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xx Month 2010 Local Government Chronicle xxlgcplus.com?? Local Government Chronicle 25 March 2010

1Investment

LGC’s regular special report

Which direction for super funds? p6

Fund mergers: does bigger mean better? p22

The race for Local Government Pension Scheme reform is hotting up p4

The greatest infl uences on local government pensions over the past 25 years p16

05.09.13 www.LGCplus.com

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NIC PATONSUPPLEMENT EDITORThe 25th anniversary of LGC’s Investment Summit, which takes place this week, is an excellent moment to step back and reflect; to reflect both on the achievements of the Local Government Pension Scheme community in successfully protecting and maximising the retirement incomes of thousands, and the intensely challenging future faced by the LGPS.

These are, in essence, the two core themes of this special LGC Investment supplement. First, the pace and scale of LGPS reform was highlighted by the expert panel convened by LGC in July to identify and celebrate the achievements of the ‘top 10’ who have made an outstanding contribution to local government pensions. This, inevitably, opened something of a can of worms, including such controversial questions as whether Lord Hutton should be included or excluded from such a list, given the scale of his influence on (as opposed to his direct contribution to) local government pensions.

As with any top 10 I fully expect there to be howls of outrage at some of our eventual choices as well as some nods of approval. We’d love to hear your views.

The succession of articles we have in this supplement, too, by Phil Triggs of Surrey CC, Nick Vickers of Kent CC and Kieran Quinn of Tameside MBC offering perspectives and insight on local government minister Brandon Lewis’ call for evidence on the merger of funds also serves to highlight the serious and complex tensions now set to be dominating the local government pensions landscape.

Within this supplement we also have Norfolk CC’s Nicola Mark examining the potential opportunity to be had from national LGPS procurement frameworks, Nick Buckland from Dorset CC outlining how his fund has been managing and mitigating risk and City of London Corporation chamberlain Chris Bilsland reflecting on how the investment landscape, and the LGPS, have changed over the years. Our reader survey, meanwhile, is also well worth a read. Terry Crossley, our editorial consultant, also offers his timely insight on the recent LGC Pension Fund Symposium and his predictions for the summit.

Finally, it was gratifying to see that so many of our expert panel’s eventual ‘outstanding’ top 10 are also regular contributors to LGC Investment, evidence of the continuing authority and ‘reach’ of the LGC brand. Long may it continue.

Contents

LGC Investment’s latest reader survey, in association with SL Capital Partners, questioned local authorities and fund managers about their current investment strategies p10

Who have had the greatest influence on local government pensions over the past 25 years? LGC’s round table event identified the ‘top 10’ who have made an ‘outstanding contribution’ p16

TERRY CROSSLEY offers a point of view on the recent LGC Pension Fund Symposium and makes his predictions for the Local Government Pension Scheme Investment Summit p4

PHIL TRIGGS provide some enlightenment – in the form of 10 key questions – to the issues arising directly from the possible introduction of super funds p6

NICK VICKERS aims to bring ‘some reality’ to the issue in light of local government minister Brandon Lewis’ call for evidence on fund mergers p22

KIERAN QUINN says it is important to consider all the options for informed analysis on fund mergers, with facts and figures – not opinion and sentiment – needed p24

CHRIS BILSLAND reflects on changes in the Local Government Pension Scheme and the investment landscape over the years p30

NICK BUCKLAND outlines Dorset County Pension Fund’s latest valuation review and its changing approach to managing its risk strategy p20

NICOLA MARK looks at the potential opportunities national LGPS procurement frameworks can deliver in these challenging economic times p26

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5 September 2013 Local Government Chronicle 3LGCplus.com

xx Local Government Chronicle xx Month 2010 lgcplus.comLGCplus.com4 Local Government Chronicle 5 September 2013

Reflecting on the very successful LGC Pension Fund Symposium held in

June, in association with AXA, and looking forward to the 25th Local Government Pension Scheme Investment Summit, being held on September 5-6 at the Celtic Manor Resort in Newport, Wales, I felt shivers of anticipation and concern about the next few valuation periods and outcomes for the scheme, its membership, employers, non-tax-raising employers and council tax payers who ultimately underpin the statutory pension promise.

Not for the first time in 25 years is the LGPS confronted by an array of internal, largely self-generated challenges – some vital, others perhaps not so – as well as global macro-economic and fiscal ones beyond even the control of the responsible authority in the shape of the secretary of state.

This was the context for the symposium. A very well thought through agenda, with considerable foresight, was much appreciated by the fund managers for whom it provided an authoritative update of current LGPS issues. There was much lively debate, challenge and discussion both within the open sessions and beyond.

A wide-ranging set of sessions about the current state of play with the LGPS reforms and the investment outlook were as worrying as they were uplifting. The April 2014 finishing line is in sight but it is only the end of lap two in the

‘Hutton Handicap’. The reforms are intended to produce savings for employers and ensure viability, sustainability and fairness but the vicissitudes of the markets, increasing risks and the actions of government, central banks and the frequently forgotten dynamics which drive the underlying nature of the LGPS locally, all combine to make it difficult to see the end of lap three, let alone the finishing tape.

Infrastructure options were mentioned, inevitably, but were not universally recognised, as some would have it, as the panacea for all ills. Cash flows, falling contributions, employer provenance and the impact of the latest round of local authority cuts were the big issues, while all around new ministerial initiatives were being thrown literally into the current Hutton mix.

These issues will doubtless emerge during the summit with further in-depth examination of the conditions surrounding investment strategies and perhaps with some much needed clarity on the outcomes of the 2013 valuation exercise.

In a more optimistic, practical mode, the symposium examined three novel and refreshing local antidotes to mergers. They each demonstrated that what works locally works best. These organic, self-generated reforms demonstrated real initiative and a response to what was needed in the light of local needs and conditions, rather than by any central

diktat. The tri-borough initiative, the partnership between Cumbria/Lancashire and the national framework model were proof-positive that at least one of Lord Hutton’s recommendations can be made to work.

Regarding the June call for evidence from the Department for Communities & Local Government, there was a wish among delegates that this should be a genuine attempt to establish a sensible, evidence-based assessment and be less reliant on unrelated overseas

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The race for pension scheme reform is hotting upTERRY CROSSLEY offers a timely point of view on the recent LGC Pension Fund Symposium and gives his predictions for the Local Government Pension Scheme Investment Summit

pension governance structures. There was considerable discussion and worry among delegates. Claimed savings by the DCLG were not considered objective; the lack of rigour so far in the debate was lamented, as was the failure to consult widely from the start of the exercise and to recognise early on, based on Welsh and Scottish studies, the many impracticalities, the role of the funds within local government financial frameworks and local democratic accountability

xx Month 2010 Local Government Chronicle xxlgcplus.comLGCplus.com 5 September 2013 Local Government Chronicle 5

itself. Had any assessment been made of the local initiatives so far developed?

The potential for market distortion, diseconomies of scale and of competition, and sheer scale of trusteeship were seen also as very significant issues, again already identified in Wales and Scotland, which could not be discounted. Any super fund or funds would seem to fall into the same camp even though these have their enthusiasts, based largely many feel on self-interested motivation.

A key session examined emerging governance, training/educational needs and the need for better standards of trusteeship within all fund authorities. The DCLG recent consultation is well primed on these areas, as were delegates. They strongly supported this aspect of reform and the importance of elected members being much more au fait and analytical in their future scrutiny within their new responsibilities for fund stewardship and their statutory management of fund

The finishing line is in sight but the LGPS race is far from over

The race for pension scheme reform is hotting up

deficits within and between valuations. Indeed, the Pensions Regulator (tPR) is likely to apply the broad terms of its excellent trustee toolkit. The practicalities of applying these new strictures in any large statutory merger format needs careful study. Perhaps the promised review of the extant investment regulations could take precedence over any legislated merger option? It is far more achievable before May 2015.

To round up the symposium, a detailed look at local governance and pension committee issues was much appreciated. Local experience and lessons are always valuable and worth codifying. Examples could well be sent to tPR.

In addition, we were treated to a transparent look into the inner workings of the shadow Scheme Advisory Board along with news of a chair appointment and a rather presumptive list of potential areas of interest. The list, given the advisory only role of the board, seemed significantly at odds with the scope of the 2013 act and the terms of the helpful DCLG recent consultation paper, which makes clear the statutory role of locally elected authorities and elected councillors who are legally charged with stewardship of their pension funds. Delegates wondered why investment management therefore would be seen as a matter for the board, when such matters are the responsibility of the relevant administering authority, as is the entire valuation/cost management process?

The summit takes these discussions forward amid a raft of ministerial initiatives and challenges, with no set implementation. The one known target is that the new LGPS benefit structure and all its spin-off payroll and data sources need to be in place from April. This remains the challenge.

And so what may the next 25 years bring? Ronnie Bowie, who has been closely involved with the scheme for the past 25 years, can, with some authority, quote his new partner, Robbie Burns. The summit will reveal their joint assessment. My own view is that we must be realistic and consider the future political landscape and the way the economy worldwide and at home unfolds.

The reforms seemed based on a very optimistic, generous benefit structure for a sector under immense resource and structural pressures. Investment income is unlikely to be the help it has been, as cash flows diminish and government at all levels is reduced, with a smaller contributing membership, high longevity and increasing levels of maturation. So, for me, 2020 will be the key point of judgement in the future life of the LGPS – that is just two valuations and another general election away.Terry Crossley is former deputy director responsible for workforce, pay and pensions at the Department for Communities & Local Government. He is also editorial consultant for LGC Investment al

amy


“There are more questions than answers, and the more I found out, the less I know…”

Acall for evidence on the future structure of the Local Government Pesion

Scheme is out there and, to cut right to the chase, some in the LGPS industry will regard the outcome as being already decided as far as the top echelons of the political hierarchy are concerned. That decision could be for mergers of the 89 England and Wales funds into five so-called super funds. As per the Johnny Nash 1972 hit quoted above, there are questions and answers, and this article aims to provide some enlightenment – in the form of 10 key questions – to issues arising directly from the possible introduction of super funds.

Q1: Is there a valid business case? What are the costs, benefits and payback period?Accurate costings arising from such a merger and the quantification of future potential benefits are required. The costs could be considerable: they include the set up costs for the super fund administrative authorities and fund transition costs, although on transition costs we have to remember that even today we have the cost of manager and mandate turnover and strictly the business case should only take into account transition costs over and above the ‘business as usual’ level.

The project and viable payback period must be

Pointing the way to a clearer futurePHIL TRIGGS provides the answers to key questions on issues that could arise if super funds are introduced

demonstrated. There is currently no suggestion merger costs would be borne by anyone apart from the LGPS funds themselves. This makes an accurate cost benefit analysis an absolutely vital ingredient in the decision making process. As things stand, we are not really sure how strong the business case is.

Q2: Is the LGPS cost information meaningful? Accurate LGPS cost information is required, especially with regard to investment management costs. The concept of the level playing field was highlighted recently with the publication of individual administering authority costs for 2011/12, split between investment fees and administration. The range from lowest to highest cost was significant. Such a range highlighted either a huge disparity of efficiency between the best and worst LPGS funds or, maybe, inaccurate data. A valid business case can only be made with precise and consistent costings. Poor and inconsistent data, especially with regard to the different treatment of pooled fund costs, will continue to cause inaccurate and unfair comparisons to be made between funds.

Q3: Assuming there will be five super funds operating across the LGPS, how will single investment strategies meet the requirements for many wide-ranging employer solvency levels and liability profiles?

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First of all, we can dispel the myth: there will be no cross subsidy among employers. Actuaries have always been able to cope with varying funding levels across individual organisations in LGPS funds. But super funds will increase the range of funding deficits across the participating employers within a single fund.

