Railpen’s chief fiduciary officer for investment tells Andrew Holt about the scheme’s evolution, advances in modern portfolio theory and positioning the scheme for the future.
What challenges have you faced during the 18 months you have been Railpen’s chief fiduciary officer for investment?
The operational impacts of Covid have been the biggest challenge to manage. Yet it has also shown the ways in which our business and employees have been able to innovate and adapt to overcome challenges and maintain operations. Railpen has coped well during the past 18 months, continuing to innovate and maintain operations in the goal of achieving our ultimate purpose to secure our members’ future. We were fast in moving from the office to remote working and have been operating at full pace since the outbreak of the pandemic, which has been great.
Regarding my role, I joined during lockdown. We went through a big recruitment drive during Covid – about a third of my team, in fact – and so I have not met the majority of my colleagues in person yet. That is something to look forward to. Covid aside, my biggest challenge has been getting my head around the complexity of the Railways Pension Scheme (RPS).
I have worked with complex structures and institutions before, but nothing as complex as RPS, given its 107 sections, trustee board and all the different intersections with its clients. It is a big and complex construct that we have to make work.
But it is complex for good reason. It has continued to evolve since the railways were privatised back in 1994 to ensure it continues to meet the needs of each section, the employers and employees. Evolution is good, but it means there is a need to adapt and innovate along the way.
You joined Railpen from Denmark’s largest pension scheme, ATP, where you were head of investment strategy. What key investment lessons did you bring to your current role?
I brought a couple. First, is the use of modern portfolio theory and techniques. At ATP we could test things and improve the portfolio to a large extent. We had the ability to do that to help deliver better returns for our members.
Essentially, the days when you could buy equities and bonds and they would turn out great are gone. So, we have to be innovative to make sure we get every penny out of the risk we take for our clients. I am trying to use my experience on that. Secondly, I ensure that I understand the client needs and make sure the portfolio evolves while being tailored to those needs. The process of understanding and collaboration – helping the client to articulate its requirements – is good experience from my ATP days.
Given what you say about equities and bonds, is the 60/40 portfolio dead?
It is dead if you want or need a return that is higher than a few percentage points on an annual basis. If you can live with that return, it is perfectly fine and a good solution. It can be made quite simply and cheaply, but if you have a return requirement that is say 5% a year, or a certain return plus inflation, then you need to do something else.
What are your key objectives in this role?
My priority is to deliver on our purpose, which is to secure our members’ future. There are different facets to how we work on that.
First, it is financial. Developing the process of checks and balances, the stakeholder management, good governance in the investments and all the processes we have. That goes all the way up to building asset-liability models to support strategic decisions that we can make on funding and investments so that we have the right framework decision-making in the business. Another is ESG, and the importance of that in our investments.
So, how does Railpen think about and integrate ESG into its investments?
We believe that as an institutional investor we have a responsibility to do the right things in terms of ESG when we are investing. We have a world class ESG team. Rigour and research are behind all the things we do here. We focus on three areas: is it doable? Does it make sense? How can we apply it?
On net zero, for instance, we have just committed to becoming net zero by 2050, with a 50% reduction in greenhouse gas emissions by 2030. This was undertaken based on a piece of analysis we did, which asked: can we deliver on this in our portfolio? How can we do it? What does it mean for our future investments?
The idea is not just to manage the downside risk of climate change, but also take advantage of the investment opportunities that decarbonisation has to offer. So here we look at the investments in different assets that are part of a greener economy. Obvious examples are wind farms and solar energy, and these are what we are considering in the portfolio.
Our approach to sustainability and ESG in general is something we have done for some time. It is a vital part of our fiduciary duty and material to the long-term expected returns. That has helped drive our approach to evolve in this area. The position is essentially to protect and help the portfolio from a long-term financial viewpoint, but also to make sure that when our members retire, it will hopefully be a slightly better world.
How optimistic are you on achieving the 2050 objective?
