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2. Investing to fund DB

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What you need to do

  • Decide as a trustee board whether to develop investment beliefs, ensuring your investment strategy then reflects these beliefs.
  • Establish your risk capacity and risk appetite.
  • Set investment objectives and an investment strategy consistent with your risk appetite.
  • Take an integrated approach to investment strategy, which considers the employer covenant and funding level.
  • Seek to work collaboratively with the employer to set the investment strategy.
  • Understand your scheme’s principal investment risks, balance appropriately the risks you are taking and put in place suitable mitigation strategies including contingency plans.
  • Take environmental, social and governance (ESG) factors into account if you believe they’re financially significant.
  • Carry out an appropriate level of analysis on investment options and understand the limitations of the analysis.

Investment beliefs

You may find it helpful to develop and maintain a set of beliefs about how investment markets function and which factors lead to good investment outcomes. Investment beliefs, supported by research and experience, can help focus your investment decision-making and make it more effective. If you do this, your investment strategy should then reflect those beliefs.

Financial and non-financial factors

The Law Commission has produced guidance on the legal obligations trustees have when considering financial and non-financial factors when making investment decisions. In summary:

  • You are required to take into account factors that are financially material to investment performance.
  • You may take into account financial factors which are not financially material to the scheme.
  • Where you think environmental, social and governance (ESG) factors or ethical issues are financially material, you should take these into account.
  • While a financial return should be your main concern, the law is sufficiently flexible to allow you to take other, non-financial factors into account. This may be the case if you have good reason to think scheme members share your view and there is no risk of material financial detriment to the fund.

View the Law Commission guidance (PDF, 123kb, 6 pages).


Most investments in pension schemes are long-term and are therefore exposed to long-term financial risks. These potentially include risks relating to factors such as climate change, unsustainable business practices, and unsound corporate governance. Despite the long-term nature of investments, these risks could be financially significant, both over the short and longer term.

You should therefore decide how relevant these factors are to inform your investment strategy. You could ask your investment manager(s) and investment adviser for help with this.

See a definition of sustainability.

Setting an appropriate investment strategy

An investment strategy essentially sets out how the scheme’s assets are to be invested. An appropriate investment strategy balances risk and return in light of evolving scheme circumstances and objectives over time. The scheme’s investment strategy is one of the most important drivers of the scheme’s ability to pay promised benefits, and you should ensure you allocate sufficient time and resource to it.

Considering the following will help you set an appropriate strategy:


You need to have appropriate investment governance arrangements in place for your investment strategy. Further details are provided in section 1: governance.

Setting scheme investment objectives

It’s important to set clear investment objectives for your scheme and to identify how and when they should be achieved. You may wish to set multiple objectives over different time periods. Your investment strategy should support and be consistent with your objectives.

Iterative process

The scheme objectives cover the trustees’ duty to pay benefits promised in accordance with their scheme rules as and when they fall due, linked to the statutory funding objective. They also need to have sufficient and appropriate assets to cover their scheme’s technical provisions (TP).

In practice, setting your scheme objectives and your investment strategy is likely to be an iterative process. This is because conclusions on your risk appetite will drive the level of expected return that the investment strategy can deliver. In turn, the level of expected return that can reasonably be targeted within your risk appetite will affect the likelihood of achieving the scheme objectives. You may need to reconsider the objectives in light of this.

Taking an integrated approach

Your scheme’s investment strategy is a key part of an integrated risk management (IRM) approach, and should be considered alongside the employer covenant and the funding level.

Our DB code of practice and IRM guidance set out the importance of taking an integrated approach in managing and monitoring the risks faced by your scheme.

Working collaboratively with sponsoring employer(s)

As a trustee, you are responsible for the scheme’s investment arrangements, including determining its investment strategy, but we anticipate that better outcomes will generally be achieved if trustees and employers work together to develop an understanding of investment and risk issues.

Risk capacity

Broadly speaking, your scheme’s risk capacity is the maximum level of risk that you could choose to take when setting an appropriate investment strategy.

Risk capacities are not static. You need to regularly monitor and assess whether there have been any material changes to the risk capacity, which will affect the suitability of the current investment strategy.

The strength of the employer covenant will inform the risk capacity. Please see our covenant guidance for further details about assessing the strength of the employer covenant.

Risk appetite

Risk appetite is a measure of how much risk you are willing for the scheme to bear, having considered the employer’s views and the upper risk limit set by your scheme’s risk capacity.

