Agenda item

Report of the Chief Financial & S151Officer giving an overview of recommended changes to the strategy of investing.

 

The Chair agreed to vary the agenda to consider item 9, immediately after consideration of the minutes as Cllr Bevan would need to leave the meeting to attend Planning Committee.

 

The Head of Pensions introduced the public part of the report which set out a review of the fund’s existing equity strategy, along with actions that could be taken in relation to this.

 

The Committee noted that Haringey Pension Fund had increased in value by roughly £350m since the 2016 valuation, and the majority of this increase was attributable to continued global stock market growth. This had materially improved the fund’s funding level , however, these gains could be reversed before the date of the next triennial valuation in 2019, should stock markets decline and this would impact on employer contribution rates.

 

The Committee noted that the Fund’s equity was currently all invested passively in market cap weighted index linked funds, with set percentages allocated to different geographic regions. 50% of the developed market equity was invested in global low carbon funds, this was also market cap weighted, however with a tilt away from certain stocks to create a significant decrease in exposure to carbon emissions and carbon reserves.

 

The Committee were asked to consider potential changes to the strategy of investing only in line with market cap indices, as well as the use of fixed allocations to specific geographic regions, and were asked to consider both alternative index use and active equity management.

 

Following presentation of the exempt information from Mercers attached at item 16 , and discussion on the merits and draw backs of the 3 models of investment proposed, which concentrated on the management fees applicable following a change in strategy, and the general risks perceived around an active style management, ,there was a vote on the proposed strawman equity portfolios, set out in the exempt part of the report.

 

Strawman 3 - [ set out as a recommended option at 3.2 ] received 2 votes and Strawman 2 received 4 votes.

 

RESOLVED

 

1.    To approve a change to the fund’s investment strategy to implement strawman 2 equity portfolio as shown in the exempt appendix 1 attached at item 16, namely to;

·         Allocate 42.6% to multi factor portfolio.

·         Allocate 14.8% to market cap portfolio

·         Retain the current allocations to emerging market equity and low carbon equity, but to switch all of the low carbon portfolio into a currency hedged fund, to retain the fund’s overall 50% currency hedged position in developed markets

 

2.    To grant delegated authority to the CFO to implement this investment strategy change, including any due diligence necessary with the requisite fund managers, and to effect the movement of investment assets.

 

3.    To grant delegated authority to the Head of Pensions to update the Fund’s Investment Strategy Statement and republish this, consistent with any changes agreed, as detailed above.

 

 

Tactical Rebalancing:

 

4.    To agree to a tactical rebalancing of the portfolio, as detailed in Confidential Appendix 2 as ‘option 3’, but namely to complete a rebalancing of 75% of the fund’s overweight equity position:

o       Allocate 50% of the fund’s overweight equity position to the fund’s multi asset absolute return strategy

o       Allocate 25% of the fund’s overweight equity position to the fund’s multi asset credit strategy

o       Retain 25% of the fund’s current overweight equity position as equity holdings.

 

 

 

Reason for Decision

 

Equity Strategy Review

 

The fund has a commitment to investing in a manner which not only secures sufficient returns to meet the fund’s strategy to increase the overall funding level, but which also takes serious consideration of environmental, social and corporate governance (ESG) factors. Mercer has previously reviewed the fund’s low carbon strategy, and this was increased from 33% of developed market equity to 50% of developed market equity in the summer of 2017. This paper does not propose any change to this part of the equity strategy.

 

The equity portfolio is all invested in market cap index linked funds: this essentially means that the portfolio invests in line with the stock market as a whole, and therefore produces returns that should be equal to the average stock market performance. For example, the Fund’s UK equity holdings track the FTSE All share index, so the returns are equal to the performance of the FTSE All share. Broadly, this means that the fund’s equity portfolio is only exposed to one ‘style’ of equity investment. Utilising a number of different styles or factors in the portfolio which are complimentary and can counterbalance one another, could reduce the volatility of returns for the fund as a whole. This is detailed further in Mercer’s report.