We took a considered approach to net zero which reflects the long-term view of our investment horizons. We outlined a clear and practical roadmap detailing our portfolio decarbonisation journey, primarily through corporate engagement, to align investee companies with Paris goals and increase the portfolio’s climate resilience. This is now about actions, not words.
We do not know exactly what will happen, but our role is to engage with companies that we invest in to help them deliver on decarbonisation targets. We are doing our part in terms of trying to influence investee companies by making sure they are driving in the right direction.
You have also signed the Asset Owner Diversity Charter. Why is that important?
By signing up we are taking action on this important issue rather than simply having warm words on our home page. We are trying to make sure that real action is taken here.
It also reflects our philosophy around people at Railpen. We think about our own team and diversity in the same way as the companies we invest in. We have important programmes to address diversity challenges, but we also ask: how can we improve our diversity? We strongly believe that having a diverse group of people working for us will improve, over the long term, our ability to meet our core objective of securing our members’ future.
Tell me more about your investment portfolio.
We have a multi-asset approach. Diversification is important and our equity portfolio is managed around what we believe the future will be.
On equities, we prefer biasing our portfolios towards the investments and themes of the future. We have investments in biotech companies, for example, which have been good in recent years, as well as emerging trends in technology. We look at companies which are disrupting their sectors, and those who are likely to impact the status quo in the future.
We are focused on building portfolios which can withstand stress and protect our members’ financial futures and anticipate future trends. We do not take a benchmark approach to investing, rather we seek out themes that will be prevalent in 20 years’ time and we are constantly evolving to identify these trends as early as possible.
For example, digitalisation will continue. So, it becomes a case of, how do we invest in that in the right way? The green economy is another trend we are looking at how we can best invest in this area. Globalisation, Brexit, and emerging trends in China are other themes we are considering. We have, and have had for many years, investments in China, but we see a range of long-term investment opportunities and trends which we are increasingly seeking to take advantage of.
Our investment portfolio reflects what the sections need, aiming to meet their financial objectives, while protecting the port- folio and positioning it to withstand future trends. This means that risk management forms a critical part of the investment process, and we are constantly evaluating different factors to build portfolios that can withstand stress and protect the financial future of our members.
What tailored investment plans do you have for Railpen’s multi-employer sectionalised schemes?
Most of our sections have their own investment strategy, which is essentially enlarging the scale of the RPS umbrella. The strategies are tailored to the needs of the sections, employees and employers. We need to evolve in line with the needs of those sections through adapting the portfolio to the different environments and the challenges they bring.
Focusing on risk management of the whole business is key. This is not just to enhance returns, but also to protect against broader macro factors and to ensure the portfolio is being run in a sustainable fashion over the long run. Risk management is an important part of the solution to the RPS.
You mentioned adapting to new environments. Has Brexit had an impact on your portfolio?
It happened before I joined, but I believe we benefitted from Brexit from the positions we took in the currency market back then. Lately it has been more around whether there are any specific areas where our portfolio will struggle in the future, given Brexit. We have analysed and looked at that a great deal.
How are you approaching the uncertainty around the inflationary environment?
It is on our radar. Higher realised inflation will erode the value of the pension scheme and so we will need a higher return to deliver that shortfall. We are seeking out investments which we think will have good returns if inflation goes higher and at the same time are delivering positive expected returns overall. Markets are not pricing in meaningful changes to inflation. But it remains a risk scenario we are monitoring as one of many factors that we look at within our risk management framework.
Do you see inflation as transitory or something more long term?
It can become a serious issue in a certain set of circumstances. It requires a few things to go the wrong way at the same time. If central banks continue doing what they are doing with their inflation focus, then it is going to be fine.
If the institutional protections that we have around inflation are broken, then it might change the game. Looking at the current situation, it seems like the current world will remain as it is.
What future objectives do you have for the scheme?
To successfully deliver our purpose to secure the members’ future – and to do that, we must continue to innovate. So, our structures, portfolios and our processes must evolve.
I do not believe in big bang changes. It is a continuous evolution of many small things, which will, in total, make us more prosperous in the future. The team we have is exceptional. So, we are well braced for the future.