This risk appetite can help you determine whether the current investment strategy is appropriate or whether you should implement any alternative strategies to achieve the scheme’s objectives.

Understanding the asset risks

As well as ensuring the overall level of investment risk is appropriate, it’s important to have a suitable balance of individual asset risks within your investment strategy. You need to identify and understand the key individual risks and mitigate these where appropriate. You should also assess the return you expect for taking investment risk and consider whether this is sufficient for the risk taken.

Understanding the scheme liabilities and how they are valued

The law requires you to invest your scheme assets in a manner appropriate to the nature, timing and duration of the expected future retirement benefits payable under the scheme[1], considering how they may change over time.

Understanding your liquidity needs

Your strategy should be appropriate for your liquidity needs, for paying benefits and expenses and for any collateral requirements. It should take into account the risks introduced if your scheme is significantly cash flow negative, or is expected to become so in the future.

Understanding other risks

You should also bear in mind the potential for other risks to arise, for example, longevity risk and operational risks related to scheme administration, legislative and regulatory risks.

Contingency planning

As part of setting an investment strategy and taking an integrated approach, you also need to consider setting contingency plans. Where a scheme has a journey plan with specific downside triggers, these can be related to these agreed contingency plans.

Please see our guidance on IRM for further information.


Monitoring risks on an ongoing basis is important to ensure the level of risk taken remains appropriate. Monitoring can provide a flag to identify developing risks and investment opportunities. Ongoing monitoring of key scheme risks can be included within your scheme’s regular investment governance updates. Section 6: monitoring defined benefits provides further information on monitoring investment strategy.

Footnotes for this section

  • [1] Regulation 4(4) of the Investment Regulations.

Journey planning

When setting your investment strategy, you should not only consider the asset allocation and risk mitigations you’ll use today but also how you expect these to evolve over time. Journey planning can assist you in setting a long-term investment plan.

Journey planning involves setting out:

  • clear long-term objectives for your scheme and interim milestones
  • how you propose to meet them
  • how you will measure and monitor progress towards them
  • what you will do to try and keep progress on track

We encourage trustees to have a journey plan appropriate and proportionate to their scheme’s circumstances. This plan should be realistic and demonstrate the principles of IRM.

You should discuss the journey plan with your sponsoring employer as part of a collaborative working approach. Information and idea-sharing between trustees and employers should assist you in formulating and maintaining your journey plan for your scheme, and help the employer to see your investment strategy in context.

Journey plans may help your scheme plan towards being well-funded on a low-risk investment strategy, which places minimal reliance on the employer covenant, in the future. A valuation basis consistent with this low-risk investment strategy is then often used as a secondary funding target alongside the formal scheme funding (ie TP) valuation. Journey milestones can then be set by reference to this secondary target.

Monitoring your journey plan

Monitoring progress along your journey plan will enable you to take action where appropriate. It’s important to consider in advance what actions to take if progress is not as expected. This applies whether progress is behind expectations or ahead of it. It’s also good practice to consider how these actions will be implemented so you can put the necessary governance and operational infrastructure in place beforehand.

Monitoring arrangements will depend on your scheme’s circumstances, including the available resource. Triggers are one common monitoring approach, especially ones based on the scheme’s funding level.

As part of developing a journey plan, you need to decide who will carry out the monitoring and how often.

Monitoring investments is more beneficial when you consider in advance how you will respond to what the monitoring reveals.

Trustee toolkit online learning

Go to the Trustee toolkit The module 'An introduction to investment' contains a tutorial called 'Setting an investment strategy'. You must log in or sign up to use the Trustee toolkit.

Understanding investment risks

You need to understand the risks associated with your investment strategy and the impact those risks may have on your scheme achieving its objectives. Sharing relevant information with the employer will help them understand their exposure to these pension scheme risks as part of the prudent management of their business.

Your approach should be proportionate to the size and complexity of the risks and you should identify the key risks to focus on. While some investment risks can be quantified, you may need to assess others qualitatively (such as political or regulatory risks, or future climate change).

You need to explore ways of mitigating risks, to address those that merit immediate mitigation, and to identify those that are acceptable today but you may wish to mitigate in the future. This will allow you to make more informed and efficient choices in the future.

Investment products are available that enable smaller schemes to implement types of risk mitigation that were previously only practicable for larger schemes. We’d encourage you to keep abreast of market developments in this area if applicable to your scheme. Your investment adviser should be able to assist with this.

You can mitigate risk by having robust investment governance and monitoring procedures in place for your scheme.

