BBC Pension Scheme STATEMENT OF INVESTMENT PRINCIPLES

BBC Pension Scheme STATEMENT OF INVESTMENT PRINCIPLES

investment 1 1. Introduction This statement details the principles governing the investment policy of the BBC Pension Scheme (the Scheme). It has been prepared by the directors of the BBC Pension Trust Limited (the Trustees), having been advised by their investment consultant and in discussion with the British Broadcasting Corporation (the BBC). It complies with the requirements of the Pensions Act 1995, as amended, and the Occupational Pension Schemes (Investment) Regulations 2005. It also has regard to the Myners Principles for defined benefit pension schemes. It is reviewed each year or whenever the Trustees are alerted to a material change in the Scheme s funding position, which is outside the boundaries the Trustees have determined for automatic changes to the strategic asset allocation and risk tolerance (See section 8). 2. Objectives The Trustees are responsible for stewardship of the Scheme s assets. Their main objectives are to ensure that: all beneficiaries receive the benefits to which they are entitled under the Rules of the Scheme; and there are sufficient assets to meet the Scheme s liabilities as they fall due. To this end the Trustees have a long-term objective of being fully funded, on a basis which would allow them to run a minimal risk investment policy with limited recourse to the BBC for further contributions. Based on the current agreed Schedule of Contributions and investment policy, the Trustees are targeting the achievement of this objective over approximately 15 years. 3. Investment policy The Trustees set investment policy. They take advice from the Scheme Actuary, their investment consultants, an in-house investment team and independent investment advisers. They also consult the BBC. The policy is reviewed following each actuarial valuation or asset liability study. The Trustees delegate responsibility for implementing investment policy to an investment committee. The investment committee appoints, monitors the performance of and removes investment managers. It oversees asset allocation and directs the cash flow of the Scheme between investment mandates, adjusting portfolios as necessary. It monitors, reviews and recommends changes to the Trustees policies in respect of investment, corporate governance, socially responsible investment and activism. Matters of substance at any investment committee meeting are decided by vote. If there is not unanimity the matter is referred to the Trustees for consideration.

4. Investment beliefs In setting policy, the Trustees have regard to a set of investment beliefs developed in discussions with their investment consultant, the in-house team, the independent investment advisers and other parties. These beliefs can be found in Appendix 1. The investment beliefs provide a starting point for strategic asset allocation reviews and other investment discussions. They are reviewed regularly, but are not expected to change radically year on year. 5. Investment management The Trustees delegate day to day investment decisions to suitably qualified independent investment managers. Their activities are defined and constrained by detailed agreements. To aid diversification the Trustees employ a number of managers with varying investment styles, both passive and active. A performance monitoring agency measures their performance, and that of the Scheme. Fees are charged either as a proportion of the assets under management or are related to performance targets. They are negotiated individually when a manager is appointed. The Trustees take advice to ensure that fees are commensurate with the services provided. The investment committee monitors the performance of investment managers and the value they provide. The Trustees believe it is not in the Scheme s commercial interests to disclose the fees paid to individual managers. Managers are listed in the Scheme s annual report, which also contains information about investment performance and major investment decisions taken during the year. 6. Return on investments Over time, it is expected that: the return on equities will be greater than that on other asset classes; and the return on all the Scheme s various asset classes overall will not be less than the assumptions used to decide the Scheme s strategic asset allocation. The current assumptions can be found in Appendix 2. 7. Types of investments held The Trustees invest in a mix of real and monetary assets deemed suitable for pension schemes, balancing returns against volatility. They restrict the activities permitted by investment managers, who are required to comply with investment regulations and this statement. The Trustees carry out due diligence and take advice from their investment consultants to ensure new areas of investment are appropriate. rinciples 2

investment3 8. The balance between different types of investments Asset allocation is driven by the specific characteristics of the Scheme, in particular its demography, the pattern of liabilities and the risk tolerance of the Trustees and BBC. It is set following regular asset liability modelling (ALM) studies that consider the full range of investment opportunities available to the Scheme. This covers all major asset classes, including asset classes such as private equity, hedge funds and infrastructure. The strategic asset allocation following the last ALM study can be found in Appendix 3. The permitted ranges for each asset class are intended to ensure that the investment risk remains appropriate. The investment committee can deviate tactically from the strategic benchmark provided it remains within the ranges. The strategic asset allocation shown in Appendix 3 is that initially determined following the last ALM study. The Trustees consider that the Scheme should only take as much investment risk as required to meet its long term investment objective. Accordingly, they have adopted a dynamic asset allocation framework whereby the strategic asset allocation is altered based on changes in the Scheme s funding ratio and rate of return required to achieve the long-term objective. The actual strategic asset allocation may therefore vary from that shown. The methodology for changing strategic asset allocation is periodically revisited to ensure that changes to the strategic asset allocation are appropriate 9. Sale of investments Contributions and investment income currently exceed benefits payable. It is not expected that there will be any material need to sell investments to meet benefits in the near future. Investment managers have discretion to buy and sell investments within the terms of their agreements. A very large proportion of the Scheme s assets are readily marketable. Some investments, such as property and private equity, are less easy to sell. Such illiquidity normally allows the Trustees to capture an improved return and is not expected to constrain their investment decisions. 10. Risk The Trustees recognise that the Scheme s assets are exposed to both investment and operational risks. They give qualitative and quantitative consideration to these risks when deciding investment policy, strategic asset allocation, the investment manager structure, choice of managers and the terms of their agreements. In particular, the Trustees have identified the following types of risks:

