Managing fixed interest assets is never going to be as exciting as equities and consequently - for councils at least - it attracts less interest and attention at investment panel meetings.
I refer specifically to councils as our private sector pension fund counterparts have enjoyed a flurry of interest because of the minimum funding requirement, which has had an effect on the demand for government gilts and therefore their yields. But even this looks to be temporary as there has to be a good chance the MFR will be abolished.
Nevertheless substantial sums are invested in bonds. The Somerset CC fund has around£86m invested, of which about£32m is overseas. When Somerset won its award this year it occurred to me that in the 10 years I have been at Somerset our returns from bonds has always been above the benchmark - I wish I could say the same for all the other assets.
Somerset's fund is divided. Two-thirds of the fund is managed actively by external managers. Jupiter Asset Management manages all except North American equities and it can take most of the credit for our performance on bonds.
One-third of the fund is managed in-house on a part-time basis, so my own treasury management team can take some of the credit.
Our in-house team is advised by Martin Cahill of HSBC while John Hamilton has always managed Somerset's bond portfolio allocated to JAM. And in these somewhat turbulent times there is no doubt John's consistent and fairly measured approach has added real value.
One of our strict rules at Somerset is never to interfere, but that does not mean we do not challenge and question our managers and advisers. Essentially, as far as bonds are concerned, what we are looking for is a good economic assessment particularly on the outlook for inflation and the impact on interest rates.
While we do not want our managers to be too dogmatic, as the economic climate can change quickly, we are very cautious of short term views. Our test for this is turnover - we would be unhappy with a high level of turnover.
Getting the right currency mix is crucial to achieving good performance, but here we expect a less mechanistic approach as market sentiment can shift quite quickly and for quite subjective reasons. Our advisers share the view that because the US economy appears to be slowing, currency will be more important in the UK than in Europe. The advent of the euro has diminished the scope for adding value by switching between European government bond markets.
So what are the reasons for Somerset's outperformance? I think an important
factor is our investment in corporate bonds as opposed to government bonds.
Corporate bonds have been cheap and despite the obvious need for careful credit analysis, have certainly enhanced our returns.
But the old adage that people make systems work rather than vice-versa is never more true than in the realms of investment management. The fact that we have had the same external manager in John Hamilton for over ten years is in my
view the real reason for our continued outperformance.
-Chris Bilsland, corporate director - finance, Somerset CC.