Mike Jensen is the co-chief investment officer of the Local Pensions Partnership. He spoke to Room151’s Peter Findlay about his support for recent regulatory change, pooling, equities and the future for Sterling.
Room151: Mike, is the LGPS in good shape now? Do the 2016 regulations give you a platform to work from?
Mike Jensen (MJ): The regulatory change is absolutely fantastic. If you compare the final regulations to our submission (to DCLG), then of course you can see that we’re happy with the way things have played out. We are extremely pleased not just for us but for the LGPS generally because the previous regulatory framework was definitely a block on doing a number of sensible things.
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The regulatory framework pre-November 2016 was unhelpful especially in the areas of risk management and efficient portfolio construction, and government hadn’t provided a suitable regulatory framework for proper risk management and proper liability and asset work to be done.
What it does bring with it, obviously, is a number of challenges in how to implement the regulations. I think LPP (Local Pensions Partnership) is in a fairly good place though because these are things that we’ve been working on for some time as the joint venture started several years before the government agenda.
Specifically, it’s the risk-based aspects of the regulatory freedoms that the constituent parts of the LPP had already been taking which will now flow through into LPP. But generally, I think the LGPS is in substantially better shape than the market perception.
R151: We’re running another piece in this issue of the LGPS Quarterly Briefing by Terry Crossley who is concerned that the scheme’s local democratic status has been weakened and that the pools are lacking geographic and functional coherence.
MJ: As I say, the LGPS, as an aggregate entity, is in better shape than the perception. I think it’s more sustainable than the perception and from here on in we can make it cheaper to manage than the past 30-40 years. Those are all plusses. I also think Terry’s got a point to a certain extent about the functioning of the pooling agenda. I don’t have much of an insight into the way the other pools are being run but we set up our venture based on our perception of what was needed rather than the government imperative that came later. We’ve had a two-year head start and make no mistake, it is a big slog.
The fact that the government imperative has now essentially become very similar to our original structure, including the FCA (Financial Conduct Authority) authorisation piece, which we think is fundamental, is a happy coincidence for us. But I’m not entirely sure where some of the other pools have got to in understanding, or accepting, that agenda or how they plan to implement it. I’d be very interested to see how they can take that through to any sort of endgame.
Now, that said, because we’ve got the experience, it’s beholden to us to offer whatever assistance we can. Obviously, we’ve got a good description of how we dealt with the FCA process, and government processes, and we wouldn’t want to be proprietorial over those pathways.
R151: So is the timetable reasonable, in terms of the transition of assets and so on?
MJ: It is incredibly tight, but I think it’s rightly tight because this needs to be done quickly. There is a generational opportunity here to restructure and reshape the LGPS and I don’t think that’s just about pooling but, more importantly it’s about the way the LGPS does its business; the way it invests, the way it manages risk and the way it manages its liabilities. Pooling is probably essential to achieve the other pieces but pooling is by no means as important as those other pieces.
R151: What are the big benefits?
MJ: It’s cheaper. It’s fundamentally cheaper to manage in-house. But that comes with costs, very manageable costs and demonstrably cheaper costs than doing it the old fashion way, but it takes resourcing and it takes gaining the appropriate skills. But we’ve already demonstrated just with the pooling of listed equity that all of these benefits are real and we’re only three months in to that. It’s very clear that this works.
That work can then be taken on into the other areas relatively easily although there may be some blowback in certain areas of private markets where there are still issues of access and intellectual capital. One of the things LPFA (London Pensions Fund Authority) and Lancashire did early on, which helps with the LPP’s development on that front, is direct investment in infrastructure. We have five years of track record between us now, and that plugs in nicely to the government’s agenda of LGPS assets being used more to fund UK infrastructure and global infrastructure. We’re totally behind that and our combined allocation now to infrastructure is getting on for 12.5%.
R151: What’s your take on the separation of asset allocation which sits at the administering authority and investment which now sits with pool?
MJ: Any investment consultant would tell you the most important decision you’ll ever make is the asset allocation and consequently the individual authorities are still taking the most important decision.
So, the key thing is that they get suitable advice. Now where does that advice come from? Well, the pool is obliged to be a source of that advice to a certain extent, but the individual funds’ independent advisors or independent consultants have a very important role to play there.
It puts a spotlight very clearly on the consulting firms. Their business model in the past with LGPS has been driven more by manager selection, that end of the operation, but, frankly, the really important piece of work is allocation. I think now they will find themselves very much in the spotlight to give really clear, really well researched, really well modelled asset/liability advice.
R151: Does it put pressure on the investment pools to be all things to all comers? Potentially you end up with very different asset allocation strategies feeding into the same investment team?
MJ: We’d like to be as broad as possible. We’ve delineated around seven or eight separate pools of capital within LPP. So, for example, we have a liquid equity pool and inside that pool there can be any number of variants of liquid equities. The asset allocator, the administering authority, sees a liquid equity pool and they make their allocation to the pool and then it’s down to us to manage the investments.
R151: So, there can be quite a bit of buying and selling going on within the pools of capital?
MJ: There can be. Let’s take credit for example which is a very cyclical business. You may feel that at this stage of the cycle, senior secured loans is the best place to be and you might not want any money in distressed debt but, two years on, that view might have changed significantly. So, we might be quite active in reallocating within the credit pool. In listed equity you can move quality based, to small cap, to emerging market, to wherever and those transitions can be made at very short notice and very efficiently. So yes, that can be done and probably should be done when appropriate.
Other areas, like property, infrastructure and private equity, for example, that’s much less of an issue because we’re talking about long-term investment of assets.
