Suffolk Pension Fund has reported a bounceback in its asset values after taking a £327m hit in the first quarter of the year, as experts said it is still legitimate for immature defined benefit schemes to lean on the equity risk premium.
The coronavirus pandemic and March tumble in stock markets hit many local government pension schemes hard, especially those with high exposure to equities.
As of March 31 the SPF, which has a comparatively moderate target allocation of 42 per cent to stocks, was down to £2.8bn, a £327m decline from its valuation in December 2019. An internal report attributed the fall to “the worldwide market reaction to the coronavirus pandemic”.
“The current estimated funding position for March 2020 shows a funding level of 90 per cent, a decrease of 8.8 per cent since the formal valuation exercise in March 2019,” the report stated.
Additionally, the overall investment return for the quarter was down more than 10 per cent.
Paul Finbow, senior pensions specialist for Suffolk Pension Fund, told Pensions Expert that, though the figure appeared to be dramatic, it did not represent the most significant drop experienced by the fund in the past two decades.
“In the past 20 years we’ve had far more significant falls in the fund value — 2001, 2003, 2009,” he said.
These things happen. Markets go up, they come down. We have a very diversified portfolio.
Paul Finbow, Suffolk Pension Fund
Furthermore, as the report did not account for the fact that “the fund had gone up earlier in the year”, he argued that in reality the drop was not as severe as it appeared in the report. “The headline number as of March 31 is a 4.5 per cent drop, not 10,” he said.
And there was a silver lining, he added, as the value of the fund’s investments had risen again since March 31. “So although it’s a big number — £327m is a lot of money — the fund has since March gone up by £170m.”
Suffolk’s experience will be consistent with that of many less mature DB schemes, which are sometimes said to be able to take equity risk owing to their long time horizons. Analysis from Unigestion on Tuesday suggested that the recovery in price of risky assets, like the fall, has been one of the “sharpest in history”.
“We’re a long-term investor,” Mr Finbow said. “These things happen. Markets go up, they come down. We have a very diversified portfolio, with a lot lower equity rating than some funds.”
Adrian Brown, senior adviser at MJ Hudson, told Pensions Expert that “many LGPS funds do have equity allocations in the 50-60 per cent range, so clearly will have experienced some volatility”.
“But, by the same token,” he added, “many are still cash flow-positive or neutral, so can afford to carry this volatility in order to achieve the better returns likely to be offered by equities.”
Signs of recovery
As previously reported by Pensions Expert, the LGPS advisory board is monitoring the current market turmoil closely and is prepared for an overall economic downturn in 2020.
LGPS prepared for lower investment return in 2020
On the go: While the Local Government Pension Scheme had a return of 6.2 per cent in 2019, its advisory board is monitoring the current market turmoil closely and is prepared for a downturn in 2020.
But funds like Suffolk that hold firm to their investment strategies may be seeing small signs of recovery, as equities have recovered by 30 per cent above their historic lows in a little over two months.
“Certainly, markets have recovered quicker than is normal in the early stages of a bull market,” said Rupert Thompson, chief investment officer at Kingswood. “In the past, the average gain has been around 20 per cent over the first three months, with it usually taking six months to see a rebound of 30 per cent.”
Sounding a note of caution however, he said: “The scope for further gains later in the year is looking increasingly limited... we do not expect [the recovery] to follow the V-shaped trajectory which the market currently does.”
As ever, DB schemes in both the public an private sector will have to look to moves in both their asset values and liabilities, said Bart Huby, a partner at LCP. He pointed to the offsetting effect of a fall in gilt yields, negating the funding improvement caused by a recovery in equities.
He also noted that the LGPS' recent valuation and revision to employer contributions are yet to recognised this twin-front attack on funding, being based on assumptions from March last year: "Unless there’s a significant recovery from where we are now, many employers will see an increased funding deficit at the next valuation."
Mr Huby continued: "With so much continuing uncertainty related to the Covid-19 crisis, it’s hard to predict where we’ll be for the next round of LGPS valuations, but employers participating in LGPS Funds need to be aware of the possibility of bigger deficits and increased contributions."
