Long-term view clouded by uncertainty for LGPS

Four in 10 scheme delegates prioritised establishing a long-term plan for reducing risk – over further diversification and investing in illiquid markets – in a vote at the Local Government Pensions Investment Forum this week.

But Graeme Russell, head of pensions at Torfaen Council and panellist at the session, said he was increasingly uncertain about the future outlook for the scheme and raised fears about further change being forced upon the scheme.

“I used to think we were long-term investors,” said Russell. “What is the timescale we are investing for? Is it longer term or are we being forced into a much shorter-term time horizon that could have long-term implications?"

Russell said it will be crucial for the LGPS to bring in investment returns and minimise downside if the scheme is to demonstrate the case for sustainability.

Catrina Arbuckle, principal at consultancy Mercer and chair of the session, said trying to reduce funding-level volatility by reducing risk must be a key objective for funds.

"While equities are never going to disappear as a key asset in your asset allocation policies... that has to be the direction of travel if you want to achieve better contribution-level stability and lower funding-level volatility. 

Assumptions about the scheme's long-term investment horizon also coloured delegates’ views of equity exposure; 40 per cent deemed reducing equity exposure amid current high pricing “irrelevant” due to the scheme’s long-term time horizon.

What is the timescale we are investing for? Is it longer-term or are we being forced into a much shorter-term time horizon that could have long-term implications

Graeme Russell, Torfaen

Generating returns

Torfaen is heavily invested in equities, with 70 per cent of the £2.2bn fund invested in UK and global equities; 80 per cent of the fund is actively managed.

Despite the fund’s high allocation to growth assets, Russell said its maturing membership profile and shrinking workforce makes generating sufficient levels of return relative to the rate of increase of the fund’s liabilities a “key frustration”.

“It takes you into the realms of saying, well, if you’re not going to invest so much in equities, what is it that is going to give you your investment return?,” he said.

Russell said risk reduction in the scheme was not happening as quickly as he would like but efforts to improve the derisking plan had lead to a systematic approach.

“There is no one solution,” said Russell.  

“We’re looking at equities… at the absolute levels that we’ve got and how best to use equities and reduce the risk premium there [through] smart beta and low-volatility-type concepts.”

Russell said he is also assessing potential for hedging in fixed interest assets.

Investing in best ideas

Merseyside Pension Fund has a similarly heavy equity bias at 53 per cent of its £6.7bn total assets – split 23 per cent in UK and 30 per cent overseas equities, spread across North America, Europe, Japan, the Pacific region and emerging markets.

Nearly 20 per cent of the fund is held in fixed income assets across gilts, UK index-linked bonds and credit.

The fund has a 5 per cent allocation to both private equity and hedge funds.

Leyland Otter, chief investment officer at Merseyside Pension Fund, told delegates that an initiative within the scheme to build an internally managed fund of funds, or “opportunities fund”,  had allowed Merseyside to access best investment ideas without being constrained to a certain asset class or silo.

“The initial idea behind that was we would use it as a sort of incubator to test ideas with a view to following up should those investments perform,” said Otter.

“It has actually performed quite well,” he said, adding that at a recent review of the fund’s strategic asset allocation, around 5 per cent of the fund, or £300m, was invested across this vehicle.

Otter said there was a “mixed bag” of capital-raising strategies in the opportunities fund, ranging from aircraft leasing to the financing of gold and copper mines – an idea that generated high double-digit returns pre-crisis but continued to generate stable returns through the global slowdown.

Otter said its current focus is assessing opportunities in infrastructure.

“We do regard it as an extremely important asset to match our liabilities,” he said.

“If we can lock into a 25-year regulated revenue stream, if you get inflation protection, effectively it’s providing better returns than bonds that aren’t providing anything at the moment."