Total assets for the UK’s 87 LGPS funds have hit a new record this year but schemes are now considering how to protect their surpluses.
A surge in global equity markets last year has fuelled a stark rise of LGPS assets, which are now estimated to stand at £400bn, compared to less than £370bn two years ago, according to Isio’s latest Low-Risk Funding Index.
Over the past twelve months, global equities, which still account for the bulk of LGPS portfolios have beaten the gloomy outlook. The MSCI World performed more than 24% in 2023. While this year has been somewhat more bumpy, the index is still up more than 9% year to date.
This rise in equity valuations has been beneficial for the LGPS who find themselves in a goldilocks scenario of falling inflation, relatively higher interest rates bringing down the present value of liability and buoyant equity markets.
A stark increase
Consequently, Isio’s Low-Risk Funding Index has grown from 104% to 106% year to date, a stark increase compared to the last actuarial valuation in March when funding ratios stood at 67%.
Isio, which acts as a consultant for some LGPS funds and employers, concludes that the imminent challenge for the LGPS is now how to balance a long-term funding approach with a short-term opportunity to lock in equity market highs and protect current surpluses.
Isio also acknowledges the risk that equity markets could fall over the next year, and that the rosy picture might not last. Steve Simkins, partner at Isio, argues that now might be an opportune moment to lock in some of the gains.
Meanwhile, there was also the need to acknowledge the diversity of sponsors: “At 31 March 2022, with very few exceptions, LGPS funds and their employers were reliant on future equity returns. This position has changed with over half of LGPS funds and their employers moving into a self-sufficient position, shown by our Low-Risk Funding Index. So the traditional “one-size-fits-all employers” investment strategies are becoming less appropriate. It also means that we might see a greater range of investment strategies emerging across LGPS funds,” he stressed.
Bonds are back
Rob Treich, head of public markets at London CIV, stressed that inflation and income protection remained a priority for many of the pool’s partner funds. Speaking on the latest Room151 LGPS podcast, he said that the pool had seen an increased demand for fixed income.
“In the first quarter of this year, we have seen inflows of more than £1bn pounds into our public market credit funds. So we have definitely seen some reallocation of capital away from equities and multi-asset funds and into credit,” he stressed.
However, Treich also acknowledged that if rates remained higher for longer, there was a risk of defaults ticking up. He flagged the emergence of pre-emptive defaults in the US as a potential concern for fixed income investors.
Andrew Singh, associate director and head of Public Sector Investment Advisory at Isio, argued that now might be an opportunity to think outside the box: “Current market conditions provide a somewhat unexpected opportunity for LGPS funds to review the risk levels associated with their investment strategies. However, 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,” he stressed.
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