R151: How does LPP grow?
MJ: Well, firstly pools aren’t finalised yet. So that’s interesting and I think the assumption that the pooling model is that you pool and then you do everything the government requested you to do — so everyone has to go down the FCA route — is open to question. Maybe you’ll get pools that have the full offer — from the very front end to the final FCA authorised piece — and others that don’t and who look for collaborative working with those that do. That’s still to be resolved.
The one thing we’re trying very hard to do is be as open as possible with anybody who wants to talk to us. We know where we are going. We know what we have established. We are confident that we have set things up completely in line with the government directive. The issue is still scale but we can deal with that in several ways.
Does a pool have to have partners alone to demonstrate its size and capacity, or can we have partners and clients? Can it have collaborative working on specific areas like infrastructure, for example, where currently the LPP pool members are in a JV with funds from the Northern Powerhouse’s pool?
Also, as far as I’m aware, the way government has structured this there is no restriction on (clients) being LGPS only. Where that then takes us is probably not a question for now, but it’s certainly something we need to be open about.
R151: Going back to investment cycles where do you stand on the great rotation from bonds to equities? Institutional investors like pensions have to hold bonds to some extent don’t they?
MJ: Yeah, the capital rules across the insurance industry and the banking industry just guarantee that there’s a huge pool of especially liquid, especially high grade fixed income that just has to be there. As long as monetary authorities are still churning QE, which frankly I think they will have to for an awful lot longer than the market generally thinks.
That’s a very difficult area from a pension fund perspective. If we’re looking to close down our overall risk over time, naturally you’d expect us to be buying index linked gilts, at RPI minus 150, 175 in some places. Can that work in the current regulatory framework? Probably not! As a CPI fund, that’s less of an issue, perhaps, than it might be for commercial or corporate schemes, but it’s a much more difficult move now that it would have been five years ago.
R151: And do equities look overvalued to you?
MJ: Equities look … I wouldn’t say they’re overvalued but they’re certainly fully valued, and an awful lot of the equity book performance over the last five years has been driven by QE and if QE is pulled back, which I don’t think it will be, but if it is, then equity performance could be hit very badly.
Actually, the expectation that there are a series of rate rises either in the US or in Europe is rubbish. So, the expectation that there may be a crash in the equity market is also rubbish, short-term.
That said, there are a number of geo-political issues, which could trigger something, and if that happens then I would say you invest in equities quite heavily on the down trade. There’s a fantastic opportunity actually … I don’t want to say it’s unusual, because as it turns out nothing is unusual, but there’s a dynamic in the equity derivative market at the moment that gives you protection against down moves in the equities market and the ability to “re-up” into equities after a major fall without having to liquidate other assets. You can get very substantial protection and almost get paid for doing it.
R151: When we spoke last year, before the referendum, you were very concerned about the value of Sterling in the event of Brexit. You were proved right – now what’s the long-term view of Sterling and how does it shape investment strategy?
MJ: Fundamentally, I’ve been a Sterling bear for 37 years, and since we started this journey in 2011, I’ve taken the view that parity in cable (British pound vs the US dollar) is inevitable at some stage. My original target for the last calendar year was 118.30. My target for this calendar year is 105.50, with a longer term view of 95.70. Yesterday (11-01-2017) we saw an attempt to break 120; we had a bounce-back today but fundamentally I think that (trend) is there.
For a holder of UK assets with Sterling liabilities, obviously, you’re insulated to some extent but there may be opportunity costs.
Now, these two funds (LPFA and Lancashire County Pension Fund) have taken a very global approach. So, both funds have relatively high exposure to non-Sterling assets. In the case of Lancashire, it’s close to 80% and in the case of LPFA it’s 65-70 %, I think.
Last year our performance was stellar. This year performance is stellar, so far, and a lot of that is based on foreign exchange rates and I see no need to change that for the minute. The fundamentals of the UK economy, particularly the productivity paradigm, is the thing that keeps pressure on Sterling.
Really though, the story here is dollar strength. There are not enough dollars in the world by a long way. And as long as there are not enough dollars in the world, dollar strength is more or less guaranteed. I think that’s absolutely crystallized by the fact that a Trump victory should have been detrimental to the dollar, if only in the short term, but it wasn’t.
If anything was going to cause a shock it would have been political rather than financial and it hasn’t.
So, the underlying issue in the global economy is there are not enough dollars. So, either they need print more which they’re not doing now because they have definitely turned off QE. I still think they’ll reverse that decision either late this year, or early next year, but for the moment they are not going to. So, where do those dollars come from? Well, the answer is nowhere.
R151: So if you’re looking beyond the UK for big returns in future, where do you look?
MJ: Well, I don’t think there are big returns in investment any more. Those people making the asset allocations need to accept that this is a declining return world we live in and, from a risk perspective, maybe you allocate a little bit to “shoot-the-lights-out” trades but they shouldn’t be the main driver of investments.
R151: Is it time to stop thinking about equities, fixed income, conventional asset classifications and time to start thinking about demography, climate change, artificial intelligence and these sorts of factors?
MJ: You have got exactly the three things on my radar. Demographics, front and center, are way up there and this is going to be really, really important going forward for investors. This has to be part of your investment decision making process and also part of your asset allocation decision making process.
For for some time now there has been a general acceptance that demographics is a problem in the developed world. What’s less clear is that it’s also a problem in the emerging world, which is far more complicated and layered than the demographic time bomb in the developed world, which by now we pretty much have a handle on. Of all the factors you consider when looking at asset allocation I think demographics should be 50% of your call, especially for the long-term investor like the LGPS.
