Rhondda Cynon Taf approves plan for alternatives

The £3.1bn scheme will nearly double its property exposure too, as it looks to lift its allocation to alternative assets to 25 per cent from its current position of 5.4 per cent.

Alternative assets began to register on pension fund portfolios in 1996, according to UBS Asset Management research, when the average scheme held 1 per cent. Fifty-three per cent of scheme assets were held in equities.

But as schemes mature, equities have fallen out of favour. The average allocation stood at 16 per cent in 2016, with 9 per cent in alternatives.

Moving money around a lot in the bond market can be quite expensive

Daniel Banks, River and Mercantile

The open RCT fund is looking to remain some way above this level following the implementation of its plan. It will lower its equity exposure to 58 per cent from 74.8 per cent.

Committee minutes from April indicate that Barrie Davies, director of financial services at the administering council, presented a review of the scheme’s assets and liabilities, conducted by investment adviser Aon.

The review highlighted the fund’s need to reduce risk, maintain return expectations and minimise long-term costs.

It also called for the scheme to increase its diversification, examine infrastructure and “optimise the transitioning of assets into the pool”.

The RCT fund is currently transitioning assets into the Wales Pension Partnership, one of eight local government pools. The fund did not respond to requests for comment.

Be careful with absolute return bond managers

The scheme has agreed a phased adjustment of its asset allocation strategy. Its equity allocation will drop from 74.8 per cent to 63 per cent, then fall again to 53 per cent.

Its property allocation will rise to 10 per cent from 5.4 per cent. This movement will be followed by a 10 per cent investment in absolute return bonds funds.

The final phase of the new strategy will include a 5 per cent allocation to infrastructure. These investments will bring the fund’s exposure to alternatives up to 25 per cent.

Daniel Banks, director at consultancy River and Mercantile Solutions, advised schemes to take caution in the absolute return bond market.

“It depends on what type of return you’re getting from your bond manager,” he said.

“Some absolute return bond managers actually still make a fair amount of their return from the spread… and therefore actually, low yields still mean absolute return bonds are going to find it hard to make return,” he added.

Other managers generate returns from buying and selling securities. This comes with its own challenges, Banks observed.

“That’s not that easy nowadays, especially post-2008 where the banks don’t hold a great deal of inventory of bonds, and therefore the buying and selling costs of bonds can be quite high,” he said.

“Actually moving money around a lot in the bond market can be quite expensive.”

The RCT fund is not alone in its search for exposure to the asset class. In June, Pensions Expert reported that the Northern Ireland Local Government Officers’ Superannuation Committee is on the hunt for two absolute return bond managers.

Move away from equities

As of the RCT fund’s last actuarial valuation at March 31 2016, the scheme was 81 per cent funded, up from 78 per cent at its 2013 valuation.

David Walker, head of Local Government Pension Scheme investment at consultancy Hymans Robertson, recognised that improved funding levels have prompted schemes to look away from equities in a quest to diversify or reduce risk.

As of July 31, the FTSE 100’s UK defined benefit schemes were 100 per cent funded on aggregate, according to JLT Employee Benefits. The average funding position of all UK DB private schemes on this basis sits at 99 per cent.

“This has often meant moving away from listed equities and traditional bond investments to asset classes such as private debt and infrastructure where there is a more visible and predictable income-focused return stream,” Walker said.

He added that schemes are also departing “existing diversifying solutions such as [diversified growth funds], where there can often be exposure to equities in favour of these more income focused asset classes”. DGF performance has also recently come in for criticism.

At a June meeting of the London Borough of Barnet Pension Fund Committee, chairman Mark Shooter described the performance of one of the scheme’s DGF mandates, held with Newton Investment Management, as “disastrously poor”.

Schemes should look to illiquid assets

The RCT fund has also committed to exploring opportunities in infrastructure investment.

Infrastructure investment is featuring increasingly among LGPS members. In March, the £3.9bn Middlesbrough Borough Council Teesside Pension Fund committed capital to energy storage assets through the British Strategic Investment Fund.

Naomi L’Estrange, director at professional trustee company 2020 Trustees, recognises the benefits of including illiquid assets in the fund’s investment strategy.

“Infrastructure and illiquidity premium is a theme,” she said. Given the timescale of LGPS liabilities, “that is the right thing to be doing”, she added.

The fund has proposed a three-step phased approach to adjusting its investment strategy.

This approach “takes some of the risk out, particularly market risk”, L’Estrange said. “The market in some of those areas is still developing,” she added.

Advisers often overlook transition costs

The RCT scheme’s total bond and cash exposure, which is separated into fixed interest, UK corporate bonds and cash, will initially rise to 27 per cent from 19.8 per cent before subsequently dropping back to 17 per cent.

The fund is also keen to avoid unnecessary costs incurred as it pools its assets in the WPP.

It enters the WPP alongside the Cardiff and Vale of Glamorgan, City and County of Swansea, Clwyd, Dyfed, Greater Gwent, Gwynedd and Powys LGPS.

The committee minutes read: “The implementation will be undertaken so as to minimise transition costs into the relevant [WPP] sub-funds when they become available.”

Eighty-five per cent of investment advisers surveyed by Hymans Robertson last year expressed concern over the costs of establishing and transitioning to asset pools.

“It is really important to look at transition costs and efficiency when you’re running [an] investment strategy,” L’Estrange said.

“In fact, I sometimes find that investment advisers don’t always think about that in terms of when they’re planning to do changes,” she added.

Pooling will help LGPS access alternatives

In May, the Avon Pension Fund threatened to terminate the mandates of underperforming asset managers, in order to avoid a doubling of transition costs as it moves assets into the Brunel Pension Partnership.

In Walker’s view, pooling has incentivised schemes to give more consideration to the strategic value of each part of their investment strategy.

“Investment strategy continues to be set locally and aligned to meet the objectives of each individual fund, as they may have different views on affordability and tolerances to risk,” he said.

“This allows better engagement with the new pools on strategic needs and helps to ensure that the range of investment options offered by pools meet the needs of their fund clients,” he added.

LGPS members had until April 2018 to finalise their plans for pooling, which was first announced in former chancellor George Osborne’s July 2015 Budget.

John Simmonds, principal at CEM Benchmarking, which provides investment benchmarks for LGPS members including the RCT fund, said that pooling represented an excellent opportunity for schemes to access new investment opportunities.

Owing in part to pressure from politicians, “they’re being pushed in some sense to rethink their approach to infrastructure”, he said.

“Also, I think there are funds that are interested in getting access to what might be regarded by some as high-cost asset classes like private equity,” he added.