Risks Concentration/ Correlation Currency Active management Matching Sponsor Liquidity Operational Definition, Controls and Mitigation The risk that the Scheme has a significant exposure to assets that rise and fall in value at the same time. Diversify investments across and within asset classes, to avoid over-exposure to any one market. Monitor Scheme assets relative to the strategic benchmark. The risk that the Scheme has a large exposure to overseas currencies. Monitor currency exposure. Partially hedge the Schemes s major currency exposures and ensure that overseas investments are diversified across currencies. The risk is that the Scheme has a large exposure to one investment manager. Monitor exposure to each investment manager. Set clearly defined objectives for each manager. Monitor the returns achieved and their continued suitability for appointment. The risk that cash-flows and investment returns generated fail to meet the liabilities. Give consideration to the specific characteristics of the Scheme s liabilities when setting investment strategy, including a liability matching programme. Regularly review progress of the Scheme s investments relative to its liabilities. The risk is the sponsor of the Scheme is unable to provide future support to the Scheme. Monitor the willingness and ability of the BBC to continue contributions at a level necessary to fund the Scheme s benefits The risk of the Scheme not meeting the liabilities as they fall due. Regularly review and adjust the amount of cash held to pay benefits, to minimise the impact of cash flow on investment policy. The risk is that there is a breakdown of the Scheme s investment back office or in the operation of financial markets. Monitor the Scheme s investment back office and the ability of the bank holding Scheme assets to settle trades on time and to provide secure custody. rinciples 4

investment5 11. Additional Voluntary Contributions (AVCs) New and Old Benefits members can pay AVCs to the Scheme, in accordance with separate provisions published by the Trustees. The funds in which members can choose to invest their AVCs are reviewed regularly, to ensure that they are well managed and represent good value. The Trustees have the right to vary the arrangements. In this they are advised by Towers Watson Limited. 12. Social, environmental and ethical considerations The Trustees believe that social, environmental and ethical decisions can affect the performance of investment portfolios and, in the long-run, good corporate governance will result in better financial performance. The Scheme s active managers have been informed of the Trustees views, which they are expected to reflect in the selection, retention and realisation of investments; insofar as they believe it will not disadvantage the Scheme financially. The Trustees believe that voting rights are an important aspect of shareholder value and should be used to bring about better corporate governance. They have appointed an engagement overlay adviser (EOA) to engage with companies in which the Scheme invests. For directly held investments, the EOA exercises almost all voting rights on the Trustees behalf. It normally does so in accordance with the code of best practice referred to below; unless it believes that doing so would not be in the best financial interests of the Scheme. The Scheme s voting record can be viewed on bbc.co.uk/mypension. Of necessity, managers retain voting rights for pooled investment vehicles, but take advice from the EOA on how the Scheme would wish to vote. The Trustees have signed up to the principles for responsible investment, formulated by the United Nations, in their finance initiative. The Trustees also support the principles of good governance and the code of best practice, incorporated in the combined code issued by the London Stock Exchange. The Scheme is also a member of the Institutional Investors Group On Climate Change and the Trustees have signed up to its investors statement.

Appendix 1 Investment Beliefs Belief: A high level of governance is required to manage a large Scheme with a complex set of assets. It requires the investment committee to be knowledgeable and educated in financial matters. Further, it requires an experienced and skilled in-house team with sufficient capacity both to advise the investment committee on all aspects of investment and oversee management of the assets. Significant advice will also be sought from external investment consultants. Consequences: The investment committee should review annually that they have the right set of skills and sufficient in-house skills and capacity to manage the Scheme s assets. Belief: Indexed linked government bonds are the lowest risk and lowest return asset class relative to the Schemes liabilities but they are not no risk as they would perform poorly in a deflationary scenario. Conventional government bonds are vulnerable to relatively high inflation and would therefore be expected to provide an additional risk premium over index-linked bonds. For all bonds one would expect longer duration bonds to provide higher returns than short duration ones i.e. there should be an upward slanting yield curve. Investors should also be rewarded for taking on credit risk. Consequences: The Scheme has commenced a liability matching programme taking advantage of bonds liability matching properties. As the Scheme matures and reduces risk, the investment strategy will move more towards matching assets and liabilities with an increasing exposure to bond assets. However the Scheme will also look to exploit additional returns available from illiquidity and credit risk as government bonds provide a level of liquidity which is not of use to the Scheme but incurs a cost. Belief: The equity risk premium does exist although it may only be achieved over longer time periods. There is long term data to support superior returns from equity investment. The Trustees are keen to capture these higher equity returns by maintaining significant equity exposure. Consequences: The Scheme is likely to maintain significant equity based investments although this is likely to decline as the Scheme becomes more mature and also as the asset allocation becomes more diversified as the portfolio of alternative assets grows. Belief: The Trustees believe that the BBC is willing to support the Scheme to the extent that it can afford to do so. Consequences: The Trustees will monitor the covenant of the BBC on a continuous basis to assess its ability to support the Scheme. Belief: There are normally additional returns available for investing in illiquid assets (the illiquidity premium). The Scheme has substantial liquidity and enjoys the benefit of positive cash flows that are expected to continue over the medium term. Consequences: Whilst mindful of liquidity requirements the Scheme should look to exploit illiquidity to increase the overall returns. rinciples Belief: Diversification is important to reduce volatility. However it is essential that real diversification is achieved and therefore the Scheme needs to ensure that differing asset classes are actually uncorrelated in practice. Consequences: The Scheme is looking to reduce exposure to quoted equity investments over time. 6