For most long-term, secure LGPS employers (for example county councils), funding levels are currently between 70% and 80% and a common investment strategy might suffice and will not be subject to much change. However, there is increasing diversity amongst employers due, for example, to outsourcing and the creation of academies.

Some will be better and worse funded. There are some well-funded employers who may be able to afford to reduce investment risk now and other mature, poorly funded employers who may not be able to reduce risk so easily even when conditions improve.

One size will not fit all, and a move to multi-investment strategies within one super fund will be necessary. Various permutations could exist among employers who are regarded as having a good or weak covenant, being well or poorly funded, and operating on a long or short time horizon. These various permutations will each require the selection of a best-fit investment strategy. Moreover, the desirability of being able to have some influence on the

level of investment risk could also become important if gilt yields rise quickly because the impact on deficits for individual employers may vary greatly in this environment.

Q4: Where will diseconomies of scale kick in? Will super funds result in large proportions being invested passively? Where will a super fund extract its alpha?It is argued that one single LGPS fund would be unwieldy: £150bn is a huge sum of money but at what level do diseconomies apply? If there were five £30bn funds, would diseconomies apply with regard to employing


COMMENTVALENTINA SHAN CHENEmerging Market Debt Fund Manager, Aviva Investors

Inflation is the bête noir of fixed income investors. It may have eased by two percentage points in the UK in the past two years, but even at 2.9%, real yields on UK gilts remain firmly in negative territory. Meanwhile, massive demand has driven the yields on UK index-linked bonds into the red. This underlines how poorly investors who choose to hedge against UK inflation by conventional means are rewarded for their trouble.

Thinking laterallyOne solution is to look to emerging markets where structural factors, such as poor infrastructure, drive far higher rates of inflation. After years of robust growth, labour markets are also tight with spare capacity wearing thin. Meanwhile, with per capita incomes still relatively low, inflation is much more influenced by food and energy costs than in the West.

Such drivers have helped emerging market inflation-linked bonds to deliver about 8% a year for the past three years, with close to 5% of this deriving from inflation accruals.

New horizonsHistorically, emerging market inflation-linked bonds have a low correlation to more mainstream asset classes offering excellent diversification potential. Credit quality from the 12 countries in Asia, Latin

America and Europe currently issuing such bonds is also uniformly high except Argentina.

More than 97% of this US$550bn market is rated investment grade meaning that UK investors need not sacrifice credit quality in the search for higher returns.

Emerging market currencies have also been steadily appreciating thanks to ample foreign reserves, healthy current account balances and much lower debt-to-GDP ratios than the West. This trend will continue to benefit inflation-linked bonds, which are denominated in local currencies. Over time, the expected convergence of emerging market interest rates with those of the West will also drive up valuations for inflation-linked bonds.

History lessonsIn only 20 years, average debt-to-GDP levels in the emerging world have fallen from 100% to just 34%, (they now tip 119% in the West). Meanwhile, per capita income has more than doubled. The next 20 years is likely to see similar advances, rewarding those who invest today. Make no mistake, it’s still a volatile market requiring an experienced guide. However, short-term volatility is a small price to pay for those with a sufficiently long investment horizon to capture the sweeping changes under way in the emerging world.

A rough guide to infl ation

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Pointing the way to a clearer future

investing in listed equity securities due to market impact costs and execution delays. There is a potential difficulty to change investment policies for larger scale funds because even small changes can affect the market.

The large schemes that have generated superior returns have done so through an increased allocation to alternative investments at favourably negotiated terms, while using internal staff to manage active strategies. This may have implications on asset allocation decisions (active or passive, liquid or illiquid, traditional or alternatives) and the composition and remuneration of the investment professionals.

Attracting and retaining in-house talented investment professionals paid at private sector rates at or above local authority director level could prove challenging (but not insurmountable), given that the super funds would almost certainly be run by five existing LGPS administering authorities. Some in-house operations already exist in LGPS administering authorities.

Continued overleaf

external active managers? Would the five super funds benefit from greater use of passive funds or might they recruit professionals to run active strategies in house? Would a more fragmented LGPS model enjoy the benefits of reduced market impact, diversified risk and possibly even reduced political interference, whilst continuing to benefit from lower expense ratios?

There is conflicting evidence with respect to the positive effect of scheme size on performance in the global pension fund industry. Some have argued that there are diseconomies of scale when

‘‘There is confl icting evidence with respect to the positive effect of scheme size on performance

LGCplus.com8 Local Government Chronicle 5 September 2013

Q5: Would fund merger help with the funding deficits?According to Hymans Robertson, funding levels across the LGPS are currently in the region of 75%. Fund merger will have no immediate effect on funding deficits but the incurring of set-up and transition costs could reduce the asset base slightly. Super funds or otherwise, deficits must continue to be tackled with additional contributions and improved investment performance from growth assets.

Deficits need to be managed and, whether or not this can be better achieved via the existing LGPS arrangement or a super fund structure, only time and experience will tell. But the starting point will be comparable data on fund deficits. We need disclosure of funding levels and deficits using like-for-like assumptions. There is currently a huge range of actuarial assumptions used in liability calculations. We need that level playing field but we need to be mindful that funds can justify varying actuarial approaches to setting contributions according to their unique liability profiles and the associated investment strategies.

Q6: Key politicians are already earmarking pension fund money for their desired projects. How will such projects dovetail with the overall investment and funding strategies?The important point here is that such projects must be relevant to the investment and funding objectives of the fund: the tail must not wag the dog here. While LGPS funds can be a valid source of

funding for infrastructure projects, a long term tie up and lack of liquidity must fit in with the fund’s liability profile. And the concept of super funds is not necessary to enable investment in housing projects or, indeed, any type of infrastructure. The pooling of infrastructure assets in common investment funds without fund merger will enable access to infrastructure investment at reasonable fee levels.

Q7: Will investment returns improve? Evidence from other countries suggests that scale benefits could improve net of fees investment performance. But there is no definitive proof that bigger is better. Indeed, there are examples of excellent results from smaller scale operations. Much of the current debate suggests that the super fund merger is about gaining more bargaining power on manager fees but, additionally, there exists a so-called ‘governance dividend’ arising from more responsive governance arrangements, more in-house specialist resource and more diversification by fund manager and asset class associated with larger funds. Interestingly, much of the evidence pointed to by the cheerleaders of super funds comes from overseas.

Whether or not such improvements can be achieved for the LGPS remains untested. Conversely, there is much negative experience associated with large funds overseas that the cheerleaders conveniently ignore.

Q8: How do super funds fit with the concepts of local accountability or localism? One key question is whether the concept of local accountability should remain and, if so, how can that be preserved with the

introduction of super funds. Super fund mergers would result in the loss of local decision making on matters such as investment risk, asset allocation and deficit recovery plans. Such decisions have a direct impact on local taxpayers and the concept of local accountability would certainly be diluted.

Q9: Is legislation required? The current LGPS structure and the powers and responsibilities bestowed on the current administering authorities were created by statute. It seems wholly unrealistic to expect that such powers can be taken away without further legislation, although whether this could be achieved through Statutory Instruments or would require a new act of Parliament probably depends on the way in which the changes are to be implemented. And that leads nicely to the question of time.

Q10: What is the time window here?There is a distinct hint that we are being rushed here. Implementing change to improve efficiency and performance is a major undertaking and the resource and effort required should not be underestimated. Time and effort invested upfront in the selection of options and

the resultant planning will lead to a better outcome. Getting legislation through Parliament must not be rushed. Administering authorities have a lot on their plates at the moment, including implementation of the new LGPS 2014 scheme by the start of next April and the 2013 actuarial valuation outcome. There is the impression of much haste and speed at the moment, and this is unlikely to produce the best result. A pilot scheme for any of the options available would highlight problematic areas, avoid costly errors and build confidence.

So, does this make the situation any clearer? Many practitioners have commented that the question of change and the various options put forward with regard to the LGPS venture into unchartered territory, and many of the questions asked have produced answers to which a stamp of certainty cannot be applied. Indeed our opening Johnny Nash lyric could have been written with this current crossroads clearly in mind. Hopefully, my next article will feature an alternative Nash lyric: “I can see clearly now.”● Read more reflections on the minister’s call for evidence on pages 22, 23 and 24. Phil Triggs is strategic finance manager at Surrey CC

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At a crossroads: the LGPS is venturing into unchartered territory

LGCplus.com 5 September 2013 Local Government Chronicle 9

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COMMENTBERNARD ABRAHAMSEN Head of Institutional Sales and Distribution,M&G Investments

For European investors, much of the first half of the year was rather uplifting in terms of investment performance.

However, as ever, in today’s market, it never pays to be complacent. Bouts of volatility are never too far away, and one arrived in May courtesy of Ben Bernanke, the governor of the US Federal Reserve. In a statement he suggested that the central bank would begin to slow down (or ‘taper’) its asset purchase programme should the US economy continue to recover. This highlighted that investors can’t rely on interest rates being at record lows forever.

In the aftermath of Bernanke’s comments, investors the world over entered a state of near-panic. June became the sixth-worst month on record for European credit, while Sterling credit posted its second-worst quarter since 1997.

Although markets have largely recovered since, such volatility highlights the dangers out there for prudent investors. How can they successfully navigate these bumpy markets?

Focus on being adequately rewarded for your risksWe believe that in many ways, the simple answer is to make sure that, as an investor, you are being adequately, or more-than-adequately compensated for the risks you are taking. Looking specifically at

corporate bond markets, do they tend to offer attractive returns for the risks?

The short answer is, in one sense they do, but in another sense they don’t. Core government bond yields are at multi-year lows, as shown by the top graph of Figure 1. Over the long-term, the only direction they can move is up. This leaves fixed rate bonds vulnerable to ‘duration’ (or interest rate) risks.

However, the bottom graph shows that, while yields are low, credit spreads are historically rather wide, and therefore attractive considering the risks. They may not be as wide as they were during 2008 or 2011, but they are wide nonetheless. This means that investors are demanding higher returns for taking on credit risks. But should they?

Corporates have generally looked after their balance sheets over the last decade, and so, in our view credit risks are not substantial.

So duration risk is not attractive, but credit risks might be. Of course, for a number of institutional

investors, duration risk isn’t a problem, since if interest rates sharply rise, the value of their liabilities will fall in line with their corporate bonds (as they will be discounted at a higher interest rate).

But for investors less inclined to accept interest rate risk, they can eliminate

it by buying floating rate bonds or hedging their fixed rate portfolios. This will leave them exposed only to credit risks (which look attractive).

For several years now, hedging out interest rate risks and only taking on credit risk has been a key

approach of our non-benchmarked total return multi-asset credit portfolios. This involves investing across a number of fixed income asset classes, from corporate bonds to real estate debt to infrastructure and loans.

Rational investors must be careful to always make sure that they are being compensated for the risks they are taking. If certain risks are simply not justified, they should be avoided or hedged in favour of risks that are.

As today’s yields are low, it can be tempting to look for higher yields through higher risks, but this is a dangerous strategy that can leave investors suffering during bouts of market panic (such as the one markets suffered in May and June this year).

In many cases, it’s best to be patient, keep your powder dry, and when there’s a good opportunity to earn attractive returns for the risks – pull the trigger.

