City of Westminster scheme to cut equities and diversify portfolio

With assets worth £1.5bn, the scheme – part of the London Collective Investment Vehicle pool – has seen its overall funding level improve by 20 percentage points since 2016, ending 2019 at 100 per cent funded.

The council saw the funding level of its own liabilities increase by 16 per cent to 86 per cent, and plans to pay off its deficit of £130m by 2021-22, with around £100m available to invest in the pension scheme investment portfolio.

From three solutions proposed in January by investment adviser Deloitte, the Westminster fund’s pension committee favoured the second option that will see its equity allocation reduced by 10 percentage points to 55 per cent.

Half of the redemption will be invested in fixed income and another 5 per cent of total assets will be allocated to an illiquid alternative asset class, a timely change in view of the UK government’s pledge to target net zero greenhouse gas emissions by 2050, the scheme committee report states.

High reliance on equities

According to Deloitte, with almost two-thirds of the scheme’s allocation to equity, there is a significantly large reliance on equity markets to deliver the fund’s return.

“Given the change in funding level over the past three years, the committee should consider whether the overall equity allocation and structure of the equity portfolio is still appropriate,” it states.

“While the fund has allocations to credit, property and infrastructure, there is scope to add further diversification, particularly with the use of more illiquid asset classes.”

Moving to residential property or affordable housing could offer another form of diversification to the existing long-lease and core mandates, the investment adviser adds.

The committee should also consider whether to place the additional 5 per cent in fixed income across the existing portfolios, or to allocate to a new mandate such as direct lending.

Despite the new strategy resulting in a decrease of 0.2 per cent in expected returns, it will also reduce volatility by 0.6 per cent and value at risk by £30m, Deloitte adds.

Strategy changes to come in March

In November 2019, the pension scheme had mandates allocated to nine asset managers.

However, to improve diversity in the equity space – where 70 per cent currently sits with the Legal & General Investment Management global passive fund and 30 per cent within the Baillie Gifford Alpha Growth mandate – the City of Westminster Pension Fund has been advised to add a third equity manager, possibly taking an environmental, social and governance-specific approach.

According to a Westminster City Council spokesperson, the scheme’s investment strategy review builds on its excellent performance over the past three years.

“We’ve decided to diversify into some alternative investments, and have recommendations to reduce risk from the portfolio and lock in some of the improved valuations that we’ve achieved,” the spokesperson says.

“We’re looking to publish a further strategy review paper in March, with a view to implementing the changes early in the new financial year.”

Managing risks essential for LGPS funds

Commenting on the proposed moves, Stephen Schofield, partner at Pinsent Masons, notes: “Like all funded schemes, the Local Government Pension Scheme needs to manage the investment risks to which it is exposed in order to protect its funders – here, the council tax payer.

“Reducing the risk and diversifying the strategy looks like a sensible step, and it is reassuring to see transparency around the decision-making process.”

For Richard Farr, managing director at Lincoln Pensions, LGPS funds are currently facing a significant challenge due to large deficits, continued benefit accrual and cash-strapped local authorities.

“While derisking may seem to be unaffordable, having a long-term plan to manage risk exposures is essential for LGPS funds to avoid future financial distress,” Mr Farr says.

Taking a wider perspective on local authorities’ ability to derisk, David Walker, head of LGPS investment at Hymans Robertson, notes: “As long as the LGPS remains open to new entrants there will be a limit to the degree of derisking that can be implemented. 

“There is a need to maintain stability and affordability of benefits and also to keep the scheme sustainable. This will require some level of investment risk to be taken to generate the returns needed to achieve that.”