When setting your investment strategy, you need to consider the scheme’s asset, liability valuation and cash flow risks. We explore these below.

Asset risks

With all assets, there’s a risk that the returns they provide may be lower than was expected when the investment was made. You should understand the expected economic and market drivers of return that underlie your investment strategy and what may cause returns to be different from expected.

In setting the scheme’s asset allocation, we’d encourage you to consider investing in a wide range of asset classes. You should also consider the available implementation routes as these influence the risks and return expectations of the investment. Issues related to implementation are covered further in section 5: implementation.

Asset risk can be mitigated in various ways, including through diversifying asset allocations and through hedging using derivatives.

More information on asset risks is covered in section 3: matching assets and section 4: growth assets.

Liability valuation risks

A pension scheme’s funding level compares a value placed on the scheme’s liabilities with the market value of the scheme’s assets. Both of these values vary with investment market conditions. Schemes are typically exposed to liability valuation risk. This means the values of the liabilities and assets do not usually respond in exactly the same way to changing market conditions. The difference in response can have a material impact on the scheme’s funding position. You therefore need to understand and quantify the liability valuation risks you are running.

You can mitigate liability valuation risks by investing in assets that move in a similar way to the value placed on the liabilities as market conditions change. These asset strategies are known as liability driven investment (LDI) or liability hedging strategies.

The way the liability value varies with market conditions depends on how the valuation assumptions are derived. Typically, long-term interest rates and long-term inflation expectations have a significant influence on the valuation. Therefore, LDI strategies typically involve a portfolio of high quality bonds and other assets and / or derivatives and their collateral whose value responds to changes in market conditions similarly to how the liability value responds.

You need to understand the nature and extent of liability valuation risks your scheme is exposed to and clearly document your rationale and approach to managing these risks.

More information on liability valuation risks is covered in section 3: matching assets.

Sequencing risk

You should understand how your scheme’s assets, liability values and cashflows are expected to develop in the short, medium and long-term when setting your investment strategy. This is because the impact of investment performance on meeting scheme objectives depends on when the performance occurs. For example, investment underperformance when the scheme is relatively large is potentially more significant than underperformance when it is relatively small. This is referred to as sequencing risk.

Put simply, it matters when investment returns occur, as underperformance when the asset base is large will need to be made good in future, all else being equal, either by higher DRCs or through higher investment returns from a smaller asset base.

Sequencing risk is particularly relevant for schemes that are more mature, where the asset base is expected to decline over time due to the net cash flow out of the scheme being greater than the investment return achieved. Schemes in this position can be more vulnerable to investment underperformance.

The materiality of sequencing risk to your scheme will depend on several factors. Schemes where it is most significant are likely to have some of the following characteristics:

  • cash flow negative, ie more benefits and expenses are being paid out than income received from contributions and investments
  • mature (and hence a short time horizon to make good any reduction in funding level)
  • volatile investment strategy (hence the degree of any underperformance is likely to be greater)
  • poorly funded (so that the outgo from scheme benefits and expenses is a greater proportion of the asset base than if the scheme were better funded)
  • weak covenant (so that the employer will find it difficult to pay additional DRCs to make good any underperformance)

It’s good practice to explore how material this risk is to your scheme, especially if your scheme exhibits some of the above characteristics or is expected to do so in the future. Where this risk is material, having robust risk management and risk mitigation strategies is key.

Scenario projections or asset-liability modelling can be useful tools to assess this risk. For smaller schemes, instead of carrying out a detailed asset liability modelling exercise, a useful insight could be obtained, for example, by applying a shock to the assets and/or to interest rates, and projecting the value of the assets and liabilities over a reasonable future time period.

Cash flow and liquidity risks

You should understand how your scheme’s benefit and expense payments and contribution income are expected to develop when setting your investment strategy, so your strategy can take into account the scheme’s cash flow and liquidity risks.

If the benefit and expense payments exceed the contribution income, they will need to be met from investment income or asset sales. Meeting them from asset sales introduces the risk that assets cannot be sold quickly enough, or they can only be sold quickly enough at a reduced price. This is known as liquidity risk. Cash can also be needed to make collateral payments if you have certain types of derivative arrangement in place, such as those associated with LDI, or currency hedging arrangements.

Your investment strategy should take account of your scheme’s need for cash, and the associated liquidity risks, and we would encourage you to develop a cash flow management policy. This should address the typical cash flows’ in ‘business as usual’ circumstances, and how you would deal with more exceptional circumstances.

