Estimated funding level based on the proxy liability calculation. This is then assessed against the expected funding level when the recovery plan was put in place.
- The quarterly asset allocation (£ value and %) compared to the previous quarter and strategic benchmark.
- Individual investment manager performance against their objectives.
- Net cash flows over the quarter.
It is proposed that the scheme actuary, with the assistance of the investment adviser, will prepare this document for discussion at each quarterly meeting. It is also agreed that the investment adviser will flag to the trustees any concerns the investment adviser has with any of the appointed managers as soon as their concerns materialise.
To help inform decision-making, the trustees and their advisers also agree to set boundaries around these statistics. They adopt a traffic light system where green indicates performance in line with expectations, amber indicates performance outside of expectations, but not materially so, and red indicates performance materially outside of expectations. An amber warning would identify areas where the trustees need to drill into more detail and a red warning would identify when immediate action may be required.
Learning points: Schemes of all sizes should consider whether their monitoring is fit for their purpose and, if not, seek improvements. Monitoring is more useful if consideration is given in advance to the values for the various statistics, which would require further investigation or action.
Monitoring investment strategy
To monitor the investment strategy effectively, you need to have a clear understanding of the objectives it is seeking to deliver. You also need to understand the expected long-term performance, the timescale over which this is being measured, and the likely range of short-term performance in different market conditions.
We encourage you to focus on the long-term when monitoring investment strategy.
If the investment strategy is failing to meet its long-term objectives or if you have investment triggers in place which are persistently not being met, you need to form a view on whether this is likely to persist and decide what action, if any, to take.
If you do have triggers in place you should consider whether the market expectations the triggers are based on remain realistic, and accordingly whether the strategy or the triggers need modifying to meet the long-term objectives. In both cases, you may also wish to review whether these original objectives for the investment strategy remain appropriate.
If developments in investment markets have been significant, you may wish to reconsider any investment beliefs you hold.
Where the investment strategy has delivered significantly above expectations, or triggers have been met more rapidly than expected, we would encourage you to undertake a similar review process. These may be indications that the investment strategy is taking more risk than necessary to meet objectives, or that triggers should be set at different levels.
Example 17: monitoring and reviewing scheme triggers
The trustees of the EFG Pension Plan implemented a ten-year de-risking strategy five years ago. This included triggers for increasing the hedge ratio, based on bond yields. They wished to increase the hedge ratio from 25% to 75% of funded liabilities over a 10-year period. They set the triggers based on their investment consultant’s view of the long-term fair value level for bond yields, which was higher than prevailing yields at the time.
Over the intervening period, very few of the triggers have been met because interest rates have remained persistently low. The hedge ratio has risen, but only to 35%. The trustees discuss this with their investment adviser, who has been keeping their expectations for future interest rates under review. These expectations are now considerably lower than they were when the plan’s de-risking triggers were established.
After much discussion, the trustees confirm they still wish to achieve 75% hedging by the original target date, ie in five years’ time. The investment adviser advises that the existing triggers are unlikely to be met within this timeframe and recommends new triggers that they believe will be met. The trustees agree to adopt these.
Learning point: If triggers for change – such as interest rate triggers for de-risking – persistently fail to be met, it is important to understand why and consider whether they are still likely to be met. If not, it may be appropriate to adjust them.
We encourage you not to be unduly distracted by short-term performance issues if you have concluded there is a good explanation and you still expect your objectives to be met. Where you have concerns over the short-term performance of your investment strategy, you should ask your investment adviser to explain how it compares to the expected range of short-term performance, the reasons for it and whether, when and how they expect performance to be recovered.
Example 18: monitoring investment performance during periods of market volatility
The trustees of the ABC scheme have invested part of the scheme’s assets in non-government bonds. These have been chosen for the cash flows they are expected to produce if they are held to redemption.
The investment manager has assessed the bonds’ credit-worthiness and monitors the portfolio on an ongoing basis. The trustees are comfortable with the portfolio’s performance until a crisis affects financial markets. This causes the capital value of the portfolio to fall, as investors take fright and wish to sell ‘risky’ assets such as non-government bonds for ‘risk-free’ assets such as high quality government bonds.
The trustees are concerned about the loss in capital value and wonder whether the investment approach remains appropriate in these market conditions. The investment manager explains that the portfolio is still delivering against its objectives. Despite the crisis affecting financial markets, the manager believes the bonds will still deliver the anticipated cash flows. She reminds the trustees that the purpose of the portfolio is to deliver cash flows by holding the bonds to redemption.
The trustees understand this and agree to hold their nerve and continue with this investment approach. The financial crisis gradually eases and markets recover. The bonds deliver the anticipated cash flows.
Learning points: It’s important to define clear objectives and understand how your investment strategy is expected to meet them. You shouldn’t be distracted by short-term performance issues if you have concluded there is a good explanation and you still expect your objectives to be met.
Where the investment strategy significantly out-performs in the short-term, we would encourage you to undertake a similar review to check that risk levels are appropriate.
As part of your approach to IRM, you should have mechanisms in place to alert you to significant changes to the employer’s covenant or the scheme’s liability profile. Changes in either of these may also prompt changes to the investment strategy.
Monitoring investment managers
To monitor the performance of your scheme’s investment managers, you need a clear understanding of their individual objectives, how they plan to meet them, and over what time period.
You may wish to focus on the scheme’s more risky mandates, including more complex or less transparent ones, and the larger ones. In this way, you can pay most attention to managers or funds that represent the greatest risk to scheme performance.
Things to consider: reviewing manager performance
- Assess the performance of the manager against their stated performance and risk objectives over the relevant long-term and shorter-term periods.
- Compare investment returns to any relevant market or industry benchmarks.
- Assess the performance against what would be expected in the relevant market conditions, given the manager’s investment approach.
- Understand the level of risk run to deliver the performance and how this compares with the manager’s risk targets.
- Seek confirmation that the risk targets have not been exceeded, especially when the manager has performed significantly outside of expectations.
- Seek confirmation that an appropriate level of risk is being taken to realistically meet the objectives in future.
- Understand the principal reasons for their performance (eg market returns or manager actions), form a view on whether the performance is likely to persist and decide what actions to take, if any.
- Evaluate the manager’s actions regarding ESG factors and shareholder engagement.
- Consider the impact of fees on investment return, as this affects the net return the scheme receives. You should check fee levels for competitiveness against appropriate market comparators for the size and type of mandate.
- Monitor levels of portfolio turnover and associated transaction costs, considering whether these are justified in light of investment objectives.
- Ensure that controls (including those related to the security, liquidity and safe custody of scheme assets) are in place to alert you to potential risks.
Form of review
Your review of each manager may take different forms, for example using manager or adviser reports, or meetings with the managers or advisers.
If you are relying solely on reports produced by your investment managers to monitor their own performance including, if used, fiduciary managers, you should consider whether you wish to seek independent advice to help interpret them.
Trustee toolkit online learning
The module 'Investment in a DB scheme' contains a tutorial called 'Reviewing the investment strategy'. The module 'An introduction to investment' contains a tutorial called 'Reviewing investments'. You must log in or sign up to use the Trustee toolkit.