Give credit where credit’s due in a volatile market

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June 03 June 04 June 05 June 06 June 07 June 08 June 09 June 10 June 11 June 12 June 13

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June 03 June 04 June 05 June 06 June 07 June 08 June 09 June 10 June 11 June 12 June 13

Gilt yield

Credit yield8

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Spreads are attractive though interest rates aren’t

FIGURE 1: £ INVESTMENT GRADE CREDIT SPREADS VERSUS GILTS (%)

Source: Bloomberg and Merrill Lynch, 30 June 2013

‘‘ Rational investors must be careful to always make sure that they are being compensated for the risks they are taking. If certain risks are simply not justifi ed, they should be avoided or hedged

xx Local Government Chronicle xx Month 2010 lgcplus.com

COMMENTDOMINIC HELMSLEYManaging Director, Infrastructure, SL Capital Partners

The private equity investment landscape is a healthy one as local government pension funds increase their allocations to private equity investments. This LGC Investment reader survey has revealed that the number of local authorities with more than 6% of their portfolio value in private equity has increased in excess of 15% over the past year.

In addition to a more positive outlook for private equity, the survey highlights that we are at an inflexion point for infrastructure allocations. Local government pension funds need and want to increase their exposure to these assets but issues around how to achieve this and increasingly uncertain regulatory frameworks are holding back significant commitments. This is detrimental to investors, infrastructure managers and the broader economy.

Just over a third of the local government pension funds surveyed are invested in infrastructure and, positively, more than 75% will be in the future. This evidence of increased appetite is supported by recent successful infrastructure fund raisings, the majority through unlisted funds.

The concern over structures and the regulatory framework reflects two things. First, frustration among investors that the industry has applied the private equity closed end fund structure, with fees on commitments, a carried interest component

and a 10-year life, to infrastructure assets.

These investments are inherently longer term in nature and steady performance rather than outperformance is the objective. A new solution needs to be found. Second, increasing uncertainty around regulatory regimes for infrastructure across many jurisdictions has undermined investment propositions. Interestingly, in the most stable and reliable infrastructure markets this has highlighted the real regulatory risks many infrastructure assets carry.

Investors have a clear preference for inflation protection and long-term liability matching that has led to the favoured nature of equity investment in UK demand-based assets. It is no surprise market activity over the past 12 months has been directed towards UK utilities with significant premiums paid over regulated asset value for water and gas distribution assets. With the improving economic outlook, it is possible more economically sensitive infrastructure assets will become more attractive given their scope for higher returns with a limited increase in risk.

Overall, we find local government pension funds are positive on the future for unlisted investments. Allocations to private equity are on the increase and there is a willingness to commit to infrastructure if solutions to the key issues can be found.

Appetite for infrastructure?

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Surveying your strategies for investmentLGC Investment’s latest reader survey, in association with SL Capital Partners, questioned local authorities and fund managers about their current investment strategies and their attitudes to certain asset classes

pension fund professionals, though this was closely followed by private equity and real estate. Infrastructure was placed fourth with bonds and fixed income viewed as the least attractive. These rankings across the Local Government Pension Scheme enable further scope for analysis on a broader platform.

Private equityResponses to the survey about private equity indicated that more than 70% of fund authorities were invested in this asset class. Significantly, the research showed that among the 78% of those invested in private equity, the asset class made up between 3% and 10% of their portfolios’ total value. How universally representative this finding is remains an interesting question.

Equally as significant is the confidence shown by respondents to the level of expected returns from their exposure to private equity, with 65% anticipating returns between 11% and 20%.

A further 30% of respondents anticipated returns of up to 10%. Effectively, more than 90% of responses demonstrated a strong level of market

Recent research from LGC, commissioned by SL Capital Partners, has

identified how the agility and flexibility of local pension fund authorities has assisted funds in adapting to a challenging economic environment to maximise investment income, at a particularly volatile time for all investors.

As part of the research, local authority councillors, officers, advisers and fund managers were surveyed about their current statutory investment strategies and the components of their asset portfolios. The research also explored the attitude towards certain asset classes, including private equity and infrastructure investments, and the appetite for increasing allocation to them.

The helpful responses, taken with the results of previous LGC surveys, again demonstrate the skill and professionalism of councillors, officers, advisers and fund managers to adapt to complex and ever-changing investment environments within challenging local authority and economic contexts.

OverviewInterestingly, equities were ranked highest among the asset classes by local authority

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Surveying your strategies for investmentFiG 1: What proportion oF your portFoLio vaLue is made up by private equity?

FiG 2: What returns are you LookinG For From your private equity investments over the next Five years?

FiG 3: is your aLLoCation to private equity at the Limits set by your advisors /trustees?

11% to 20 % 65.2%

21% to 30% 4.4%

0% to 10% 30.4%

3% to 5% 36.8%

6% to 10 % 34.8%

Greater than 10% 4.4%

0% to 2% 17.4%

No 43.5%

Don’t know4.4%

Yes 52.2%

FiG 4: do you beLieve the present market presents a Good time to inCrease aLLoCations to private equity investments??

FiG 5: are you GoinG to inCrease your aLLoCation to private equity?

FiG 6: rank in order oF attraCtiveness the FoLLoWinG sub-seCtors oF the private equity market

No 43.5%

Don’t know 21.7%

Yes 34.8%

No 39.1%

Yes 60.9%

0 20 40 60 80 100 120

1. Secondaries

Total score

2. North America

3. Turnaround

4. Energy

5. Europe

6. Real estate

xx Local Government Chronicle xx Month 2010 lgcplus.comLGCplus.com

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confidence. More than 50% of survey participants confirmed that their allocations were set by a combination of trustees (councillors) and advisers.

Further confidence in private equity investments was again expressed, as 61% of fund authorities reported that the present market provided a good opportunity to increase existing investment levels, though just over a third of the respondents indicated that such a step had not yet been realised.

Peter McKellar, chief investment officer of SL Capital Partners, comments: “We are very encouraged by the increasing importance that local authority pension funds are placing on allocations to private equity. It reflects the continued relevance of this form of company ownership that can deliver positive results and returns for all stakeholders.”

InfrastructureThe topicality of infrastructure investment provides a timely context to this element of the survey, particularly given the importance attached by the government to its relevance within growth policies for the UK economy.

While the government’s prime focus is on private sector pension funds to further their policies, there is some belief that there are opportunities for local government pension fund authorities to engage in this objective as well.

The survey responses suggest that 33% of local authorities are currently invested in infrastructure and, on average, there was a high level of satisfaction with this decision, and indeed a reasonable level of satisfaction with the extant regulations.

Current allocations within

investment strategies were predominantly within the range of 3% and 10%, with none in excess of 10%. Interestingly though, 63% of survey participants expressed immediate or likely intent to increase their allocations. Once again, this indicates a latent, if not actual, degree of confidence in the infrastructure asset class and its expected returns.

As to the type of infrastructure investment, the range of opportunities in Fig 10 best illustrates funds’ positions.

Target returns envisaged by fund authorities were equally as variable. Significantly, 50% expected returns to fall within a healthy 5% to 8%, with another 17% of respondents

Continued from previous page ‘‘ We are very encouraged by the increasing importance that local authority pension funds are placing on allocations to private equity

Yes 36.4%

3% to 5%36.4%

No 36.4%

6% to 10%45.5%

FiG 7: does your pension Fund authority CurrentLy invest in inFrastruCture assets?

FiG 9: are you pLanninG to inCrease or deCrease your aLLoCation to inFrastruCture investments?

FiG 8: What is your Current investment strateGy aLLoCation in inFrastruCture investments?

12 Local Government Chronicle 5 September 2013

0% to 2% 18.2%

Maybe 27.3%

Yes 33.3%

No 66.7%

xx Month 2010 Local Government Chronicle xxlgcplus.comLGCplus.com

indicating it to be up between 9% and 12% (see Fig 11).

In terms of geographic sector allocations, responses showed that the UK was most favoured, with global investments a very close runner. Infrastructure debt was least favoured.

More specifically, investments by type favoured exposure firstly to equity in PPP demand assets (such as water companies and rail) followed by equity in PPP availability assets (such as hospitals and schools) and equity in economically sensitive assets (such as airports and regional ports).

Fund authorities were invited to rank key attractions when making decisions about infrastructure investments,

with long term investments and inflation hedging being the standout attractions for making an investment in infrastructure in order of preference.

“Infrastructure investing has, to date, not fully delivered on its potential as an asset class,” says Dominic Helmsley, managing director, infrastructure, at SL Capital Partners.

“Given the positive characteristics of the assets for all pension funds, there is a clear incentive for all parties to create an improved model of ownership and risk management in the future. It will be important for both the investment returns and the UK economy in general,” he adds. ‘‘

Given the positive characteristics of the assets for all pension funds, there is a clear incentive for all parties to create an improved model of ownership and risk management in the future

5 September 2013 Local Government Chronicle 13

FiG 10: hoW do/WiLL you invest in inFrastruCture?

FiG 12: are you LikeLy to invest in/support the napF’s inFrastruCture initiative, the £2bn pensions inFrastruCture pLatForm?

FiG 11: What are your tarGet return expeCtations From inFrastruCture?

Through an unlisted infrastructure fund

33.3%

Through a fund of funds13.3%

Through a listed infrastructure fund

20%

7% to 8%33.3%9% to 12%

16.7%

5% to 6% 16.7%

No 16.7%Don’t k now 63.3%

Yes 20%

Directly into the assets 10%

I am not planning on investing in infrastructure23.3%

0% to 4% 6.7%

Greater than 12%3.3%

Don’t know6.7%

N/a16.7%

Strategic move: survey participants intend to increase their infrastructure allocations


▼

Investment

COMMENTSTEPHEN CASTLE Client Relationship Manager, Legal & General Investment Management

The availability and cost of credit has been the key driving factor of economic activity throughout the financial crisis. The easy credit conditions witnessed prior to the financial crisis in 2008 certainly helped to fuel the US and Spanish housing booms, which spectacularly imploded once credit vanished. Indeed, the broad withdrawal of credit throughout the system led to the worst recession seen for many decades. The subsequent quantitative easing (QE) measures implemented by various central banks aimed to reduce the cost of credit and force banks to provide new lending once again.

Credit conditions are just as important today, which is why significant changes warrant so much investor attention. As such a significant economic driver, investors pay special attention to squeezes in global credit conditions, and two important changes of late – an apparent change in the US Federal Reserve’s QE policy and tighter credit conditions in China – had an immediate market effect. Should these changes affect how we view our investment grade fixed income exposure?

Tapering tizzy First, talk of tapering the pace of US QE sent interest rates higher, notably US mortgage rates, which rose by around one percentage point for a 30-year deal. Reducing the

affordability of housing is not ideal, particularly given the hope the US housing market would boost US economic growth in coming months. It brought an abrupt halt to the waves of mortgage refinancing that have been boosting US consumers’ spending power and also increased the cost for new corporate borrowing, via loans or bonds.

The question for investors is whether it is necessary to reduce exposure in US companies such as retailers or banks, which are exposed to higher borrowing costs or to weakened US consumer spending. It is worth emphasising that US interest rates were incredibly low before the tapering talk, and even after the latest increase, the cost of credit remains pretty low. Furthermore, many economists are expecting an acceleration in GDP growth in the second half of 2013, thanks to a modest housing recovery, reduced government cutbacks and lower commodity prices boosting disposable incomes.

While a keen eye should be kept on US consumption, any slowdown of the US housing market recovery and, most importantly, any sign that banks have reacted to higher rates by tightening lending conditions, we think that keeping US exposure steady seems reasonable for now.

China chewThe impact of the second

Familiar sound of credit crunching change is more difficult to predict. Chinese credit has been expanding at a phenomenal rate in recent quarters – fast enough to prompt policymakers to fire a warning shot across the bow of the Chinese banks by suddenly restricting overnight liquidity. This forced banks to pay very high rates for a few days before the authorities eased conditions once more.

