Agenda item
Investment Strategy Review
The Committee to receive a verbal presentation from Mercers.
Minutes:
The Committee received a presentation from Steve Turner of Mercer, on the Investment Strategy Review. The aim of the review is to consider the allocation between asset classes; risk and returns, ensure that there is a reasonable balance between the two objectives and to identify improvements to the investment strategy to help achieve these objectives.
There are a number of reasons to undertake a review and these range from funding changes, legislation change, new solutions, consolidation, Liabilities change, outlook change, change to employee and providing a clear plan.
When making investment decision the Committee will need to remain cognisant of pooling and options that are available on the current Collective Investment Vehicle (CIV) platform. The review will be the key determinant of overall investment performance. The Committee during a question and answer session: Noted:
· That there was an opportunity to reduce risk and volatility of their past deficit by £26m or more.
· That more diversification of their portfolio would potentially lead to better returns and reduce their exposure and that their Investment Policy must be aligned
· The forward looking equity market returns were unlikely to be as strong as they have been over the last 7 years and that it was a good opportunity to address the equity risk; the reduction will help the funding position.
· That Bonds accounted for 18% of their Portfolio and was divided into two distinctive types; return seeking bonds and liability hedging bonds.
· The best estimate expected return for Gilts was + 4.1% p.a. and this return surpassed the requirements of their Actuaries. There is a 73% probability of achieving Gilts +2.0%
· The Level of liability hedging was 7% and that currency hedging should be considered.
· That their Asset Portfolio should be increased; this is linked to inflation. A long term strategy would need to be agreed and should be guided by the CIV, the asset allocation would need to be determined as this will have the biggest impact on the CIV.
· That the current funding level had improved over a 5 year period and at current was at 86%, this was attributed to strong asset returns. As funding levels approach nearer to 100% this period should be used as an opportunity to decrease risks.
· The assessed Value at Risk (VaR) indicates that there is a 5% chance that the current deficit £223m could be increased by at least £329m over a 1 year period to £552m. This is based on the deficit as at March 2017.
· Equities are expected to provide 75% of the Funds excess returns and account for 56% of the Fund’s risk on the VaR.
· That they consider reducing the allocation to equities by 10%, in light of strong performance, an increase in the funding level and level of risk concentration in equities.
· That an increase in allocation to both Ruffer and Baillie Gifford be considered; they are ‘best in class’ managers and this would achieve additional diversification and would be relatively quick and easy to achieve. Members raised questions about both managers and asked what percentage was driven by their equity. Baillie Gifford had 40% in their portfolio and Ruffer 50%. The Committee were reminded that allocations should be reduced from poor performing managers.
· That investments in high grade and long-lease properties be considered; it is anticipated that between 66% - 80% of returns will come from income and will be linked to inflation rather than capital appreciation, which at current is poor. Members questioned whether these investments would be at risk from potential government changes to housing and were advised that portfolio would comprise of ‘extremely high quality commercial properties’ and that the UK Fund have performed ok. The income expected will account for 60 – 80% of total return and a high portion of the income will act as a cushion. The assets are resilient to both financial and economic shocks.
· That half of Absolute Return Bonds (ARB) be allocated to Multi-Asset Credit (MAC), this will ensure returns are driven by markets and not wholly reliant on investment managers and are multi-based. The returns which have been based on the decisions of current investment managers have been poor.
· That current allocation to Index-linked gilts be continued and be increased over a period if current actuarial valuation approach is maintained.
· That a review of their current equity portfolio be undertaken and that the Fund invest more globally over a period of time. The passive global equity fund at LGIM should be utilised in the interim and the usage of the new global equity strategies available from the CIV should also be considered to achieve the above.
· That the fund has materially benefited from the fall in sterling and that consideration should be made to bank gains by hedging. Currency hedging would allow the Fund to bank a portion of these gains and move to a more neutral position of a 50% hedge. This move will slightly reduce the risk of the portfolio, relative to sterling based liabilities.
· That the Pensions Committee interest in low carbon investing was welcomed and that support would be given to incorporate this into the investment strategy. MSCI Low Carbon Target index was identified as the most appropriate index for the fund as it reduces the carbon (relative to the MSCI World) by around 70%. A 30% investment as a starting point was viewed as appropriate; other clients have used this percentage as their starting point. The long term tracking error target is 0.3%.
· That overall expected return of the portfolio would be expected to increase by 0.1% to gilts + 4.2 % p.a. following the proposed changes, predominately as a result of increased exposure to MAC.
· That there was a loss of confidence with GMO and that this matter could be reviewed with the CIV and noted recommendation on moving the passive global equity fund. This could be implemented in the new year.
· Asked about, Multi Asset Credit (MAC) and was advised that it was an unconstrained strategy which invests in a wide range of the credit markets. These include investment credits, high yield debts, bank loans and emerging market bonds. Returns are driven by market allocation plus active management from market and security selection. The target return; cash + 3 – 5% and the expected volatility; 5 – 10%. It was recommended that 12% of the Fund’s assets be split between absolute return bonds and Multi Asset Credit.
· Noted that the Pension Fund has included Multi Asset Credit for the last 4 – 5 years and that MAC was a government solution to address access to the credit market following the financial crisis and encourage diversification and mitigates risk. MAC has performed above expectation.
· Members were supportive of Multi Asset Credit and agreed that they should receive further information and training in this area.
· Members commented on the recommendation to disinvest from UK equities and the poor performance of the GMO mandate and were advised that the transition from UK Equity to Global Equity was relatively easily and was a sensible way of achieving strategies and objectives.
· Members raised questions about currency hedging and its effect on cash flows and were advised that Legal and General manages funds and that contracts to sell currencies are taken out every 3 months and rolled over. During increases the currency will be held and equities are sold when there are loses. The Committee was advised that they could review the currency hedging as part of their 3 years strategy and that this was a good strategic policy to have in place.
· Members commented that they had received a presentation about diversity and investment and at their previous committee had agreed to consider investing 5% of the fund in a sustainable / low carbon or clean agenda fund(s) and highlighted that the recommended initial investment in this area was below this percentage. In reply, it was noted that the returns for Low Carbon Funds may vary and other clients had invested the recommended amount as part of their risk mitigation strategy. An investment in renewable energy was advised to be preferred and it was estimated that it would take between 3 to 4 years to get a full return on investment. The Committee was advised that they should reduce their funding risk and be in a stable position before considering further investment. Investments should be phased and preferably be undertaken when oil prices are low. A 15% would be considered as a good return over a 3 year period, this percentage is equal to 30% of the equity portfolio. This can be reviewed annually or part of their 3 year strategy review. At current the oil market is outperforming low carbon market.
· That it was an ideal time for the Committee to bank equity and balance their portfolio.
Members thanked Steve Turner for his presentation and agreed that the presentation be converted into a strategy and implementation plan and that preliminary discussion be held with Mercer on achieving this.
RESOLVED:
1. Following consideration of the draft Investment Strategy and in the light of the committee’s decision to terminate the Global Equities mandate for GMO the Committee agrees to:
a) Appoint LGIM to manage the GMO portfolio on a transitional basis;
b) Increase the investment in the Council’s Diversified Global Funds mandate from 10% to 20% by topping up the existing DGF fund mandates (Bailie Gifford and Ruffer) by 5% each; to be achieved through a reduction to the GMO Global Equities mandate as part of the LGIM transitional management arrangements;
c) Reviews further all other aspects of the draft Investment Strategy at their September meeting.
2. Receive training on Multi Asset Credit.
Supporting documents:
- Restricted enclosure View the reasons why document 6.2/1 is restricted