London-based Railpen Investments is the investment arm of Britain’s Railways Pension Scheme, which manages investment for the pension funds of over 150 railway companies. The fund is made up of nine schemes, with around £13 billion in assets invested for 340,000 members.
Stephen Lowe, Railpen’s head of asset strategy, says the company has received pitches for structured products such as principal-protected investments, but has never committed to any. “It may be that protected products are more passive, but we can’t see any particular reason why in general we would value a capital guarantee,” he says. They are, after all, “risk-taking investors”.
When it comes to derivatives-based investments, Lowe says Railpen has looked at cap and collar products but is yet to use them. He admits that this could change if a cap and collar strategy offered “very acceptable” upside. “If it only cut off what we think of as a very small amount of the potential upside that could be earned – bearing in mind that rebalancing might mean that one was taking some money off the table on the way up – and if it cuts off quite a lot of potential downside, then in those circumstances it could well be worth paying extra for a collar.”
Lowe believes Railpen’s in-house expertise can often be used to put together complex investment scenarios without the need to bring in a solutions expert from an investment bank. “Whenever we do see an enticing product from an investment bank, we want to re-engineer it to see whether we can get an even better pay-off by getting a segregated mandate or a specific mandate that we ourselves initiate, without somebody taking a cut,” he adds.
But Lowe agrees that the big structured product manufacturers, which have significant hedging books and the ability to warehouse risk, are able to create products that cannot be copied in-house. “Yes, there is value there,” he says, adding that there are investment scenarios he can foresee which an investment bank could help monetise, but that getting the board to sign off on such a deal would be difficult.
So what kind of structured products have been pitched to Railpen? “We’ve only been talking about specific equity strategies that deliver a rather favourable risk-and-return pay-off with some kind of protection. We’ve also been offered protection on a hedge fund investment.”
Would it consider more complex products, such as hybrid notes that combine investments in various asset classes? “If somebody did come along to us and propose, for instance, an investment in gold with an investment in Asian stocks and so on, all in a wrapper that offers an appealing risk-and-return profile, then we would certainly consider it, but it would be difficult for us to take that much further.”
The pension scheme has an unusual structure in that the trustee – the Railways Pension Trustee Company – offers a menu of different assets to the “sponsored sections” of the scheme. “Then the actual fiduciaries that decide the split between different asset classes are different people, so we have another layer of decision-making and presentations to the people who take responsibility for those individual bits of our pension scheme,” Lowe says. “It means we not only have to convince the trustee that [an investment] is appropriate, but we also have to go to the underlying sponsored bit of our scheme and get their approval as well.”
Such a complex structure makes the adoption of new investment techniques rather cumbersome. But it does happen. Last year, for example, Railpen announced the commitment of around 5% of its assets, some £600 million, to hedge funds, overtaking BT Pension as the largest single UK hedge fund investor.