When considering your cash flow management policy, you need to be aware of the liquidity characteristics of all the investments the scheme holds and how they might vary in different market environments. You need to ensure you have sufficient liquidity within the portfolios to meet scheme benefit cash flows and any collateral requirements arising from derivative or currency positions held.

Even where the risks associated with cash flows are not material, we consider it good governance to set a cash flow management policy to help keep the scheme’s actual asset allocation in line with the investment strategy. It can also help you deal with unexpected cash flow requirements promptly and efficiently.

Trustee toolkit online learning

Go to the Trustee toolkit The module 'An introduction to investment' contains a tutorial called 'Capital markets and economic cycles', and the module 'Investment in a DB scheme' contains a tutorial called 'Changing asset and liability values'. You must log in or sign up to use the Trustee toolkit.

Using models to assist in setting your investment strategy

You or your investment adviser may make use of models to assist in setting your investment strategy. You can use models to help identify and quantify risk as well as to illustrate the likelihood of achieving scheme objectives. Modelling can also be useful when comparing the risk and rewards of different investment strategies.

We expect your use of models to be proportionate to the complexity of the risks concerned. Sophisticated risk assessment tools may not be necessary if the risks facing the scheme are simple and straightforward; the modelling approach should be appropriate to the circumstances. You may wish to seek the help of your investment adviser on whether a detailed risk analysis would be beneficial. As a minimum, we expect you to complete some scenario or sensitivity analysis.

If it is appropriate to carry out comprehensive modelling of your scheme, for example long-term modelling and/or decomposition of the risks into the key components, you will need to review and update this modelling at appropriate intervals as the scheme develops. When undertaking long-term modelling you need to consider the potential impact of the covenant on the payments under the recovery plan and on any contingent assets.

Where the scheme risks are significant in the context of the employer’s business, we would expect you (and the employer) to consider the risk management benefit that might be achieved by undertaking more comprehensive analysis.

Metrics used to quantify and assess risks

You may find it useful to develop specific risk metrics for your scheme. Identifying and quantifying risks, as well as considering mitigation strategies, may be carried out using models and metrics such as stress tests, scenario analysis, asset-liability modelling and / or VaR analysis decomposed into the various contributing risk factors (amongst other models and metrics).

Modelling output can help you identify the most material risks for your scheme, so you can monitor and mitigate them. It may also show you where your scheme is exposed to common risk factors across its investments, the employer’s business and any contingent assets.

This process will also help you identify which modelling assumptions you should consider in greater detail when interpreting the results.

While models can be useful tools in setting investment strategies, it’s important that you are aware of model limitations and the key assumptions that underlie their outputs. This is important as the output is ultimately a reflection of those assumptions. There are significant differences between models and between modelling approaches; not all models identify the same risks.

For example, a short-term VaR model will not identify the risks to a scheme associated with how its cash flow profile is expected to evolve over the medium or long-term. For schemes where this is a significant risk, long-term modelling, where the asset cash flows are modelled accurately, would be appropriate.

Understanding assumptions

We expect your advisers to clearly identify the key assumptions used in their advice. We encourage you to discuss these assumptions with them to ensure you understand them and assess the degree of confidence the advisers have in them. You need to ensure that they are consistent with your documented investment beliefs and that they are appropriate for how the investment strategy will be implemented in practice.

Given that interest rates are often the primary source of funding volatility, it’s important that you understand whether the central modelling assumptions follow current market expectations or whether they incorporate a different view of how these rates will evolve over time. For example, some models assume interest rates and / or gilt yields will rise to a higher level in the long-term than currently priced into markets.

For some alternative asset strategies, advisers may have limited experience and data from which to develop modelling assumptions. Where you consider it proportionate, you may wish to look at the model output using a different set of assumptions to help you assess how material the assumptions that underlie the model are.

There can be significant differences between theoretically modelling an investment and the real-life implementation of that investment. In practice, asset classes can be accessed through various routes and the asset modelling may not reflect the possible implementation routes and / or investment manager approaches to the assets. This can be a particular issue when modelling and implementing multi-asset investment strategies such as diversified growth funds (DGF).

For more information on modelling and DGFs see section 4. DB growth assets.

Trustee toolkit online learning

Go to the Trustee toolkit The module 'Investment in a DB scheme' contains tutorials called 'Future projections and scenario planning' and 'Stochastic modelling'. You must log in or sign up to use the Trustee toolkit.