Funding levels for the LGPS have risen to a new high, fuelled by a continued rise in gilt yields but consultants warn that a deteriorating equity market and lower gilt yields could soon worsen the outlook.
The aggregate funding level for the 87 participating funds has risen from 106% at the end of March 2024 to 109% by the end of April 2024, according to Isio’s latest Low-Risk Funding Index, which shows a significant improvement in the funding levels for the Local Government Pension Scheme (LGPS) in England and Wales.
This marks the highest reported month-end funding position, including a record high of 110% achieved during April.
The improvement is primarily driven by rising UK gilt yields, but partially offset by slight reductions in asset values. Of the 87 funds, 59 have funding levels of 100% or higher, with levels ranging from 68% to 163% Isio said.
At the previous actuarial valuation on 31 March 2022, the aggregate low-risk funding position was 67%, with none of the funds having a funding level of 100% or higher.
As the 31 March 2025 actuarial valuation approaches, these results suggest that ongoing funding levels for LGPS funds and their employers are expected to be higher than in 2022, indicating increased surpluses. However, there is a risk that equity markets and gilt yields could fall over the next 11 months, potentially impacting funding levels negatively the consultant warned.
“The countdown to the 2025 valuation continues, with LGPS funds finding themselves in new territory, with the highest reported month-end low-risk funding level since launch and the Index exceeding 110% during April,” said Steve Simkins, partner and public services leader at Isio.
“Higher assets, combined with higher long-term yields, are a recipe for improved pension scheme funding. While the LGPS takes a long-term perspective on funding, the evidence from the Index suggests that ongoing funding positions and surpluses have further improved since the 31 March 2022 valuation.”
“This creates a tension between LGPS funds’ long-term funding strategies and short-term planning for the next valuation to secure the best outcomes for their employers, some of whom would welcome cost and investment risk reductions. Locking in some of the gains made from the current equity market highs presents an opportunity to achieve both. Higher gilt yields put the spotlight on the merits of an equity for gilts switch” he warned.
Andrew Singh, associate director and Hhead of Public Sector Investment Advisory at Isio, commented, “Current market conditions provide a somewhat unexpected opportunity for LGPS funds to review the risk levels associated with their investment strategies. However, despite the fall in gilt prices, reducing investment risk does not necessarily have to mean transitioning all the way from ‘growth’ equities to ‘protection’ bonds. It can instead involve modest reductions to expected returns in exchange for more contractual investment return profiles.”
“Given the market movements we have seen, it might be necessary for funds to rebalance assets back towards the strategic allocation or go further and review the strategic allocation. While investment strategies are built for the long-term, there are times when short-term considerations come into play and with the next actuarial valuation looming, this might be one of those times” he stressed.
As of mid-May, markets are pricing in two Bank of England rate cuts as the central bank forecasts to hit its inflation target with in the next few months.
However, long-dated bond yields, which are decisive in measuring the present value of liabilities are expected to drop from their current levels at 4.3% to 3% by the end of 2025, according to Capital Economics.
Isio’s Low-Risk Funding Index will undergo a recalibration using information available from the 2023 published annual reports when the data is available for all funds. Analysis of strategic asset allocations suggests that funds are starting to take small steps to ‘lock-in’ improved funding positions and reduce the risks associated with growth assets, the consultant said.
However, closer inspection shows that despite the shift on an aggregated basis, some funds actually increased their risk over the year to 31 March 2023, Isio warned.
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