Morten Nilsson, chief executive of the BT Pension Scheme and founder of Now: Pensions, talks to Mona Dohle about capitalising on volatility, Brexit challenges and how climate change affects the scheme’s portfolio.
How has the first year as chief executive of the BT Pension Scheme (BTPS) been?
Let’s start with why I was interested in the job. I already knew our.CIO, Frank Naylor I met him around 10 years ago when I moved to the UK, so I knew that the scheme had already been quite innovative. It had established Hermes and then sold its majority stake. It had in-sourced the admin, which I thought was quite a bold move and quite a challenge.
It had also completed the world’s biggest longevity swap. So the scheme has a history of doing quite ground-breaking and interesting things. Because of the size of the scheme, the usual off the shelves options do not quite work. All of that was quite interesting.
So I joined and met a team which I thought was competent and has successfully introduced all these changes. Over the years, it has built up a strong liability driven investing (LDI) and hedging capability, a small illiquids team and a good actuarial team, so quite a lot of core skills.
With the sale of the Hermes stake there was quite a big transition. Hermes initially managed all our HR, external communication and finance, all of that had to be brought in house and I took the opportunity to revisit our overall business strategy. We also had a new chair of the trustee board joining us, Otto Thoresen, who formally took over in March. There have been a lot of changes, but it’s been a good year.
Before joining BTPS, you set up Now: Pensions. What was it like moving from a DC scheme to a DB scheme?
I worked for ATP in Denmark, which is a DB scheme without a sponsor, so I had a pretty good idea of having pension liabilities and how that worked with an LDI approach. I felt pretty used to that way of thinking. But as I said, ATP doesn’t have a sponsor, it is an insurance company, so I hadn’t had that sponsor angle before, and I found it interesting.
I should also add that Now: Pensions is a commercial provider competing with other pension funds and we had the joy of building something from scratch and seeing that grow to one of the top workplace pensions providers. It’s certainly been different, coming from an organisation with no history to one with a lot of history and more than £50bn of assets.
BTPS has that sponsor relationship which is important for us. We also have an interesting setup in the sense that we are organisationally independent from the sponsor, but employees and ex-employees have a close financial link with them.
It is a different organisation. Now: Pensions was extrovert, BTPS has not been so historically, it has perhaps been a bit more introvert when it comes to external communications. So there are different cultures. Now: Pensions is on a rapid growth trajectory while BTPS is still growing in assets but has been a closed scheme since last year. That of course means that the dynamics are different.
It is also quite a different structure where at Now: Pensions we had 1.7 million members with small pots, many of which did not realise they were members of the scheme.
At BTPS we have 300,000 members. We pay £2.5bn in pensions and benefits every year to the 200.000 retired members, so quite a lot of people are relying on us as either their sole or main source of income. That is something to be quite proud of and also a very big responsibility.
There is a kind of feeling of a higher purpose that you get when working here, something that you don’t get when you work for an asset manager or investment bank. We did a survey internally when I joined to find out what motivates people and this scored high on peoples’ reason for being here. We are doing something quite important for society and our members.
The DC world is in many ways still in its infancy. Although we have started to enrol quite a lot of people, the average pot sizes of assets are still quite small compared to the DB world. Of course, it is growing quickly and at some point it will take over. From a political standpoint there is so much focus on that side of it, for example discussing infrastructure investment, and less focus on DB, which is still where all the money is.
In terms of investment strategy, DB schemes are obviously a lot easier to pin down than DC schemes, where things tend to be less centralised.
It is quite interesting how much airtime master trusts and DC players have and how little attention is being paid to DB strategies. Practically all DB schemes have a sponsor relationship so the dynamic is quite different. There is an opportunity there for DB schemes to engage more proactively from a pension policy perspective, on how things could be done differently.
Coming to investment strategy more broadly, BTPS closed for further accrual last year and the trustee now aims to reduce investment risk gradually. How is that reflected in your asset allocation?
We have been reducing our exposure to growth assets for some time and are planning to do that over the next 10 or so years. We have been hedging our interest and inflation risk and also hedged currencies to some extent, not fully but we have the capability to use the fall in the pound to our advantage.
We can hedge all our exposures, which means we can for example hold more equity risk than we ordinarily would because we have the downside protection. So we are pleased with having the in-house LDI team for active management and can work across all risk factors in a cost efficient and flexible way. That has reduced our overall investment risk. We are moving towards a more cash-flow aware portfolio where we are looking for assets that match our cashflows, our pension payments. We have been building those assets by investing in bonds, corporate bonds, real estate and infrastructure, many of which we plan to hold until maturity. That creates a slightly different risk profile than if we were to sell them. We are still on that journey of having a more cash-flow aware portfolio.
With so many bonds trading at negative rates, aren’t there pitfalls in holding them until maturity?
The big thing for us with negative interest rates is the impact on pension liabilities. During the past few months we have seen falls in interest rates and we have held up pretty well, but we are not a hundred percent hedged which means it does impact us.
One thing we should be proud of is that we have done nothing to promote ourselves as responsible investors other than doing what we think is right.
The main challenge for us is interest rates risk. We are less nervous on the impact on cash-flows than on the impact of liabilities, but you can say that the overall long-term expectation will have an impact.
