Jill Davys considers next years LGPS valuations and implications for cashflow, risk managment and ESG.
It feels like only yesterday when the sense of relief at getting 2019 valuations signed off by the 31st March 2020 deadline was done just as we all headed home for covid lockdowns (was it really that long ago!).
With the 2022 valuations just around the corner, thoughts of “can it really be time for the next valuation?” and “is our data going to stand up to scrutiny?”, start to overwhelm. For many, the valuation also coincides with considerations of strategic asset allocation and potential updates to Investment Strategy Statements.
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I was fortunate enough to chair a recent roundtable event for Room 151 on the 2022 valuations, which facilitated a stimulating discussion on what people were focusing on, including cashflow and data.
It was interesting to hear that a number of funds were still in the process of implementing the strategy agreed following the last valuation and therefore expecting to take a lighter touch approach this time around. For others, it was more thinking about the changing dynamics that might come from reaching that magic 100%+ funding position (something which seemed a long way off when I joined the LGPS at a fund with 64% funding and more than a few data issues).
On reflection, perhaps this valuation gives more cause to focus on investment strategy than it might have done in the past when the emphasis had to remain on optimising investment returns to achieve full funding, often with a need to retain high contribution rates.
So, what might the 2022 valuation mean for investment strategy. I think there are a few key aspects to reflect upon:
Cashflow
As funds reflect on where they are, and whether there are opportunities to perhaps shave contributions for employers and help with affordability and sustainability, this could have a knock-on impact to strategic asset allocation.
The increasing maturity of the LGPS means that more attention needs to be paid to the long-term cashflows, with some funds already drawing on income to meet the ever-increasing benefit payments.
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Understanding how your asset allocation affects the overall risk within a portfolio, and assessing a fund’s risk appetite, are critical to helping make decisions on which asset classes are appropriate for your fund. — Jill Davys
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Some long-term cashflow forecasting and a focus on regular income, inflation-linked where available (do we believe current inflation trends are only transitory?) would avoid the need to raise cash from assets at the wrong point in time.
Despite the value of such assets being pushed up, there are still opportunities to access attractive assets like core infrastructure, housing and real estate, EMD, etc. Time to focus on the income element of the portfolio.
Risk Management
There’s been a lot of talk about the LGPS de-risking, having reached some lofty heights on funding. But it’s more about ongoing risk management than de-risking.
The LGPS remains an open defined benefit pension scheme with membership and employers continuing to evolve over time. It isn’t on the road to buyout, like the private sector schemes, and therefore full de-risking is not an option.
Understanding how your asset allocation affects the overall risk within a portfolio, and assessing a fund’s risk appetite, are critical to helping make decisions on which asset classes are appropriate for your fund. It should provide trigger points for both taking risk out (in particular focusing on growth assets, given the returns they’ve delivered for funds), but also acknowledging the possibility of adding risk back into the fund at appropriate times.
Setting these triggers in advance will help to avoid either hasty decisions or rabbit in headlight moments.
Also thinking about employers within the fund, is it time to reflect on whether there should be different risk strategies for different employer groups depending on funding and covenant?
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ESG
Of course, you can’t have an article on the 2022 valuation and investment strategy these days without some thought given to climate change and the wider ‘S’ (social) and ‘G’ (governance) and how that might impact on strategy.
Climate change has been on the LGPS agenda for some time and ensuring portfolios are both able to withstand the risks associated with climate change as well as capture benefits from opportunities associated with climate transition is going to be crucial.
Likewise, making sure your investment strategy is aligned with your responsible investment beliefs, particularly as we move to greater transparency with TCFD (Taskforce for Climate-related Financial Disclosures) reporting.
It can only be hoped that requirements to report will result in more standardisation of reporting, enabling clear decision-making and journey planning towards net zero made with some greater certainty. We expect pooling to be an invaluable tool in this area going forward.
Taking time out from the day job to focus on investment strategy as you go through the valuation will really pay dividends in terms of long-term planning and keeping funds on track to achieve long term objectives. Good luck to everyone in 2022.
Jill Davys is finance & investment manager & head of LGPS, London Borough of Sutton / Redington.
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