Some China observers suggest such a spike in overnight lending conditions is nothing like the stress we saw in developed market interbank lending during the financial crisis. Chinese policymakers insist that they are in complete control of the banking system and simply chose to temporarily raise rates to let the banks know that they couldn’t rely on automatic liquidity to fund their lending sprees.

Arguably, if they are in such control they could simply have called up the banks and told them to lend less, which suggests the policymakers may have less control than they would have us believe. But whatever the truth around the reasoning for recent actions, the result is a tightening of lending conditions to a system that has recently seen an explosion of debt and a seemingly unstoppable housing boom. This sounds familiar.

However, we should put this into perspective. Even

with economists cutting Chinese growth forecasts, expected growth should be at levels that the developed world can only dream of. Nonetheless, those companies that have budgeted for 8% or 9% Chinese growth for the next few years may announce rather disappointing results if growth comes in at 6% or 7%.

Indeed, even before the Chinese credit tightening, we have already seen some signs of disappointing growth as excessive investment by resource companies has led to too much supply and declining commodity prices. This may only be the start of price falls and weak profitability if Chinese consumption slows. Sales should still be on a rising trend, but the growth of emerging market demand has been the answer to the world’s problems for a number of years now, and companies have invested accordingly.

With this in mind, the Chinese credit crunch has resulted in significant scrutiny. Investor expectations may have to shift from strong growth to over-investment and low prices, and some companies could struggle to get through such a period. The secular trend of the rise of emerging markets may be intact, but when we look to pick up emerging market bargains, we need to avoid the falling knives.

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It goes without saying it has taken the hard work, expertise and outstanding dedication of many

thousands of people across local government to help the Local Government Pension Scheme successfully navigate the very complex turbulence of the past few decades.

Nevertheless, to mark the 25th anniversary of the LGC Investment Summit, LGC convened a high-level expert panel to decide who, among those who lead and guide the local government pension agenda, have been the ‘top 10’; those who have made an ‘outstanding contribution’ to local government pensions over the past quarter century.

Given the challenge our panel faced, it was important, first, to establish some ground rules as to what constitutes an ‘outstanding contribution’.

Simply doing one’s job, for example, was deemed an insufficient qualification. However meritorious someone’s work, they would not make the 10 unless they had ‘gone the extra mile’, perhaps by being involved over much of the period in sector-wide bodies and professional circles, advising government and delivering or sharing innovation.

Our judges (see panel) used categories such as corporate governance, constructive and expert stewardship and collaboration to steer their thoughts, but did not make specific category awards. Nor did they attempt to rank in any way those finally chosen.

The LGPS over the past

quarter century has experienced major changes, not just in political and structural/regulatory terms but on the investment side such as the switch from active to passive management, together with greater diversification and an increased use of overseas portfolios.

The mid-2000s saw increasing allocations to UK corporate bonds, emerging market equities and hedge funds. Then, with the 2008 crash, the move to diversified growth grew stronger in response to equity volatility, with increasing allocations to emerging markets and high yield debt. Liability-driven investment started and investors looked at fixed income absolute return strategies and new areas like infrastructure investment. A seminal moment, of course, was 2011 the Hutton report and recommendations to government for the reform of public service pension schemes which then set the LGPS on a course for its future reform.

This led to the first difficult decision for the panel. Should Lord Hutton make the top 10?

The key question was whether Lord Hutton, despite recent influence on local government pensions, was a suitable top 10 candidate, given also his lack of direct involvement in or responsibility for local government pensions. Could he, in essence, truly be said to have made an ‘outstanding contribution’ over the period?

Some panellists argued that the reverberations from his report meant he needed to be

included; he had been a “game-changer” when it came to the future of the LGPS, argued one for example. Others, conversely, took the position that he had simply endorsed the coalition government’s agenda.

Another who sparked debate was Lord Myners, with discussion around the influence of the Myners

▼

Investment

Greatest influences on local government pensionsLGC convened a round table in July to identify the ‘top 10’ who have made an ‘outstanding contribution’ to local government pensions over the past 25 years. MARK SMULIAN reports

Principles and his role in encouraging the move to alternative asset classes.

Active use of shareholder voting power has become a stronger theme over the period, and the panel considered whether this meant PIRC chief executive Alan MacDougall should make the grade for his influence on this aspect of


Continued overleaf

‘‘ It was important, fi rst, to establish some ground rules as to what constitutes an ‘outstanding contribution’

Greatest influences on local government pensions

corporate governance.Some nominees were

recognised as having made important and positively influencing contributions, yet it was felt they perhaps were just outside being included in the top 10.

These included Steve Lee, now with Investec Asset Management, for his services

to education in the sector, and Chris Derby for founding the LGC Investment Summit.

Another point of contention considered fully by the panel was the extent to which the 10 chosen needed to be focused on those currently dominating the landscape and those up and coming, or how much it should be overarching and celebrating

personal influence and contributions within the 25 years under review. The latter view prevailed but it was recognised that the LGPS for the future was in safe hands considering the talent, expertise and professionalism of a key group of younger, emerging experts

And the final 10? Overleaf are

those the panel selected. As with any ‘best of’ list there will be bound to be omissions or inclusions and LGC will be keen to hear the opinions of those both inside and outside the local government pension fund community.

THE PANEL

Lyndon BoltonClient director, SchrodersAlex CarpenterManaging director, EMEA institutional global client group, BlackrockStephen CastleClient relationship manager, Legal & GeneralTerry CrossleyFormer head of workforce pay and pensions, DCLG Peter Scales, OBEFormer chief executive, London Pensions Fund AuthorityLinda SelmanPartner, Hymans RobertsonKaren ShackletonIndependent adviserPhil TriggsStrategic manager, pensions and treasury, Surrey CC

PETE

R SE

ARLE

xx Local Government Chronicle xx Month 2010 lgcplus.com

▼

Investment



Brian BaileyDirector of pensions, West Midlands Pension Fund 2008-12, former director of finance, Wolverhampton City Council and chair of trustees, Birmingham International Airport Pension Scheme.Judges’ verdict: “Willingness to share his experience with others and one of those people DCLG could phone and say ‘we have to talk to the Cabinet Office, could you come down and talk with a voice of authority’, and Brian would be there speaking with authority and knowledge and a bit of passion as well.”

Ronnie BowieHymans Robertson’s senior partner, first president of the combined Institute and Faculty of Actuaries, trustee director of Royal Bank of Scotland Pension Scheme.Judges’ verdict: “Able to articulate the importance of funding of pension schemes, what the current situation looks like and the outlook, good and bad. A forward thinker who made us think more about liabilities and has the ability to be constructive in a very negative situation.”

Terry CrossleyDeputy director at DCLG responsible for workforce, pay and pensions until his 2012 retirement. He held a variety of appointments in DCLG and its

predecessor departments, moving into pensions in 1990. Judges’ verdict: “A touchstone over the last 25 years who has seen the scheme through a number of crises, whose oversight has been as an excellent regulator who moved the scheme to the point where it is now.”

Ian GreenwoodLeader of City of Bradford MDC until losing his seat in May 2012, before which chair of the West Yorkshire Pension Fund, of which he remains a trustee. Chair of the Local Authority Pension Fund Forum until January 2013.Judges’ verdict: “A politician who understands the fiduciary objective of a pension fund and carries his committee with him, a leader on the importance of good corporate governance, and very strong in the Local Authority Pension Fund Forum, which he made grow.”

Stuart ImesonFor 15 years until his 2009 retirement, head of pensions and investments, and later as director at West Yorkshire Pension Fund. Now in part-time role with Aurum Funds.Judges’ verdict: “One who buys and sells securities where others buy and sell managers. A fine example of internal management, and he’s responsible for hedge funds coming into the LGPS.”

Nicola MarkHead of the Norfolk Pension Fund since 2001, member of the CIPFA Pensions Panel, National Association of Pension Funds’ investment council and local authority steering group. Leads the National LGPS Frameworks procurement initiative.Judges’ verdict: “A powerful influencer and collaborator with others. A strong protagonist for doing the best for her local authorities and a noted thought leader with a very public profile.”

Richard McIndoeHead of pensions, Strathclyde Pension Fund. With Glasgow City Council since 1996, in 2003 became responsible for managing its role as administering authority for the Strathclyde fund. Member of the Scottish Local Government Pensions Advisory Group.Judges’ verdict: “Just very good stewardship of a very large fund. He did a lot with the CIPFA pensions panel, an innovator who is very collaborative.”

Peter MorrisDirector of the Greater Manchester Pension Fund, administered by Tameside MBC, where he has worked for 20 years, responsible for administration and investment. Member of DCLG’s Policy Review Group on the LGPS.Judges’ verdict: “Excellent stewardship

Top 10 most influential people


The LGC panel debate was sponsored and facilitated by three of the LGC Investment Summit’s longest supporting fund manager partners, who gave their reflections on the key trends driving the LGPS over the past 25 years, and the challenges it now faces.

Lyndon Bolton, client director, SchrodersI’ve been in local government pensions since 1988 and when I started funds were either managed internally by fund management teams or they employed one of the very few investment managers around. Each had the same strategy, which was to beat the median of their peer group, so they were all shadow boxing each other.

That gave way to more specific targets set by individual funds, which then selected from a much wider range of specialist managers and led to the profusion of mandates and managers we now have. What caused that change was a collective underperformance of the managers and a feeling that the funds had increasingly exclusive objectives.

Fund A’s objective was not the same as that of Fund B and in local authorities they will always compare themselves against the local authority average. But you can have one authority that has a completely different objective to another and so should have a completely different management structure. The question for the future will be that, as pressure hits local government schemes in terms of costs, will there still be 99 individual funds or some form of amalgamation as in the London boroughs, where that discussion is most advanced?

Alex Carpenter, managing director, EMEA Institutional Global Client Group, BlackrockPassive investment or indexation is much more prevalent really because of a disappointment with active management, and it’s fair to say active managers did not perform well. Costs came under greater scrutiny and indexation offered a lower cost approach to investing in equity markets. There was also a desire for greater certainty and to avoid the costs of active underperformance.

We also started to see greater interest into diversifying, with moves into alternative investments out of equities as the primary investment, and that trend continued into the 2000s. There were moves into property, hedge funds, infrastructure, private equity and those gave better returns in more diversified portfolios and were not correlated with equity markets in any great way, so the overall risk of the portfolio could be reduced.

In the past four years we’ve seen a greater focus on liabilities for pension schemes and a recognition they are exposed to interest rates and inflation risk, so we’ve seen liability-driven investing. I would expect that to increase as we see a greater appreciation of the trade off between risk and return; certain risks do not offer much in the way of return so you should look to manage those more carefully.

Stephen Castle, client relationship manager, Legal & General The biggest change has been the move by local authorities from active to passive management of funds, with index funds now used by local authority pension schemes. It’s because it was difficult to find good performance in active management, which is difficult as it’s very hard to outperform the index because the market is efficient and information is known quickly. Some funds have pursued diversified growth and absolute return, but passive has been the most common approach.

The consequences of the Hutton report are important because it has set the LGPS on a more sensible footing, recognising that people are going to live and work longer and that is now an important trend. Longevity is absolutely our largest challenge. With people living longer the rates previously used may not be appropriate. Someone used to retire at 60 and might die 10 years later, but now people live longer and the actuaries have to update their mortality tables every year, and the only ways round that are by insurance, or as some local authorities have done by taking out liability hedging.

One other trend is trying to link liabilities to assets in liability-driven investment, for example in infrastructure. I think we will see greater interest in that.

of a large scheme, with innovation in areas like infrastructure and collaboration with local authorities. An independent thinker, not too easily swayed by what others are thinking, unless he believes in it himself. He runs the standout local authority pension fund in the country.”