investment7 Belief: The timing of moves into and out of asset classes is critical for the long term returns achieved. For instance, if equities had been purchased in March 2000 (at a peak in the market) then it would have been an extremely long time before the equity risk premium was achieved. In contrast, if equities were purchased in March 2003 (at a trough in the market) then a significant equity risk premium would have been achieved over almost all time scales. Consequences: Great care should be taken to try and make sure that moving between investment classes adds rather than detracts value. Belief: It is difficult but not impossible to identify active managers that will add value over time. However there is a place for passive management in efficient, more liquid, markets where information flows are good and it can be difficult for active managers to add value on a consistent basis. Evidence suggests that active managers overall find it difficult to add value after fees. However analysis of the Scheme s experience is that value has been added by active management, although not in a consistent way on an annual basis. Consequences: The investment committee should monitor closely the performance of its managers to ensure that active management is adding value. However the committee should be willing to use passive management to gain exposure to efficient markets and also to facilitate tactical moves or when no really good active managers can be identified. Belief: Risk should be managed and monitored, although the conventional view of risk (i.e. volatility) is a narrow view of risk and changes with markets. It is therefore difficult to set rigid parameters within which conventional risk should be maintained. Consequences: The Scheme will monitor conventional risk but will also look at other embedded risks such as liability risk, sponsor covenant risk etc. The Scheme will also undertake stress testing under various scenarios to highlight possible risks. Belief: There is a first mover advantage in many areas but it is difficult to exploit. It requires the Trustees being willing to take on unconventional risks. Consequences: Exploiting first mover advantage is difficult to do on a consistent basis. It is likely that the Trustees will only look to invest in new areas in exceptional circumstances where there is some established research or empirical evidence to support such an investment. Belief: It is logical to assume that well governed companies that manage their business in a responsible way will produce higher returns over the long term. Consequences: The Scheme will look to engage with companies in which it is invested to encourage them to maintain high standards of governance and to operate in a socially and environmentally responsible way. Further it is the Scheme s policy to vote at all company meetings although in some emerging areas this is not possible at present. Belief: Liability driven investment is an essential tool for all pension funds especially those that are mature or are closed to new members. It is less important for less mature pension schemes and in particular those with positive cash flows, a strong sponsor and a well funded scheme. Consequences: Whilst the Scheme has a positive cash flow the need to acquire matching assets is much reduced. However given the gentle maturing of the Scheme, attractive opportunities to acquire matching assets should be taken.

Appendix 2 Expected Return on Asset Classes * Asset Class Global (ex UK) equities, unhedged UK equities UK long corporate bonds UK long government bonds UK index-linked gilts Fund of Hedge Funds, hedged Private Equity, hedged Property Inflation (RPI) 10 Year Median Real Returns 5% p.a. 4.3% p.a. 1.8% p.a. 1.0% p.a. 0.4% p.a. 3.0% p.a. 3.8% p.a. 4.0% p.a. 3.2% p.a. * Asset return assumptions used in the asset liability study carried out as at 1 April 2010 which was used to determine the current strategic asset allocation. The real return is the nominal return of the asset class less inflation. rinciples 8

investment9 Appendix 3 Asset Allocation and Permitted Ranges agreed following the last ALM study Asset Class Strategic Benchmark Permitted Ranges Minimum Maximum Equities 47.5% 37.5% 57.5% Bonds 30% 20% 40% Property 10% 5% 15% Alternative Assets 12.5% 5% 20% Cash 0% 0% 15% In practice the strategic benchmark will vary as the Scheme has adopted a dynamic asset allocation framework for responding to changes in its funding ratio and required rate of return. The actual asset allocation will always fall within the permitted ranges of the strategic benchmark. For the latest published asset allocations see the annual report and accounts.

Produced by: Pension and Benefits Centre Telephone:029 2032 2811 Fax: 029 2032 2408 Email: mypension@bbc.co.uk Website: bbc.co.uk/mypension December 2011