TKU: Statement of Investment Principles

May/June 2010

The regulatory requirements for trustees in relation to the preparation of a scheme’s Statement of Investment Principles (SIP) are set out in the Occupational Pension Schemes (Investment) Regulations 2005. These describe the required content and process for preparing and reviewing the SIP. The regulations are quite prescriptive about what has to be included. By contrast, unit 11 of the TKU guidelines specifies that trustees should have a “working knowledge” of the SIP rather than simply making sure it ticks all the required boxes.

Trustees need to understand that their SIP is a regulated document which identifies specific tasks they conduct in relation to how they manage their scheme, as well as the regularity with which they conduct these tasks. There are few public documents where trustees make such a declaration; if they state in their SIP that they do something, they put an obligation on themselves to do what they say. Consequently, it is vital that trustees understand the contents of the SIP, as well as how the SIP relates to the scheme’s investment strategy and objectives and, also, how it should be prepared, monitored and updated.

It is worth examining your SIP closely, identifying the tasks you have committed to undertake and then building these into your scheme business plan, to ensure that you fulfil the requirements you have set. Arguably, given that trustees make commitments in their SIP, it may be advantageous to exclude matter which is not required, finding an alternative home for this in other scheme documentation which is non-regulated.

11a – Roles and responsibilities for preparing the SIP

The responsibility for preparing the SIP sits with the trustees; however, there a number of other parties involved in this process. These include the scheme actuary, investment consultant, fund manager and sponsoring employer.

Before preparing or updating the SIP, trustees must first consider written advice from a person of suitable knowledge and experience. This will normally be a combination of the investment consultant and scheme actuary. Their advice will ensure that all the relevant issues are covered relating to both the investment and funding strategies. The fund manager(s) may be asked to confirm their agreement with any parts of the SIP relating to their role within the scheme. As recommended by section 11a, trustees should understand where each party is best placed to provide input and advice and involve them accordingly.

Although the trustees are responsible for the SIP, it is a requirement that they consult the sponsoring employer. Whilst the employer may not have a great influence on what is included, the trustees must involve them in the preparation process.

11b – The scheme’s investment objectives and asset allocation strategy

The ultimate objective for a pension scheme has always been to pay members’ pensions at retirement. However, the way in which schemes can achieve this has changed considerably over time, with many now closed to new entrants, or future accrual. Increasingly, specialist investment products are being developed that either take different types of risk in order to generate returns, or aim to minimise risk relative to a scheme’s liabilities.

As set out in 11b, it is important that trustees understand the different types of product in which they invest. They also need to be aware of how these combine within their aggregate investment structure, and how this relates to the scheme’s liabilities. Mathematical modelling, based around expected returns and volatilities of asset classes, is now widely used as a means of illustrating the likelihood of meeting funding objectives and the investment risks of any particular strategy relative to a scheme’s liabilities. This type of analysis can be used to identify areas of real concern to trustees. Strategy and structure modelling can be combined to set and manage an investment framework that is in line with the trustees’ need to generate a required level of return, subject to their appetite for risk.

In the SIP, trustees set out their broad expectations of the level of expected returns on the scheme’s assets and how this strategy will allow them to achieve their investment objectives. The framework used to arrive at this strategy should allow them to achieve greater understanding of why this has been chosen. This will also permit more effective discussions with the sponsoring employer on strategy, in order to come to a compromise should there be any conflicting views.

11c – The contents of the SIP

Section 11c covers the trustees’ understanding of the contents of the SIP. The majority of the content identified in the TKU is set out by regulation. One important requirement is an understanding of the investment objectives and how the scheme monitors and manages risk. This section also highlights trustees’ preference for the use of active and passive management and any limitations on investments that are specifically identified in the SIP.

The trustees must also set out their policies on subjects such as corporate governance, disclosure of transaction costs and soft commissions and socially responsible investment (SRI). Scheme members are becoming more vocal in their views of areas such as SRI so trustees need to be aware of the process they have in place for managing the risk associated with each of these aspects.

11d – Monitoring and updating the SIP as appropriate

Any piece of scheme documentation needs to be reviewed on a regular basis; otherwise, it can become out of date and could be misleading to parties with access to it. It is important that trustees review the SIP regularly, with the minimum being a triennial basis, and more regularly if it needs to be amended because of a policy change by trustees.

If events or changes to existing circumstances have a material impact on the scheme, trustees need to consider whether this merits a review of the SIP. This is crucial, as scheme members may make financial decisions based on the information included in the SIP. With a working knowledge of each area identified through sections 11a through 11c, trustees can take an informed decision on whether this should require an immediate review.

The importance of scheme documentation such as the SIP is often underestimated. It covers a wide range of topics such as a scheme’s investment objectives and strategy, as well as outlining how trustees deal with wider governance aspects such as SRI.

Each item included in this will at some point have required a decision by the trustees. Trustees must therefore have a working knowledge of what is included in the SIP and critically why they have taken these decisions.

David Walker is an investment consultant at Hymans Robertson