Howard PearceHead of environmental finance and pension fund management at the Environment Agency for 10 years until retirement in May. Past member of the DCLG’s LGPS policy review, technical, investment regulations and procurement groups.Judges’ verdict: “Strong on corporate governance and introduced environmental factors into investment structures. He really led that and shared all his knowledge.”

Peter Scales, OBERetired as chief executive of the London Pensions Fund Authority in 2006 after some 20 years in local government investments. Now an independent governance adviser to the North Yorkshire and Dorset funds. Judges’ verdict: “His was the standout fund along with Tameside and West Midlands. Peter’s commitment to Cipfa’s pensions panel was notable and Peter gave sensible and balanced advice when things were in a state of flux.”

REFLECTIONS ON THE KEY TRENDS


In 2011, when we commenced our traditional post-actuarial valuation review of the

fund’s strategic asset allocation we did so with no preconceived ideas about where we would end up. But one thing was clear: whatever we decided to do needed to have the full buy-in of the committee. The best way to do this, in my view, is to ensure committee members are involved right from the start and so, even before the consultant started work, we presented the broad concepts of the project to ensure there was opportunity to get this buy-in.

The key focus of the review was to understand and optimise the risk inherent within the investment strategy, and therefore the initial stages of the process would be to identify what and where they were, quantify them, and assess what could we do to manage them.

By way of background, fig 1 shows the asset allocation of the Dorset Fund as it was at the start of the review. To put it into context, the fund was holding higher balances in cash than the target position, awaiting

Dorset’s approach to managing key riskNICK BUCKLAND outlines Dorset County Pension Fund’s latest valuation review and the changes it has made to its risk strategy

investment in property and private equity, but other than that, we were close to our strategic targets at the time.

The first task, therefore, was to establish where the key risks in the current strategy were. Fig 2 shows the results of the analysis. In summary, the expected return of the fund, based on market consensus views of each asset class at the time, was 8.45%, comfortably ahead of the actuary’s assumed long-term rate of return of 6.9%. The assessment also calculated that the value at risk (VaR) of the portfolio was plus or minus £242m, which can be seen in the dark blue total column. It is clear where the key risks for the fund were.

Interest ratesThis initial assessment of the Dorset Fund was undertaken using the traditional ‘Gilts

Plus’ actuarial modelling, which gives a large interest rate risk. However, Dorset’s actuary does not use this method, preferring to use forecast actual returns. As a result the risk to us of interest rate movements is very much minimised.

Market riskThis is the risk of volatility within global investment markets. A risk that is clearly necessary to take in a fund trying to make good its actuarial deficit, and also one for which, in the long run, the investor should be rewarded for taking.

InflationAll Local Government Pension Scheme benefits are linked to the consumer price index, and therefore the Dorset Fund, like everyone else, has significant risk in this area.

▼

Investment

I have deliberately excluded mortality risk, although it was considered. I felt, while it is clearly a significant risk, it was one that would emerge over a longer period of time and with a likely rising interest rate environment one where protection may be cheaper in the future.

Given this initial assessment, we decided Inflation was the area we would focus on, and so, with the help of the consultant, we held another training session with the committee to explain the work undertaken, what assessments of risk had been made, and what the proposed solution was.

The problem, therefore, was how to reduce this risk without

FIG 1: OLD ASSET ALLOCATION

Actual 31/12/10%

Target%

UK equity 30.5 30.0

O/S equity 28.5 28.5

Property 7.1 10.0

Corp. bonds 20.4 20.0

Hedge funds 5.8 6.0

Private equity 2.4 4.0

Cash 5.3 1.5

-0.4

-0.2

-0.0

0.2

0.4

0.6

Inte

rest

rate

Infla

tion

Basis

Dive

rsifi

c’n

Mar

ket

Dive

rsifi

c’n

Tota

l

Mor

talit

y

FIG 2: THE CHART SHOWS INFLATION, INTEREST RATES AND MARKET RISK ARE WHERE THE FUND HAS THE BIGGEST ISSUES

FIG 3: NEW ASSET ALLOCATION

Target%

Change %

UK equity 28.0 -2.0

O/S equity 27.0 -1.5

Property 10.0 0

Corp. bonds 10.0 -10.0

Inflation hedging 10.0 +10.0

Hedge funds 6.0 0

Private equity 4.0 0

Diversified growth 5.0 +5.0

Cash 0 -1.5

‘‘ When we come to revisit the strategy after receiving the results of the 2013 actuarial valuation, it is likely to be a case of looking to see how we can increase the level of protectionDe

ficit

risk (

£bn)

Source: JLT Benefit Solutions based on the results of the 31 March 2010 actuarial valuation and JLT Market Forecast Committee.

xx Month 2010 Local Government Chronicle xxlgcplus.com

COMMENTDON JORDISONManaging Director, PropertyThreadneedle Investments

The recent upswing in the UK commercial property market reflects the impact of the third round of quantitative easing (QE3). This emphasises the maxim that price movements in property tend to be driven by liquidity rather than by trends in fundamentals, such as economic activity, tenant demand and rents. We believe that investors currently have a significant opportunity in the commercial property sector.

So if property provides a good opportunity to investors at the moment, what are the advantages for those also seeking to exploit and help to drive the growing interest in carbon efficiency? Quite simply, the UK commercial property sector currently accounts for about 20% of the country’s total carbon emissions and, unsurprisingly, the government has introduced legislation designed to reduce this figure. Hence, demand for low carbon commercial buildings in the UK is rising sharply.

What may surprise institutional investors are the opportunities these new regulations have created. Indeed, the Carbon Trust estimates latent demand for low carbon workspace at about 4.3 million square feet. But with annual new build supply only accounting for 1%-2% of stock, existing properties – 80% of which are more than a decade old and unlikely to

comply with low carbon requirements – will need to be upgraded.

Due to the imbalance between supply and demand, low carbon properties should benefit from better security and quality of income, greater potential for capital gains, shorter void periods and access to pre let developments. The Carbon Reduction Commitment (CRC) has brought a welcome focus back onto existing stock. With a significant proportion of standing properties due for refurbishment in the next 10 years, this presents a key window of opportunity for owners and investors to ensure that their office space meets the CRC standard, enabling them to differentiate themselves from properties at risk of obsolescence.

It is important investors realise that property is a long-term investment, which provides a high and stable income return, as the majority of returns in the sector are generated through income rather than capital appreciation. Therefore, by investing in a fund that targets the low carbon properties, investors can benefit from the twin tailwinds of the general improvement in the commercial property sector and the growing imperative for businesses to improve the environmental impact of their properties.

The drive for low carbon

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Dorset’s approach to managing key risk

significantly affecting the return. We concluded it would be possible to add an element of inflation protection, which would potentially reduce the VaR by around a third, but only affect the potential return by about 0.2%.

Therefore it was decided to allocate an initial 10% of the fund’s assets, to be funded from the corporate bond portfolio, to a liability (inflation) matching manager. Fig 3 shows the new strategic asset allocation and the changes made; inflation hedging, and a new investment in diversified growth funds.

The inflation hedging portfolio had an initial target of protecting around 30% of the fund’s asset value, by using a range of inflation-based derivative instruments, with the following objectives:● To protect the fund against adverse movements in inflation● To reduce volatility of funding level and contribution rates● To do so using a range of derivative instruments● Initial ‘trigger levels’ agreed with manager, implementation delegated. We agreed strategic target trigger levels for buying inflation protection and gave the manager discretion to act upon them.

It is generally accepted the LGPS investment regulations do not allow funds to undertake derivative transactions, even when used in a risk-reduction exercise such as this, so the implementation of the inflation protection

programme was not entirely straight forward.

It required Dorset’s appointed fund manager to setup a Qualifying Investor Fund to give us access to the range of instruments required to effectively manage the liabilities. In effect, it has been set up as a pooled fund in which we are the only investor.

There have been suggestions this could be seen as using a ‘loophole’ in the regulations. However, we prefer to see it as effectively managing the assets and liability risks within the fund, using all tools available. The other point I would make is that, if the LGPS Investment Regulations were revised to allow such transactions, it would make the whole process much easier and less expensive.

In conclusion: have we been successful in managing our inflation exposure? So far, so good. When we come to revisit the strategy after receiving the results of the 2013 actuarial valuation, it is likely to be a case of looking to see how we can increase the level of protection. In addition, I would add the next time we look to make any significant changes to the fund’s asset allocation, I will not underestimate the value to be gained from ensuring the committee are given sufficient time and training to be comfortable with the proposals. Nick Buckland is head of treasury and pensions, Dorset County Pension Fund


One of the great privileges of working with local authority pension

funds is the insights we get from our investment managers into the key macro economic issues. Issues such as what is the likely impact of the tapering of quantitative easing or the consequences globally of a prolonged slowdown in the Chinese economy; real issues that will materially affect our investment returns and our ability to pay current and future pensions.

For elected members and the directors of finance ultimately responsible for the management of the funds, there is the incredible challenge of the SR13, which is likely to give local authorities year-on-year reductions of 10% in central government funding for the reminder of the decade.

That backdrop makes the local government minister’s 22 May announcement of a call for evidence on the merger of funds all the more difficult to understand.

The high-level objectives of the exercise are dealing with deficits and improving investment returns. There are then a further six secondary objectives, including reducing investment fees, improving the flexibility of investment strategies, more investment in infrastructure, improving cost effectiveness of administration, access to higher quality staff resource and more in-house investment resource.

So far I have followed the

Bigger doesn’t necessarily mean better Following local government minister Brandon Lewis’ call for evidence on fund mergers, NICK VICKERS aims to bring ‘some reality’ to the issue, and overleaf, Kieran Quinn of Tameside MBC gives his perspective

arguments for merging funds with great reluctance and with a degree of amazement, so here is my attempt to bring some reality to the issue.

One of the major claims is that larger funds produce better investment returns.

Well, we have just received the 2012/13 annual ‘league tables’ from the independent WM Company. They provide a very clear answer to this issue and once again it shows clearly, as it does year after year, that there is no correlation between investment returns and the size of the fund.

In fact the top two performers were two of the smallest funds, Orkney Islands and the Isle of Wight. And (with even more pleasure for me) the best performing large fund was Kent CC.

As we all know a little knowledge is a dangerous thing. Funds that two to three years ago thought they were being very clever to move out of equities and into exotic alternative investments have cost their funds tens of millions of pounds. A typical 70% allocation, rather than a 15% allocation to equities, over the past year would have cost a £2bn fund £180m in lost returns from equities.

There is no single model that guarantees the holy grail of consistent investment outperformance, and it is ludicrous to pretend there is. Currently funds go about achieving their objectives in different ways and these evolve and change over time to fit their local circumstances.

Another major argument is around scheme costs, with some media clearly wanting to present Local Government Pension Scheme funds as being ripped off by the City.

Again it’s a great shame to let facts get in the way. The £3.8bn Kent Fund paid £11m in investment manager fees in 2012/13, or 0.29%.

All investment manager appointments for all LGPS funds are subject to EU procurement legislation. Price will be one of the factors in the

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‘‘ There is no single model that guarantees the holy grail of consistent investment outperformance, and it is ludicrous to pretend there is

The annual league tables show there is no correlation between investment returns and the size of the fund

xx Month 2010 Local Government Chronicle xxlgcplus.com

COMMENTNIALL O’LEARY Head of EMEA Portfolio Stategists Group, State Street Global Advisors

Emerging Markets (EM) have underperformed developed markets in recent times, perhaps leaving some investors more wary about their commitment to the asset class. However, it is important for investors not to lose sight of their longer-term strategic asset allocation goals.