 

One of the downsides of investment in market cap indices is that the fund is increasingly exposed to the largest and most expensive companies in each index. Over the past few years this has been strategy that has greatly benefitted the fund, due to prevailing market conditions, and sustained stock market growth. However, this strategy is unlikely to perform well if we enter a period of equity market decline, and in this scenario, the fund could actually suffer disproportionate losses: reversing some of the recent gains made.

 

It is therefore sensible to reconsider the current equity strategy of investing 100% in market cap indices, (albeit with a partial low carbon tilt), and consider other equity investment strategies with the aim of hopefully smoothing the fund’s returns, and trying to reduce the fund’s dependence on one particular style of equity investment. This is a move to diversify the fund’s equity strategy further: in the best interests of the fund’s membership, and particularly employer base, as investment returns impact on employer contributions to the fund.

 

The current equity strategy also has fixed allocations to specific geographic regions. This is problematic, as the allocations made in the strategy at one point in time are not agile, and do not allow for the fluctuating size of different geographies within the global economy. For example, the Fund’s current allocation to UK equity is significantly overweight when considered within a global context, as the weighting to UK equity was determined prior to the Brexit vote in 2016, and the UK stock market has since shrunk as proportionally. This can be overcome by the use of a global index which automatically rebalances different geographic weightings. A global index is currently used by the fund currently within the low carbon portion of the portfolio. Strawman portfolios 2 and 3 in the paper produced by Mercer address this problem fully, strawman portfolio 1 partially addresses this.

 

Tactical Rebalancing:

 

Mercer have produced Confidential Appendix 2 with advice to the Committee and Board regarding the fund’s current overweight position in equity.

 

The fund has appointed a number of private market or real asset fund managers in recent years: the long lease property and renewable energy infrastructure mandates. These mandates are illiquid and take a number of years to fully invest. The funds waiting to be drawn down to these investments are all currently held temporarily within the equity portfolio, and this equates to roughly £141.6m at the time of writing. This takes account two bulk transfers that will occur later in the year, and which will both be funded by equity drawdowns, estimated at £50m. However, as Mercer suggest in confidential appendix 2, this £141.6m figure should be updated in light of the 28 February valuation as soon as this becomes available (it was not at the time of writing).

 

The fund has allocated 5% to renewable energy infrastructure (with Copenhagen Infrastructure Partners and Blackrock), but it will take a number of years before this is all invested. The fund has also allocated 5% to a long lease property mandate (with Aviva). This is likely to be invested later in 2018. The funding for these investments is currently all held and invested within the fund’s equity portfolio, on a temporary basis, until these fund managers have sourced appropriate assets, and are able to invest the funds.

 

The equity portfolio is the most volatile section of the investment portfolio overall. There is therefore a risk that equity markets may decline, and consequently the valuation of these funds temporarily allocated to equity will drop.

 

To hedge against this risk, it is therefore recommended that the Committee and Board consider a tactical rebalancing of the portfolio, in order to rebalance this temporary overweight position in equity, and to move a portion of this £141.6m into funds held with Ruffer and CQS, to hedge this risk that the equity holdings fall in value. Moving the funds would be a relatively quick exercise due to the liquidity of all three investments.

 

The paper produced by Mercer has looked at a number of options:

 

o       Option 1 essentially rebalances 100% of the overweight position in equity, and splits this as follows:

o         50% allocated to the fund’s multi asset absolute return strategy (London CIV – Ruffer)

o         50% allocated to the fund’s multi asset credit mandate (CQS).

o         0% remains within equity.

 

o       Option 2 essentially rebalances 50% of the overweight position in equity, and splits this as follows:

o         25% allocated to the fund’s multi asset absolute return strategy (London CIV – Ruffer)

o         25% allocated to the fund’s multi asset credit mandate (CQS).

o         50% remains within equity.

 

o       Option 3 essentially rebalances 75% of the overweight position in equity, and splits this as follows:

o         50% allocated to the fund’s multi asset absolute return strategy (London CIV – Ruffer)

o         25% allocated to the fund’s multi asset credit mandate (CQS).

o         25% remains within equity.

 

Mercer have indicated that they have a marginal preference for option 3, however that they are also supportive of option 2.

 

 

Other options considered

 

The exempt paper from Mercers at item 16 contained a number of options for the fund’s equity strategy.