As LGPS pools take over manager and stock selection, administering authorities have the opportunity to focus on asset allocation. Room151 asked an officer and a multi-asset manager for their views on the future for asset allocation.
Nick Vickers
Head of financial services
Kent County Council
Now that the Local Government Pensions Scheme (LGPS) pools are tasked with manager selection and finding attractive investment opportunities, administering authorities can focus their attentions on asset allocation, an area many believe to be the primary driver of investment returns.
Subscribe to our LGPS Quarterly Briefing and be first to receive more content like this.
So, at this critical juncture, do administering authorities need to rethink their approach to devising asset allocation and, if so, how can they get the best out of their pools?
It does now feel that we have been doing pooling for a very long time and certainly at ACCESS we are still a long way away from getting in to investment issues; its still all about CIV’s, operators and all the governance paraphernalia that a pooled arrangement requires. And that’s all good and important stuff, but in Kent what really interests the superannuation fund committee is adding value.
As we get our minds round the pooling issues three other very significant things have been happening: Firstly, the funds have been rocketing in value with the Kent fund seeing an increase of £600m in the year. Secondly, we had really good actuarial valuation results. And, lastly, existing investment managers have been coming to us with significant fee reductions.
So, it certainly feels like the Kent fund is in a really good place.
We have already flagged with the superannuation fund committee that we need to look at asset allocation in advance of starting to move funds in to the pool. As a county fund we actually have quite a small window to do that because of the May county council elections.
We are planning on the basis of significant changes to the composition of the committee who we then need to get up to speed very quickly with what the LGPS is all about, how our roster of investment managers is doing and of course pooling.
That small window to review asset allocation looks like it will be in the last quarter of 2017. The committee to date has not bought in to the alternative assets story in a major way, still highly favours UK commercial property, has now invested in UK residential property and remains a highly committed investor in equities. We will see how much that changes with the new committee and we can then focus on working with our ACCESS colleagues to put in place a high quality set of investment managers.
Toby Nangle
Columbia Threadneedle
Choosing a suitable asset allocation is likely to be the biggest active decision any investor will make. Strategic asset allocation relies on actively determining both the likely level and correlation of asset price returns over the long term. Getting this approximately right will be more important for LGPS funds than getting manager selection perfectly right.
A “set and forget” strategic asset allocation strategy has actually worked well over the past 35 years. This is because long-dated bond yields have steadily fallen from around 14% to around 2% today, delivering bond returns beyond most people’s wildest expectations, while keeping overall portfolio volatility low. But in order for this strategy to continue working, LGPS funds require the bond market rally to continue. This is looking less and less certain.
At Columbia Threadneedle, we believe that the bond market rally has been a function of globalisation. Emerging market — and specifically Chinese — workers have joined the global labour force and labour power has diminished in the West. This has dragged down interest rates, and with them bond yields pushing bond prices higher.
But China won’t be joining the global labour market again, and its working population looks likely to soon start to shrink. Indeed, the global labour glut that has fuelled the bond market rally risks petering out, and the issue of deeper economic integration across borders is unlikely to persist at the same pace it has in the past. We believe that the stage is set for an environment where bond yields stop falling, and they could begin to rise.
So, a set and forget strategy is unlikely to be fruitful on a five-year forward time horizon — the same horizon that LGPS funds are implementing their pooling, whilst retaining asset allocation at a local level.
Asset allocation managed dynamically to adjust to changing correlations and current market conditions provides opportunity for better risk-adjusted returns than strategic asset allocation alone. With that in mind, LGPS funds will have to think harder about how they generate the returns they require. A tactical approach using an investment process which looks over 12 to 24-month periods to find opportunities as they arise, through a confluence of valuation analysis combined with earnings and economic analysis, will be key. This is typically shorter than the horizon of 3+ years that LGPS funds typically work with around their valuation cycle.
But dynamic asset allocation requires a certain skillset, which some local authorities may have, some will rely on the professionals within their chosen pool, some might want to develop within their pool, and some pools, typically those without internal fund manager capability, may wish to bring in from outside using external asset managers.
Managing active asset allocation dynamically using in-house resources may suit pools equipped with large internal resources of experienced investment personnel.
Alternatively, LGPS funds could use an approach whereby a portfolio of assets is managed on a “go-anywhere” basis (for example, allocating to a diversified growth fund), as part of their strategic asset allocation. This approach recognises the individuality of each LGPS fund’s liability profile and plan for deficit reduction, while retaining the ability to seek strong risk-adjusted returns through asset allocation. Both the London CIV and the Brunel Pension Partnership have indicated that diversified growth funds will form part of their asset allocation offering, and other pools may have done the same.
Whichever route LGPS funds take, they must be more active in how they approach asset allocation in the future if they are to generate the risk-adjusted returns they require.
Nickers Vickers is head of financial services at Kent Country Council.
Tom Nagle is head of multi-asset, EMEA, and co-head of global asset allocation, Columbia Threadneedle.