What has contributed to the recent underperformance relative to developed markets? Monetary policy in the US – in particular the potential to reign in the extent of quantitative easing – is seen as negative for EM growth prospects. The slow-down in Chinese growth, a core feature of the overall EM growth story, has elevated worries about possible flow-on effects to other markets dependent on the Chinese growth engine. The weakness of the Japanese yen has also damaged growth expectations for other Asian economies, where the relative strength of their currency is seen as a disadvantage. Meanwhile, disturbances in countries like Turkey, Egypt and even Brazil have added to the negative vibe.

A look beyond these immediate events, however, shows that the secular case for EM hasn’t been undermined. The economic growth forecast for EM this year is around 4.5%, rising above 5% next year – perhaps lower than we have come to expect, but still significantly faster economic growth than major developed markets. Over the past 10 years EM

has outperformed developed markets by 6% per annum – so it is perhaps not unusual to see some of that relative outperformance unwind in the shorter term. Favourable demographics and generally more stable democracies – crucial for longer-term growth – remain fundamental characteristics of many EM countries.

Our outlook for EM is influenced by the economic factors at play – EM earnings are forecast to grow by 13% over the next 12 months. In terms of multiples, EM equities are trading at 9.9 times 12-month future earnings, which is almost one standard deviation cheap to their long-term average. With a yield of 2.9%, its it is difficult to argue that EM is an expensive asset class. Add to that the improving outlook for the developed world – in particular the pickup and growth in the US, Japan and now Europe – and there are reasons to be optimistic about EM as we go forward.

So, despite the short-term headwinds of US monetary policy, concerns around China and some country-specific events, the broad long-term secular case for EM remains favourable. Now accounting for more than 40% of world GDP, EM is an asset class likely to generate strong performance in the years ahead and remain an important component of diversified investment portfolios.

EM – down but not out

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Bigger doesn’t necessarily mean better

contract award, for the Kent Fund typically 20% of the evaluation is based upon price.

Well the ‘shocking’ truth is that, when we go out to tender, as we currently are for a global equity manager, managers with excellent investment performance track records tend to charge much more than those with poor investment records.

So in a market economy those with stronger products charge more. I am thoroughly unconvinced larger funds will pay less in fees unless they manage more funds passively and therefore deny themselves the opportunity for any outperformance or of course appoint poorer quality investment managers who charge less.

Moving on to the oft-repeated claim that we need to create larger funds so they can invest more in infrastructure and act more in the fashion of international sovereign wealth funds. Much as I can dream of LGPS funds being comparable with sovereign wealth funds, it is a laughable comparison.

Sovereign wealth funds are primarily working on behalf of developing economies to invest, often oil-related, surpluses. That’s not quite the financial environment of local authority pension funds.

At the last actuarial valuation all local authority funds were in deficit with liabilities of £200bn. Despite the good investment returns we have all achieved over the past three years I’m pretty confident deficits will remain and if anything increase.

Just look at what has driven Detroit into insolvency-pension liabilities and trying to be very clever in how you manage them, with appalling financial consequences.

And that reminds us that LGPS funds are not primarily vehicles for long-term investment. They are, of course, there to manage cashflows for the payment of current and future pensions.

The 2013 actuarial valuation is also likely to show increased proportions of pensioners and deferred pensions to active members; and major reductions in the level of positive cashflows. We know that is going to impact on asset allocation and on fund liquidity. So, tying more money up in illiquid, risky development infrastructure projects looks highly irresponsible.

Overall it is difficult to avoid the view that this merger agenda is very much a London issue, and maybe some people forget that there is quite a lot of the country outside London.

So, rather than being distracted by inter-authority wrangling, perhaps there is more to be said for focusing on issues such as improved governance of funds and increased collaboration. The Norfolk framework contracts and the Kent CC-led administration system framework are excellent examples of the scope the current 89 administering authorities have for being more transparent and more efficient.Nick Vickers is head of financial services at Kent CC AL

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W e welcome minister Brandon Lewis’ announcement

that there will be a call for evidence on the future structure of Local Government Pension Scheme council pension funds, and we support initiatives to improve efficiency and performance of these funds. It is important all stakeholders keep an open mind.

Gathering evidence is the first step. There is a lack of quality data on current costs of running the LGPS, particularly investment management costs where the potential to make significant savings is greatest. Good data will ensure an informed analysis is possible and allow objective decisions to be made. By focusing on facts and figures, rather than opinion and sentiment, we can achieve the twin aims of improving efficiencies and performance while retaining a level of local control.

A lot of the debate centres around the potential benefits from economies of scale. Some research has been carried out in the UK and overseas which suggests that scale benefits could improve net of fees investment performance by 50 basis points or more per annum over the long term (equivalent to nearly £1bn per annum in cash terms). Much of the debate so far has focused on gaining more bargaining power and driving down fees. While this would be very desirable it is not the only advantage. There is further research that suggests further gains of about half this amount could be achieved from a

‘governance dividend’ such as more responsive governance arrangements, more in-house specialist resource and more diversification by fund manager and asset class.

The extent of any performance improvement achieved will depend on how effectively any structural changes and associated ongoing governance arrangements are implemented. However, if these efficiencies can be realised this would achieve the government’s aims of providing better value for money while the savings could be put towards repairing the deficits of the LGPS funds.

There is more than one way of achieving benefits of scale on council pension fund investments and there are pros and cons in all of the potential approaches.

Fund merger is one potential way of achieving this, and is the route which has grabbed the

Consider all the optionsKIERAN QUINN says facts and figures, not opinion and sentiment, are needed for informed analysis on fund mergers

headlines and stirred most emotion. But merger would involve loss of local control, would require legislative change and could take considerable time and effort without necessarily delivering benefits beyond those which could be achieved by other approaches.

So can we achieve benefits of investment scale without some of the drawbacks of fund merger? For example, pooling of assets to achieve benefits of scale could be implemented more quickly without regulatory change. This approach would make it possible to realise significant economies of scale with less disruption, while still retaining local decision making on key matters such as asset allocation and deficit recovery plans.

Smaller LGPS funds currently have more limited investment options than large funds and even the largest funds have limitations. Either

option (merging or pooling of assets) would allow funds to be more innovative in their investment strategies.

In addition, either option would allow sufficient diversification to extend the range of assets held, achieving the twin aims of investing for growth and investing for the greater good – green investments, investing to grow the economy, investing in infrastructure and investing in local communities, for example. A series of collectivised investment vehicles available to all LGPS funds could be used for these asset classes to enable more affordable access for all LGPS funds irrespective of size.

Any decision on the preferred approach (mergers to create fewer, larger funds or pooling assets without fund merger) will depend on government policy about localism and practicalities such as any required legislative change, the up-front cost and effort involved and the expected payback.

All stakeholders should be able to agree that it is worth exploring how LGPS council pension funds can work together to achieve scale benefits to improve efficiency and performance.

However, implementing change to improve efficiency and performance is a major undertaking. Time and effort invested up-front in option analysis and planning will be rewarded with better long-term outcomes and a sustainable LGPS for the long term.Kieran Quinn is executive leader of Tameside MBC

Consider all the options

PROS ● Possible benefits of investment scale● Lower investment manager fees● More internal specialist resource● More responsive governance● May give critical mass for certain types of investment● More diversification possible● Larger funds may result in better net of fees performance on average

CONS ● Loss of local accountability and control● Implementation cost and effort – selecting, resourcing and setting up new or enlarged authorities● Significant legislative change required● Better performance not guaranteed – depends on effective implementation, proper resourcing and governance● Alternative approaches may achieve similar benefits with less disruption and cost?

ADVANTAGES AND DISADVANTAGES OF MERGER


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COMMENTJENNIFER GORGOLL, CFA & NISH POPATCo-Lead Portfolio Managers, Emerging Markets Corporate Debt, Neuberger Berman

In the midst of recent volatility, we believe it makes sense to get ‘back to basics’ in assessing emerging markets corporate debt.

Over the past few quarters, as growth has remained tepid, we have seen some deterioration in credit fundamentals in emerging market corporates, particularly in Latin America, most notably among Mexican home builders and within the oil and gas sector in Brazil.

In the latter case, a particular emerging market corporate issuer with virtually no revenue, negative EBITDA and significant capital expenditure commitments managed to issue $3.6bn in bonds over a two-year period on expectations/hopes of the company potentially striking oil.

The prospect that such an issuer would eventually struggle seems less than surprising. Yet many investors, searching for yield, were willing to make a bet based only on a highly speculative assessment of the company’s oil and gas resources. Indeed, during the run-up in fixed income valuations in 2012, it became all too common for managers to set aside fundamentals, whether at the company, sector or country levels, in search of yield.

Fundamentals matterThe lesson to us is that fundamentals always matter. Within our investment team, this means looking closely at profitability, leverage profile and growth prospects for a company and its industry.

Does the business have enough liquidity to cover operations, working capital needs and other requirements? Does it reinvest wisely? Does it engage in excessive acquisitions or stock buybacks, or excessive dividend payments that could reduce credit quality? Does the company have well-

Emerging market corporate debt: why it is time to get back to basics

defined governance policies and are its management’s practices friendly to bondholders overall?

Most emerging market corporates are also influenced by the performance of the country within which they are located, leading us to take our analysis one step further. What is happening to growth in the country? Is inflation/unemployment under control? How much debt does the country have? What is happening to the country’s local currency?

These questions are key to determining whether or not a

company will have a stable operating environment. Therefore, we overlay bottom-up corporate analysis with not only a sector view but also a comprehensive country view in approaching corporates.

Structural improvementsThe emerging corporate debt market has grown by leaps and bounds in recent years – and for good reason. Investors benefit from stronger emerging market economies, deeper and more sophisticated local capital markets, increased financial transparency, and better understanding by global investors of the opportunities in the emerging markets corporate space.

Structural improvements in emerging countries have markedly reduced the country risk premium of many sovereign issuers, in turn allowing corporate issuers beyond blue chip names access to international capital markets.

All of these factors contribute to our confidence in the long-term prospects of the sector. Indeed, we believe recent setbacks have provided attractive entry points in some names. That said, we believe that any investment should be made with eyes wide open – based on real research and an understanding of the basic fundamentals.

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Many investors have been willing to make highly speculative assessment of emerging market corporates, such as in Brazil


The Local Government Pension Scheme exists to do exactly

what it says on the tin – provide those involved in delivering public services on behalf of local government with a source of income for their retirement.

Like many other sectors, local government has felt – and continues to feel – the brunt of the difficult economic times. Within local government, no one is more acutely aware of the financial challenges and their impact than the elected members and officers with responsibility for administering the LGPS.

We know from direct, first hand experience the anxiety and very real stress experienced by scheme members and employers as difficult decisions are taken about jobs, employment arrangements and of course the impact of rising pension contribution rates.

We also know the life-changing difference that membership of the LGPS can make for our members. Despite the oft prevailing fallacy about our average member – that he is a fat cat licking the cream off his ‘gold plated’ pension – the truth is more often that she is a part-time, lower paid worker whose small pension makes a very big difference.

Local accountability is also a very powerful force. Officers

and elected members are directly accountable for the quality, effectiveness and value for money of the services we provide. I can tell you from first-hand experience just how effectively this focuses your mind to continually seek ways to sharpen your act. Quite rightly, there is no hiding place.

