Agenda item

62.1.    The Committee considered a report providing an update on the investment activities undertaken by the ESPF.

62.2.    The Committee’s discussion included the following key issues: 

·         WHEB has a more concentrated portfolio of stocks than Wellington so is more volatile and susceptible to rises and falls in the market. Similarly, Baillie Gifford has fewer than 100 stocks so is expected to be more volatile than the UBS fund that it is replacing.  

·         There is limited value in the performance measure “since inception”. The meaning of the term is not clear, i.e., does it mean since the investment manager was founded or when ESPF decided to invest with them; and it makes comparisons difficult, as some investment managers have been with the Fund far longer than others.

·         Equities have performed well for the Fund for several years now, but the future is not looking as promising. Inflation is increasing on a sustained level above 3% and, in response, there are clearly signs of governments and central banks beginning to plan to enact monetary policies that will restrict the flow of money supply through raising interest rates, which will make equities a less attractive asset class and could also cause a recession if enacted too soon, further reducing equity’s value. Whilst the UK and other countries do now seem to be in a period of inflation it may not be a long-term issue, as it appears the inflation is supply-led rather than demand-led. It could, however, become self-replicating should people begin demanding pay rises to meet the rising costs of inflation.

·         Whilst 40% of the Fund’s value is in equities, there are a number of other asset classes in the overall portfolio of the Fund that are designed to protect against inflation. Private equity and credit will do better than equity; private equity is less volatile than the listed market as performance is reported on a quarterly basis that smooths out fluctuations in value. Private equity managers are also well placed in this scenario to fund poorly performing companies struggling from the effect of inflation, which will benefit them as the companies recover. Infrastructure and property are designed to protect against inflation as they track inflation quite closely and infrastructure provides an attractive return on investment. Ruffer’s diversified growth fund is also designed to offer inflation protection via its choice of asset universe. Finally, in terms of equities themselves, value equities offer more resilience than growth equities, and the Fund has exposure to the former through its investments held by Longview.

·         The Fund is currently overweight in equities to its strategic asset allocation due to strategic changes still to be implemented such as global open-ended infrastructure and inflation linked property, although suitable managers have not yet been identified. Isio will investigate further and produce a future report on possible infrastructure managers, as infrastructure remains outside of ACCESS and the time frames associated with this asset class being available through the pool impact the Funds strategy implementation. Increasing the Fund’s exposure to inflation linked property and infrastructure will offer further inflationary protection, however, it is likely to be costly as they are now in high demand. Rebalancing was discussed, although there are limited options due to strategy implementation timeframes, so officers and advisers to look into further.

·         Whilst an infrastructure fund is planned by ACCESS, it is several years away and an open-ended infrastructure fund does provide the Fund with the option of transferring to the ACCESS offering if it is financially viable. Conversely, the ACCESS pool may wish to adopt existing ACCESS Funds infrastructure investments if it looks worthwhile.

·         Equity remains an important asset class as it provides growth to the Fund, which is necessary as the Fund’s membership continues to increase. Equities may also pay out dividends, which are not vital for the Fund as it is cash neutral, however, these too can become less common in inflationary periods as the companies are less likely to be making profit.

·         Inflation also decreases liabilities of a Fund by decreasing the value of the paid pensions and reducing the discount rate of the Fund, although there is not identical correlation between the two, and this will have a balancing effect on the Fund.

·         Understanding how the different fund managers are performing against each other and how their different portfolios correlate to protect and grow the Fund would be helpful for the Committee to understand given the current uncertainties. The impact of inflation on the performance against benchmark is also important to understand.

·         Schroders’ property fund is a ‘fund of funds’ and is invested in a privately funded vehicle with Civitas, which was the recent victim of a short seller. The Fund’s own holdings in Schroder were not affected by this event.

·         Schroders currently holds 6.8% of the Fund’s assets that it is responsible for in cash.

·         The Fund has agreed already to reduce its asset allocation in property from 8% to 7%. Isio will investigate whether this cash is planned for investment elsewhere by Schroders or could be taken out to be put into infrastructure assets, as agreed by the Committee in July. This could be a good opportunity due to the high cost in divesting from property, e.g., paying for stamp duty.

·         Property assets remain outside of ACCESS currently due to the illiquidity of the asset which are not yet available on the Pool. Property is a difficult class to move into LGPS pools because some LGPS funds invest in it directly and others used fund of funds like Schroders.  This makes it hard to bring the assets together and those who directly invest would not make much of a saving. 

·         The energy transition of commercial property remains a considerable risk to the Fund because of this illiquidity and requirement of considerable retrofitting of offices and other buildings.

62.3.    The Committee RESOLVED to:

1) note the report;

2) request that future quarterly monitoring reports include for all investment managers a 5-year performance column rather than “since inception” column;

3) request that Isio produces a correlation table in the next quarterly report showing how the different investment manager’s portfolios overlap and how each is performing relative to the other; and

4) request that Isio produces a report looking at the impact of secular inflation on portfolio assets and liabilities.