Surrey looks to lock in gains as funding level rises

Many defined benefit schemes are considering derisking strategies as they approach full funding, but the unique characteristics of local authority pension schemes, such as longer-term liabilities, may affect how they approach the decision.

The council fund is looking to implement a small-scale liability-driven investment platform initially. It will then expand its allocation in line with funding improvements.

Earlier this year the scheme completed a triennial valuation effective at March 31 2013. The funding level was estimated at 72.3 per cent, but has since improved due to asset outperformance and a rise in the gilt yield.

“The actuary is of the opinion that we could be at around 80 per cent,” said Phil Triggs, strategic finance manager at the scheme. “We want to derisk as full funding approaches.”

The £2.5bn scheme is predicted to reach 100 per cent funding in 2021, according to projections by its consultancy Mercer.

Surrey is considering increasing its allocation to gilts and diversified growth funds, but a plan is unlikely to be finalised before the summer, said Triggs. 

It is also looking at investments in infrastructure debt as a means to provide “stable, transparent and inflation-linked cash flows”, according to minutes from a scheme meeting.

Triggs said “the ability to look long term” when choosing investments made local government schemes well suited to investing in infrastructure debt, as they are better able to handle the illiquidity.

“[It’s] one of the most illiquid investments,” said Simeon Willis, principal consultant at KPMG. “If you want to sell it you’ll be doing it in the secondary market at a discount.”

Tracking liabilities

Willis said schemes implementing LDI generally did so with a view to developing it as the funding level progresses, but platforms with higher levels of hedging and leverage were generally more difficult to implement.

“Often people are put off by the complexity,” he said. “At the very simple end you can buy long-dated gilt funds, but there’s a limit to how much hedging you can achieve with that.”

The typically longer-term liabilities of local authority schemes may lead them to view LDI differently, experts said.

“Because of the nature of local government authorities, risks like inflation aren’t necessarily such a risk as they have the ability to raise taxes,” said Willis.

“It’s important for them to consider what constitutes true risk to the sponsor and decide how to address the risk accordingly.”

A strong covenant, longer time horizons and being open to new entrants are other factors that set local government pension schemes apart, said Linda Selman, partner at consultancy Hymans Robertson.

“The argument for the use of LDI is not as clear cut as it is for private sector [schemes], though we do believe there is potential for it to be used selectively, eg for pockets of liabilities, for orphaned liabilities or employers in particular circumstances,” she said.