This year marks a decade since Room151 was launched. Karen Shackleton looks back at the way LGPS has transformed.
Looking back over the past ten years, it is clear we are in a very different place today compared with 2011. Even putting the pandemic and Brexit to one side, investment thinking has changed somewhat. Committee agendas today look very different to committee agendas then.
Ten years ago, the focus was on “de-risking” the investment portfolio with allocations to diversifying assets growing across the board (a knee-jerk reaction to the 2008 credit crunch which saw equities falling dramatically).
It was not uncommon, even prior to 2011, to see an allocation to private equity and to hedge funds in an LGPS portfolio. Diversified Growth Funds (DGFs) were beginning to make an appearance but that was a theme that evolved more over the next five years.
According to WM, in March 2011, the average LGPS fund had an allocation of 8% to alternatives (with a range of 0-20%).
Typically, half of this was invested in private equity, and a third in hedge funds, but many funds were looking for new opportunities to diversify equity risk in their portfolios whilst still achieving a reasonable rate of return.
For example, some LGPS funds were being approached by the early institutional residential property managers in 2011. It took a while for that asset class to take off, but London Borough of Islington pension fund was an early investor, publicly making an allocation at that time.
Cashflow
One of the emerging challenges facing the LGPS was cashflow negativity. Funds were beginning to reach the tipping point where the sum of pension payments leaving the fund exceeded the value of contributions being paid in.
This had been exacerbated by cost cutting exercises and staff redundancies, following the credit crisis, which in turn resulted in lower contributions to pension funds.
One consequence of this was a growing interest in alternative secure income asset classes, such as long lease property, which promised to deliver higher yields than gilt holdings over the longer term.
Passive investment continued to be a popular allocation, with the average LGPS fund holding around 20% in passive funds in 2011—typically around one-third to one-half of the equity allocation. This continued interest in passive was partly a response to growing complexity in the underlying investment strategy which, in turn, resulted in increased fees being paid as well as a drag on performance from restructurings as funds diversified.
Roll the clock forward five years to 2016, and by now DGFs were well established in pension fund portfolios. Some consultants had been recommending sizeable allocations (up to 25%) to diversified growth.
This allowed pension funds to introduce tactical asset allocation to their investments, so that they could respond to rapidly changing markets.
Often, DGFs promised equity-like returns with lower volatility over the long term. Yet, these funds subsequently lost their flavour-of-the-month status over the next five years, as mediocre returns disappointed LGPS investors.
Private debt allocations were also becoming more common, with several LGPS funds going out to tender over the next few years. This was a response to an environment of low gilt yields following quantitative easing by central banks as a response to the credit crisis. Infrastructure was also being discussed by committees for the same reason.
Pooling & purpose
However, for many LGPS funds, it was pooling that preoccupied pensions committees. The government had announced in summer 2015 that it would force the 89 local pension funds in England and Wales to pool their assets in a bid to deliver cost savings, efficiencies, and greater scale.
This was followed by a period of decision-making as the different pools were set up and LPS funds negotiated which to join. Two years later, eight pools had been established, and the pooling process began.
It was also around this time that responsible investment started to make a more regular appearance on committee agendas.
Pensions for Purpose was launched in October 2017 to raise awareness among pension funds of Environmental, Social and Governance (ESG), sustainable and impact investment.
At that time ESG (environmental, social and governance) was a term that managers referred to, but it occupied far less of their attention than it does today. Many LGPS funds had not even heard of impact investing and there were concerns about how an investment which delivered social or environmental impact could also deliver to the fiduciary responsibilities of pensions committee.
Move to the present day and ESG—sustainable and impact investing—is now the dominant discussion topic for many LGPS funds. Some funds now even hold an annual committee meeting which focuses 100% on this agenda.
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Discussions around investment beliefs are common practice, feeding into investment strategy statement and new mandates that are aligned to those investment beliefs.
With increased government attention on climate change, many funds are focusing on climate action to decarbonise their investments, with some even setting net zero targets and interim goals. This agenda is becoming an everyday topic of conversation at conferences, in the pensions press and at committee meetings.
Covid & the future
Five years ago we probably could have predicted the growing urgency for the LGPS to address climate change in pension fund portfolios. What would have been harder to see was the impact of the Covid pandemic in 2020, forcing governments to impose lockdowns, roll out vaccination programmes, and consider new ways of working.
This continues to present challenges to world economic growth and will likely do so for some time, although LGPS portfolios have overall held up well.
At the end of the day, we can reflect on the past, and learn from mistakes. We can see some investment trends, such as ESG, that are likely to continue for some time. Others will fade away.
Room 151 has informed, commented, and shaped local authority pension fund decisions on these issues over the past ten years and as a leading publication let us hope they continue to do so over the next ten years.
Let us also remember that LGPS pension funds remain well governed. They are focused on value-added risk adjusted returns, and investment committees are aware of and responsive to long term risks such as climate change and biodiversity. As a result, the LGPS continues to deliver secure, reliable pensions to members… and long may that last.
Karen Shackleton is founder of Pensions for Purpose and senior adviser for MJ Hudson.
Photo by Nicholas Cappello on Unsplash
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