So – knowing the value and the cost of pensions – no one is more motivated than LGPS funds to find ways of achieving savings and efficiencies and safeguard the LGPS lifeline for

Safeguarding the LGPS lifeline for the futureWith local government continuing to feel the brunt of challenging economic times, NICOLA MARK looks at the potential opportunities national LGPS procurement frameworks can deliver

future generations.The question is, how should

we respond? How do we safeguard what is most valuable – ensuring affordable and sustainable pensions for those delivering essential and diverse services on behalf of local government?

The answer, of course, is we must respond in the same way we always have, by challenging ourselves and each other to find new and innovative ways of delivering better value – saving time and money while

safeguarding the essential, never being complacent.

And that is exactly what is happening right now. Even while we await the outcome of the minister’s call for evidence on the future structure of the LGPS, the transformation of how we do what we do is happening and already delivering positive outcomes for funds, and consequently employees and employers.

Continued overleaf

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The LGPS makes a big difference for many lower paid workers


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COMMENTMARTIN DAVISHead of Farmland Investments, Insight Investment

The menu of opportunities for investors in real assets is expanding. A sustainable and global approach to farmland investing merits particular attention.

Real assets have rightly caught the attention of local authority pension schemes and other institutional investors. Many pension funds have an explicit link between their liabilities (the benefits they pay) and inflation. Real assets offer the prospect of inflation protection, income generation and long-term capital appreciation. At the overall portfolio level, low correlation with mainstream asset classes also provides diversification benefits.

In the 1970s real assets meant property. Since then governments, starting with the UK in 1981, have issued increasing amounts of inflation-linked bonds. Innovations such as futures markets and Exchange Traded Funds have made investing in commodities easier. Farmland is also a real asset that has become investible, through fund structures. As an investment, farmland has a number of compelling characteristics: ● Demand: Global population is estimated to rise from seven billion to nine billion in the next 40 years; and as nations get wealthier, they eat differently. The Chinese eat four times as much meat as they did in 1970. But that is still less than a third of the per capita annual meat consumption in the US.

● Supply: The benefits reaped by the ‘green revolution’ of better fertilisers, crops and pest control peaked in 1975 when growth in the production of cereals per hectare was 3.5% per annum. In spite of the promise of genetically modified crops and other agricultural innovations, that has fallen to 0.6%. Urbanisation, the rising population and other trends have seen the amount of arable land per capita almost halve over the past 40 years.

Against this supply and demand backdrop, it is perhaps not surprising farmland has delivered impressive performance. It is ultimate beneficiary of the returns from agriculture – both the value of the land and the food produced on it. Farmland is also resilient to the economic cycle.

The US is the one global market where a long-run data series exists. In the 60 years between 1951 and 2010 in inflation-adjusted (real) terms, farmland values increased by more than 100%. Over the same time period, the CRB Foodstuff index rose 40%. Remarkably, there are only two years in which both the prices of US farmland and the CRB index fell simultaneously.

Think global, act local Though the investment case for farmland is compelling, it requires skill to access the opportunity. A global, commodity-diverse approach adds further to the resources needed, but makes investment sense. The three biggest risks

to any investment in agriculture are: fluctuating commodity prices; weather and climate impacts; and pests and disease. Investing in a single country leaves an investor exposed to risks which are outside their control.

A globally diversified strategy can mitigate these risks and select investments in countries and sectors where there is a clear comparative advantage. Insight’s farmland strategy has investments in assets as diverse as a New Zealand dairy and a Romanian arable farm. Over its summer, the New Zealand dairy industry suffered from seven weeks of drought. Low prices for milk have risen fast. Cereal and oilseed prices, the main outputs from the Romanian investment, have been buoyant. Good weather and increased yields have seen falling prices more recently.

Global diversification of highly specialist agricultural assets is a modern variation of an age old theme. The Norfolk four-course rotation developed in England by Charles Townshend in the 18th century moved fields between wheat, turnip, barley and grazing. It was the cornerstone of the British Agricultural Revolution which saw productivity soar. In spite of a rapidly expanding population it also helped put an end to the recurrent famines.

Green fingers and valuesAn operating model for farmland, one in which the assets are actively managed rather than immediately

leased, provides scope for land development and the potential for higher returns. Insight’s global farmland strategy purchased the Tanumbirini cattle station in the Northern Territory of Australia in 2012. There is an extensive programme of improvements, including nine new boreholes and 24 waterpoints. The aim of generating a double-digit internal rate of return (IRR) has so far been realised.

However, the stewardship of land is not just about maximising its productivity and value. Insight is a signatory to the United Nations Principles for Responsible Investment in farmland. It is also committed to Integrated Farm Management, a bridge between industrial and organic farming which encourages farmers to protect and enhance the countryside. This is championed in the UK by LEAF (Linking Environment and Farming).

The CEO of LEAF is part of Insight’s independent Socially Responsible Investment committee. The combination of integrated farm management and an independent committee ensures SRI principles are embedded both as part of the due diligence process when making a purchase and in the management of the assets. Investing in farmland is not just a prudent way of generating inflation-hedged returns that match liabilities. It can also help promote sustainable agricultural practices.

Farmland: where the grass really is greener

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A great example of this are the national LGPS procurement frameworks (www.nationallgpsframeworks.org) being set up to give funds a faster, more cost effective way to access high-quality services, retaining local decision making but leveraging the combined buying power of the LGPS and influencing the marketplace.

Croydon and the South West Funds did the initial groundwork for LGPS procurement frameworks and the National LGPS Framework collaboration has been able to build on this, developing multi-supplier, multi-user frameworks. As a result there are now nationally available frameworks, giving all LGPS funds fast and efficient OJEU-compliant access to services, driving down costs but still supporting local choice and decision making.

By the LGPS and for the LGPS, national procurement frameworks are in place already for Actuarial and Benefit Consultancy Services and Investment Consultancy Services, with a custodian framework due to be up and ready for use in October.

The next framework let under the national frameworks umbrella is likely to be for legal services, building on and supported by the experience developed for the South West regional framework which is nearing the end of its shelf life.

Procurement in the LGPS world is big business, after all, together we are the fifth largest pension scheme in the world, and we all need to procure a wide range of specialist services. So we are looking into further opportunities to extend procurement beyond the classic ‘support services’ – for example there definitely seems to be a case for a passive investment manager framework.

It would be a complex piece of work requiring detailed research and preparation, but the prize could be very significant and should be considered alongside all other options in response to the minister’s call for evidence.

Supported by the Department for Communities & Local Government and the LGA, discussions about the frameworks are also ongoing with HM Treasury and Cabinet Office as part of the wider efficiency programme.

As Cabinet Office minister Francis Maude has put it: “Enterprising and effective collaborations like this are the type of approach we are keen to encourage. I am excited about the opportunities the frameworks could create as part of the wider HM Treasury and Cabinet Office efficiency programme.”

Similarly, local government minister Brandon Lewis has stated: “These frameworks provide a real opportunity to harness the combined buying power of the LGPS and achieve real savings in time and value for money.”

All funds that use the national frameworks benefit from the protection of the framework (for example the pre-agreed terms and conditions) and also from the combined value of LGPS business being brought together.

This means that funds reap

the benefits in three ways:● By significant savings on the procurement costs and timescales (typically reduced from six to nine months to four to six weeks) ● By sharpened prices under further competition ● By sharing in the annual rebate linked to the combined value of LGPS business going through the framework

Granted, we’re not talking billions but we are certainly talking many millions across the LGPS. Setting aside the savings from sharpened prices and shared annual rebate, the cost of OJEU procurements on their own run into tens of thousands of pounds for each fund for every individual procurement.

Using Norfolk’s own experience calling off under the Actuarial and Benefit Consultancy Framework, savings on procurement and pricing (compared to pre-tender prices) equate to £700K over the lifetime of the

contract – and that’s before adding in any further LGPS volume rebate.

Multiply this by the 103 LGPS funds and you start to get some idea of scale of benefits to funds and scheme employers easily delivered from just one of the more straightforward procurements.

With custodian procurements on their own often costing in excess of £100K each we could be talking about £10m savings in custodian procurement costs alone before any pressure on prices is taken into account.

As more funds use the frameworks as existing contracts come to an end, the greater the benefit to the LGPS – real money and time savings being delivered right now.

And the national frameworks are built upon a self-funding model, with no ‘profit taking’ by any party – they really are by the LGPS and for the LGPS.

We all know in the context of the LGPS that, next to investment returns sustaining long-term outperformance, the greatest opportunity for delivering better value for money is by reducing investment fees. But as Benjamin Franklin, one of the founding fathers of the US, said: “Beware of little expenses; a small leak will sink a great ship.”

Procurement frameworks on their own are not a panacea. But what they show is opportunities for delivering real savings exist right now, without the need for expensive and potentially high risk restructuring. They also prove that when the LGPS gets the right people with the right skills and a clear common purpose and shared vision together, we can make a difference.Nicola Mark is head of the Norfolk Pension Fund, chair of the LGPS Framework National Group and practitioner representative on the LGPS Shadow Scheme Advisory Board


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‘‘ These frameworks provide a real opportunity to harness the combined buying power of the LGPS and achieve real savings in time and value for money

The transformation of the LGPS is delivering positive outcomes


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COMMENTJAY EISENHOFERManaging Director,Grant & Eisenhofer

Local Government Pension Schemes should move carefully before plunging into alternative investments. If the past couple of years have demonstrated anything, it’s the industry lacks transparency and accountability to its investors. Too often, fund managers have ignored their fiduciary responsibilities, abetted by corporate governance rules that do little to protect their limited partners. Furthermore, if a fund’s bets go south, investors can spend years trying to reclaim their assets. Four years after the financial crisis, billions of dollars remain locked up in illiquid ‘zombie’ funds that suspended redemptions following the meltdown.

Though alternatives have eased into the economic mainstream, a serious ethics problem plagues the sector. In the past two years there have been some 60 convictions or guilty pleas by hedge fund executives. Chief among them: Raj Rajaratnam, the billionaire manager of Galleon Fund who was sentenced last November to more than 11 years in prison and fined $10m for masterminding a trading scheme that netted almost $54m in illegal profits.

More disturbing have been revelations of widespread illegal practices – including bait-and-switch investment tactics, conflicts of interests, and intentionally mispriced assets – employed by some fund managers to prey on their own clients.

In June, the Securities and

Exchange Commission sued Philip Falcone, the founder of Harbinger Capital Management, who once reaped billions by betting against the US sub-prime mortgage market, charging that he had broken the law to support his lavish lifestyle at investors’ expense. Among the allegations: Falcone borrowed $113m from one of Harbinger’s funds in 2009 to pay his personal taxes without disclosing the loan to clients – effectively using the fund as his personal piggybank. The SEC also charged that Falcone favoured a few Wall Street institutions, including Goldman Sachs, above other investors and manipulated bond prices.

There’s no single fix to clean up the industry but a good place to start would be strengthening the laws under which most funds operate so that their fiduciary duties are explicit, irrevocable and publicly recognised. Most US hedge funds and private equity are incorporated as limited partnerships in Delaware. Under Delaware’s Revised Uniform Limited Partnership Act, general partners are legally permitted to void virtually all of the fiduciary duties they owe to their limited partners.

They can also disclaim virtually all remaining liability when they take action in reliance on the opinion of an investment banker. Considering how many instances we’ve seen of bankers and third-party consultants covering up or

facilitating wrongdoing, this provision is an invitation to fraud and abuse. In fact, some law firms are now marketing their ability to draft general partner agreements that leave limiteds unprotected and managers secure from accountability.

About those zombie funds: at the worst of the market turmoil in late 2008, an estimated $175bn of capital was locked up in illiquid funds. Today, an estimated $50bn-$60bn remains locked up in dormant funds, out of the reach of investors and producing little if any return – while their managers still collect their fees.

