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Managing risk in the LGPS

William Marshall
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‘Risk’ is a word commonly used in the pension industry.

However, it means different things to different people. For some, risk is viewed as something that, where possible, should be avoided; for others it represents an opportunity to be exploited. From a Local Government Pension Scheme perspective, the reality is both definitions apply – eg managing the risk associated with a maturing scheme and a diverse mix of employers, while at the same time generating the returns needed to keep the LGPS affordable for its employers.

Reflecting the fact that a range of views exist, we surveyed independent advisors from a number of LGPS funds for their opinions on risk-oriented topics, (see diagram, right).

We summarise some of the main findings below. Full details of the results can be found on our website

Objectives and beliefs

Some 90% of respondents felt that LGPS committees have a clear understanding of their fund’s current investment objectives. However, only two thirds believed committees had a clear view of how their investment strategy will look once the fund’s objectives have been achieved. There was unanimous agreement among the advisers that statements of investment beliefs are important and are a key part of committees’ decision-making frameworks.

Knowing where your fund is going, and how you intend to get there, are key elements of your fund’s journey. As we see funding levels improve, and funds become increasingly diverse, we believe there is an increasing need for committees to consider what long-term balance between funding and investment risk they would be willing to accept so plans can be put in place to work towards this.

We believe a clearly articulated set of investment beliefs is hugely important in helping a pension committee consider its decisions in light of those beliefs. For any funds without a set of investment beliefs, we strongly recommend that you consider putting them in place. For those that already have investment beliefs, we encourage you to revisit them to ensure they are appropriate and test your investment strategy relative to them to ensure the beliefs are being reflected.

Employer investment strategies

About 50% of those surveyed were of the view that employer-focused investment strategies are important for the LGPS.

We have seen the greatest use of employer-focused strategies where employers have specific liability profiles (eg very mature employers) or are extremely well funded (eg closed employers heading towards cessation) and therefore a growth-oriented investment strategy is not appropriate.

We believe that the increased focus on the risk to employers from their LGPS pension obligations means that the demand for employer-focused investment strategies will continue to grow. We also believe that the ever increasing focus on governance will mean that the funds themselves are more concerned about specific employer risks and will be more willing to offer those employers bespoke (lower risk) investment strategies.

Asset pooling

The responses reiterated that the relationship between the pool (effectively acting as an external supplier) and the funds needs to be carefully managed, with the former needing to offer clear reporting on all the decisions that it makes on funds’ behalf (ie not just manager performance) and the latter needing to understand how their strategic goals and beliefs are being reflected in the investment options offered by the pool, challenging the pool where it is necessary to do so.

There was also a consensus that committees having a greater focus on strategic decisions may well be beneficial. Having this additional strategic focus is likely to tie in well with the comments on the need to have greater clarity on what the investment arrangements should be at full funding and the potential need to develop specific strategies for certain employers.

Market risks

The risk of funds being unable to generate sufficient asset returns was highlighted as the main market risk for the LGPS. This is a concern that we share and which we have commented on previously, most notably at the LGC’s Celtic Manor conference.

LGPS funds have the ability to take a long-term view and generally have sufficient scale to access a very wide range of investment opportunities. Increasingly, as funds mature, particularly for some employers within funds, avoiding being a forced seller of assets at inopportune times is critical. As such, an increased focus on income generating assets to reduce volatility of returns and meet cash flow requirements is becoming a key part of funds’ planning.

Summary

The results from our survey highlight that, although a range of views exist when it comes to risk, there is general agreement that clarity of direction travel is needed (ie objectives and beliefs) and a framework to understand what risks exist and how they should be managed should be in place.

William Marshall, head of LGPS investment clients, Hymans Robertson

Column sponsored and supplied by Hymans Robertson

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hymans robertson logo

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