You do have a relatively high allocation to property – 10% according to your last annual report. Is that also an attempt to match cash-flows?
Yes, we see our real estate investment as part of our cash-flow matching strategy. The focus is on the long-term nature of some of these real estate investments and how resilient they are to the four key longterm risk factors to our portfolios: climate change, scarce resources, demographic changes and technological disruption. So, especially with real estate where we plan to hold assets long-term, we have to assess these risks carefully.
We try to run these four risks through our portfolios to see how exposed we are to these risks, for example if global temperatures rise what happens to our portfolio. That gives us an ability to test what would happen to our portfolios in certain scenarios. That is one way of helping to find opportunities and determine outcomes.
One of our big real estate investments is the development around Kings Cross and I am really proud of that. It used to be a rundown area and the investment has been part of an urban renewal project, where we regenerated the whole area.
We created jobs and homes, there are even solar panels on some of the properties, so it’s been wonderful to contribute to that and there have been some strong returns from the investment.
Our property investments are now at 8%, we have reduced them slightly. There is the challenge to source the right investments, given the stage of the cycle. For example, retail has been exposed to technological trends. But the problems of high street retailers are creating opportunities in logistics and warehouses.
What ESG factors would you consider when investing in property?
It is about the impact climate change will have on the building. That helps assess how risky your portfolio is. In the case of Kings Cross it is about modern buildings, and using better building materials and a central heating source for the estate.
The falling pound has had a beneficial effect on the growth-oriented side of your investment portfolio. Do you foresee this continuing and are you planning to capitalise on it with, for example, currency overlay strategies?
We have locked in a lot of gains as we have gone through this. Also, we need to buy a lot of pounds to pay our pensioners and now we can do that cheaply.
There could of course be a big turnaround if Brexit goes well and the pound suddenly appreciates.
Brexit will have a massive impact on the UK pensions industry. It has massively divided views, but every pension fund has been encouraged by the regulator to do Brexit scenario planning. The weird thing is that in the current world Brexit is one of many big global risks, such as trade wars.
Because you are European do you tend to have a more global perspective?
In Demark, where I am from, we have been Eurosceptic, but that has changed with Eurosceptics becoming a lot quieter recently. But the UK is a big country and one that the Danes share a lot of views with.
Why are more than half of your listed equity exposure invested in factor-weighed strategies?
Factor-weighted investment has worked pretty well for us but we have been reducing our exposure so it now accounts for 34% of our portfolio. We have moved into more active strategies where we are focussing on exploiting opportunities coming out of this uncertain market scenario and to be quite agile in getting out of investments where there aren’t so many opportunities. The philosophy behind that is that we have relatively few managers where we have deep relationships and we spend a lot of time designing the mandates. We need to make sure that what they do suits us and that they deliver.
If the market is going down, it is easier to get out of certain industries if you have an active mandate. You can have a view on that and act on that view.
BTPS has recently been named as one of the key pension funds promoting the Principles for Responsible Investment (PRI) in the UK. How are you incorporating ESG and SRI criteria into your investments?
One thing we should be proud of is that we have done nothing to promote ourselves as responsible investors other than doing what we think is right. We were one of the founding signatories of the PRI and now that it is integrated into our broader strategies we are focussed on making sure we think about the impact.
It is such a hot topic, everyone is shouting about it, but we haven’t been. One thing I like here is that responsible investing is about more than just words, there’s some real substance behind it.
Because of the size of the scheme, the usual off the shelves options do not quite work
At BTPS it is integrated in all our processes, we are considering what the ESG impact is with every investment.
We see it as a way to protect our investments and we are engaging with the companies we are invested with. We are, for example, invested in Fallago Rig, a windfarm in Scotland that offsets quite a bit of carbon emissions and it has been delivering good returns.
Those four themes we talked about earlier are a way of thinking about our portfolio, making sure our carbon exposure is being brought down. Within our public equity portfolio, our carbon exposure is 40% lower than the MSCI World index. That is something we are pleased about. We are looking at carbon exposure not only on listed equities but also bonds and real estate, so we are constantly expanding how we monitor ESG risks.
Where we are weakest is measuring how all our investments are offsetting carbon emissions.
We are looking at the negative effects of our investments and not so much at the positive.
Having a portfolio that produces less carbon than the benchmark is positive but including the carbon offsets and thinking more about that will be even better.
As an investor, the assets that you are managing are significant, so if you engage as a shareholder that could pull a lot of weight. Have you been doing this?
We engage through Hermes which allows us to pool our engagement and have an even bigger impact. We do monitor the results of our engagement and take necessary steps if nothing improves.
Climate change is currently high on the agenda but when did you start considering it as a key investment challenge?
That was something I was impressed with when I came here. Climate risk was first considered by the trustees in 2007. That is also why we do so well compared to the benchmark, but we are always looking where we can do more.
In addition to listed equities, we have recently expanded the carbon intensity reporting to our bonds, infrastructure and real estate portfolios, although the metrics there are not as well developed. It is something where the scheme is a front runner. When I joined, I thought those four key risk themes were an interesting way of running the portfolio. It is a way of looking what factors we can predict with certainty and where we should do more.