While managers’ assertions that they needed time to liquidate assets and return

cash might have been justified immediately after the financial crisis, four years later those claims have worn thin. Tired of waiting, fed-up investors are resorting to the courts.

Delaware Chancery Court last year ordered a fund managed by Paige Capital Management to return a $40m investment by the Lerner family, which owns the Cleveland Browns football team. The court ruled the Paige Capital managers did not have authority under its governing documentation to employ a redemption-stalling device, and had breached

their fiduciary duty by continuing to collect their management fees. Paige’s managers were ordered to return the entire Lerner investment, plus interest and certain excess fees.

Investors should also take heart from recent developments in the Cayman Islands, where many funds are domiciled. Earlier this year Cayman’s Grand Court ordered the liquidation of the Heriot African Trade Finance Fund, which had suspended all redemptions since 2009, after its underlying investments defaulted. Investors had initiated proceedings to liquidate the fund, asserting that it was no longer viable. The court agreed.

With the assistance of legal and financial advisers, investors can leverage their rights to audit a fund’s books and records, independently value portfolio assets and, in extreme cases, force a liquidation to recover assets.

And all fund investors, including LGPS, need to assume a more activist stance regarding their fund holdings, adding their voices to those calling for greater transparency across the industry, and refuse to accept onesided provisions that restrict the rights of funds’ limited partners.

Investors beware the limitations of limited partners

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‘‘ There’s no single fi x to clean up the industry but a good place to start would be strengthening the laws under which most funds operate so their fi duciary duties are publicly recognised


My first real engagement with the Local Government

Pension Scheme was in 1991 when I was appointed county treasurer at Somerset CC and suddenly became responsible for the management of a very large pension fund. Like most people, I took my pension pretty much for granted and how it was managed was a complete unknown.

With the benefit of hindsight, some may say the first nail in the coffin of the final salary scheme came in 1993 when government started to manipulate advanced corporation tax so pension funds could not reclaim all the tax. At the time, this looked like a victimless crime – pension funds were in surplus, shares were performing well and companies were using pension funds to store profits.

Others may say the real damage for the LGPS began when government dictated that LGPS pension funds need only be funded at 75% – to keep tax down – which also seemed relatively harmless – but few realised the true cost of employers taking that undeserved contribution holiday, the cost of which is still being repaid today.

But generally the 1990s were halcyon days for the LGPS, with the discussions mainly about investment strategies – bonds vs equities, emerging markets, active versus passive management and so on.

However, we probably should have taken more notice of the various tax changes

coming in, which by taxing savings and pensions began to nibble way at the double taxation rule – that income should only be taxed once. It was the sign of things to come.

The 1990s also saw an efficiency scrutiny of the LGPS that coincided with recognition of the Treaty of Rome and, at last, some overdue changes in benefits and regulations to improve equality. Still this was an opportunity missed. Even by then the inherent unfairness of a final salary scheme was clear but there was little will then to do anything about it.

Accountants among us will recognise the next big event – the introduction of FRS 17 in 2001. FRS 17 was the accounting standard which required assets and liabilities of a pension fund to be valued according to market values, rather than long-term actuarial assumptions, and for the pension fund surplus or deficit to be recognised on the balance sheet as an asset or liability.

Well, by then the halcyon investment days when FRS 17 was being designed were coming to an end and liabilities rather than assets were the order of the day. This had an important and probably unintended consequence. Companies simply could not carry these liabilities on their balance sheets and began to close down their defined benefit schemes.

For the LGPS the impact was less immediate – at the Chartered Institute of Public Finance & Accountancy we impressed upon government

How we got where we are

how unsustainable and inappropriate this private sector accounting treatment would be on local government revenue costs – and of course on the council tax – and agreed an alternative accounting treatment which, though it accords with both the spirit and the detail of FRS 17, nevertheless was fiscally neutral. There is no doubt in my mind that without this, by now the LGPS would be a distant memory or a shadow of its former self.

But there was a second, unforeseen consequence: as companies wound down their pension schemes – and regrettably many took advantage to reduce their own costs at the same time by making inferior alternative arrangements – the LGPS became first of all – a ‘gold standard’ scheme and then , according to some critics ‘amazing’. Then, ‘pensions envy’ became a new phase in our world, and an important one at that which regrettably shapes much current thinking.

At about the same time we saw a succession of

amendments to the scheme introducing some further and welcome modernisation in benefits up until the 2008 regulations but this was perhaps the lull before the storm. The storm being the global financial crisis in 2007. The financial crisis did not in itself do irretrievable damage to the LGPS but there was an unintended consequence in the government’s solution – quantitative easing (QE).

As the World Pensions Council summarises it, QE induces artificially low government bond yield rates which has an adverse impact on the underfunding position of pension funds. Obviously this is critical to the LGPS and coming at the same time as the Hutton Review into public sector pensions was bound to shape public opinion – as well as hastening the general demise of final salary pension schemes.

Which brings us to where we are today with the LGPS 2014 scheme. At last, to be based on a career average that is fairer and, although not necessarily less costly, is much more financially sustainable.

So, what hasn’t changed? Back in 2001 our biggest issue was Japan – after decades of growth Japan was facing economic stagnation and the question was would Japan, with its ageing population and facing rapid technological change and increasing global competition, be able to adapt and recover? Well, it’s the same issue today. Although not of course confined to Japan. Chris Bilsland is chamberlain at City of London Corporation

CHRIS BILSLAND reflects on how the LGPS and the investment landscape have changed over the years

How we got where we are

‘Pensions envy’ regrettably shapes much current thinking

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Investment


GEORGINA TAYLORProduct Director – Multi Asset,Invesco Perpetual

We see the investment landscape as having changed significantly in recent years, which has important implications for investment strategy. In particular, we would highlight the emergence of four key themes for investors post the financial crisis.

First, bonds have been overwhelmingly favoured as an asset class in recent years. Globally, data from EPFR show 60% of cumulative fund flows by institutional investors since 2003 have been into bonds. This has reflected the broad-based ‘hunt for yield’ as investors have sought the higher yield of corporate bonds, emerging market bonds and equities.

Second, in the aftermath of the financial crisis, economic growth has remained sluggish and inflation contained – even after the massive amounts of quantitative easing (QE). It is hard to see that easy stance of policy being removed at all quickly if, as we expect, these economic conditions remain key themes for an extended period.

Third, since QE policies were introduced by central banks around the world from 2008 onwards, financial markets have become particularly sensitive to announcements with regard to changes in monetary policy.

Fourth, these changing circumstances have been reflected in changing correlations across assets. In that respect, we identify three broad phases in global

markets since the 1990s. From 1990 to 2000, the

general trend was that bond and equity markets rose together. This was a period of a trend decline in inflation, interest rates and bond yields and more stable economic growth than in the past. That environment benefitted bonds and equities alike.

From 2001 to 2011, we saw ‘risk-on/risk-off’ shifts. During ‘risk on’ periods, there was a higher demand for equities and their prices rose at the same time as bond prices tended to fall; and vice versa in ‘risk off’ periods. So, for much of the time there was a negative correlation between the returns on equities and bonds.

Since the start of 2012, we have seen relatively high positive correlations between bonds and equities again. This positive correlation has been indicative of the importance of economic policy decisions for all asset markets: further QE stimulus has pushed up bonds and equities together; the threat of its withdrawal has seen both assets suffer.

In such circumstances, we see merit in expanding the scope of investment beyond standard asset classes. Using a wider range of asset types can help in implementing ideas about the direction of economies and financial markets. Three examples illustrate this theme:

1. Currency-equity market relationships Currency markets can be useful in providing diversifi-

cation. The Canadian dollar, for example, has typically strengthened against the US dollar as the US equity mar-ket has rallied. This is partly because both tend to benefit from stronger global eco-nomic growth, not least because Canada tends to benefit from stronger com-modity prices. Conversely, as global growth has slowed in recent months, the Canadian dollar has tended to weaken against the US dollar.

2. Volatility as an alternative source of returnsVolatility itself can be seen as an alternative source of returns. In May and June 2013 when almost all financial assets fell in value, volatility

increased and it was the only major source to give a positive return in that period. Volatility is particularly interesting for diversification purposes because when equity markets rise, they tend to rise steadily and volatility is low; but when they fall, they fall sharply, and volatility tends to spike higher.

3. Taking pinpointed sector exposure across markets A view, based on an assessment of economic and financial developments of a particular sector of the

economy, can be implemented by taking a relative position across markets and asset types.

For example, in recent years, a view that the European bank sector would survive could be implemented by favouring investment in bank credit (which would likely benefit from measures to strengthen bank balance sheets) while remaining concerned about the value of bank equity (as profitability would likely be limited as increasing capital requirements would force the scaling back of new lending).

In a similar vein, a view on the relative competitiveness of different companies in an industry can be expressed by

taking offsetting ‘long’ and ‘short’ positions.

ConclusionsFinancial markets are dynamic and constantly changing. Monetary policy, in particular, is currently playing an important role in driving asset prices, and investors are lacking some important cyclical triggers for making asset allocation decisions. In this environment, sourcing investment ideas from a broader range of assets can help navigate these changing market conditions.

Navigating the changing investment landscape

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‘‘We see merit in expanding the scope of investment beyond standard asset classes. Using a wider range of asset types can help in implementing ideas about the direction of economies and fi nancial markets

P o t e n t i a l . D e l i v e r e d .

Successful equity investment requires the vision to see future potential, wherever it may be, and the ability to respond swiftly to take advantage of tomorrow’s opportunities.

At Standard Life Investments we have: • A team of over 100 expert analysts and portfolio managers • Strategic partners in India and Japan providing local insight • An established track record in global, regional, emerging market and single country strategies • A broad range of styles including core, unconstrained, income, large and small caps, ethical and ESG integration, and enhanced diversification strategies • An unflinching drive to deliver consistent and repeatable outperformance from high-conviction portfolios

Find out more at standardlifeinvestments.com/equities

The value of an investment can fall as well as rise and is not guaranteed. You may get back less than you put in. Past performance is not a guide to future performance.

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This communication is for investment professionals only and should not be distributed to, or relied upon by retail investors. Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL. Standard Life Investments Limited is authorised and regulated by the Financial Conduct Authority. Standard Life Investments (Hong Kong) Limited is licensed with and regulated by the Securities and Futures Commission in Hong Kong and is a wholly-owned subsidiary of Standard Life Investments Limited. Standard Life Investments Limited (ABN 36 142 665 227) is incorporated in Scotland (No. SC123321) and is exempt from the requirement to hold an Australian financial services licence under paragraph 911A(2)(l) of the Corporations Act 2001 (Cth) (the ‘Act’) in respect of the provision of financial services as defined in Schedule A of the relief instrument no.10/0264 dated 9 April 2010 issued to Standard Life Investments Limited by the Australian Securities and Investments Commission. These financial services are provided only to wholesale clients as defined in subsection 761G(7) of the Act. Standard Life Investments Limited is authorised and regulated in the United Kingdom by the Financial Conduct Authority under the laws of the United Kingdom, which differ from Australian laws. Standard Life Investments Limited, a company registered in Ireland (904256) 90 St Stephen’s Green Dublin 2 and is authorised and regulated in the UK by the Financial Conduct Authority. Standard Life Investments (USA) Limited, registered as an Investment Adviser with the US Securities and Exchange Commission. Standard Life Investments Inc., with offices in Calgary, Montréal and Toronto, is a wholly owned subsidiary of Standard Life Investments Limited. Calls may be monitored and/or recorded to protect both you and us and help with our training. www.standardlifeinvestments.com ©2013 Standard Life, images reproduced under licence.

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