This paper provides an update on the London Borough of Hammersmith & Fulham Pension Fund’s investment activity since the Pension Fund Sub-Committee approved the delegation of all decision-making to the Chair, in consultation with the Director for Treasury and Pensions in April 2020.
This report has two appendices that contains information exempt within the meaning of Schedule 12A to the Local Government Act 1972 and is not for publication. The appendix has been circulated to the committee members only.
Any discussion on the contents of an exempt appendix will require the Committee to pass the proposed resolution at the end of the agenda to exclude members of the public and press from the proceedings for that discussion.
Kevin Humpherson (Deloitte) provided an update and noted that the pension fund had been invested in the M&G Inflation Opportunities Fund (IOF) since 2015. As at 30 April 2020, the pension fund had £113.0m invested with the Fund. In February 2020, the pension fund approved an asset allocation of 10% to inflation strategies and 5% to property. To meet the inflation objectives of this mandate, the M&G IOF had a sizeable allocation to long lease property. This allocation effectively meant that the pension fund’s exposure to long lease property was around 9%, and exposure to UK commercial property (including income strips and ground rents) was around 13.5%. Whilst the Fund had outperformed its return objective since inception, it had largely underperformed its expected sector allocation. 84% of the Fund was exposed to UK commercial property compared with the expected 55% target allocation. The Fund had a larger exposure to the office, hotel and leisure sectors which had been significantly impacted by the lockdown measures put in place earlier this year as a means to minimise the spread of the coronavirus disease. In addition, the Fund had faced some challenges in rent collection which had led to more rent deferrals from the tenants. As a result, the pension fund faced an increase to its cash flow risk which could lead to increased difficulties in paying out pension benefits if this was not addressed.
Therefore, the Pension Fund Sub-Committee was recommended to either partially or fully disinvest from the M&G IOF and commence the search for a replacement manager to achieve the Fund’s diversification targets.
discretion whereby they don’t have to distribute more than 5% in any one dealing date. The Council’s total holding within the Fund was 22% therefore a full disinvestment could be distributed over a 5-month period should this be necessary. In addition, there would be an option to keep the income strip allocation. However, it was felt that this wouldn’t be a viable option. In addition, a dilution levy would be applied purely based on market pricing in September 2020. This would be 25 basis points as an estimate.
Kevin Humpherson explained that going forward the Council would need to explore alternative options to reallocate the investment. Some of the factors to consider when reviewing alternative options would be exposure to UK property, exposure to UK linkage and expected return on the Fund as a whole. A number of discussions had been held with some fund managers as a possible alternative to M&G. In the long term, the proceeds should be invested in assets which delivered inflation linked income while adding diversification to the Fund, such as infrastructure debt. Recognising this would take time to identify and select, and was not helped by the current market conditions,
Phil Triggs (Director of Treasury and Pensions), commented that officers agreed with Deloitte’s suggested approach, primarily on the basis that the existing M&G portfolio was over exposed in several sectors and this was exemplified with the impact of Covid-19 and the potential downturn possibility that it placed on the future prospects for that part of the portfolio.
Councillor Matt Thorley asked whether there was a risk of a longer exit from the Fund due to the 5% cap if the Council partially disinvested and at what stage would the Council need to allocate the capital. Kevin Humpherson provided an outline on what it would mean to partially disinvest and how long this could take. He noted that the fund manager had discretion to defer a full redemption request and implement on successive dealing dates. The fund manager would review the liquidity of the portfolio at the time to determine how much of the redemption could be executed on the dealing date.
Councillor PJ Murphy asked for clarification around the total property exposure to the Fund. He also asked if a partial disinvestment was carried out, were Officers confident that the Fund would perform whilst the Council explored other investment options, particularly around sustaining the inflation balance. Kevin Humpherson explained that the over total exposure to property was 13.5%. Full sale of M&G would take this down to 5% and a partial disinvestment would bring this to 9.25%. The Council would have expected a 7.5% exposure to the property market via the M&G fund if the recent changes to the market had not taken place. It was difficult to predict the performance at this stage. This would depend on how quickly tenants were able to pay their leasing.
Michael Adam felt that a full divestment would result in a better outcome, given M&G’s exposure to certain chains. In addition, it was important to consider retaining high RPI linkage in the Fund and if there was an opportunity to replace it with other RPI linked assets in the future, this would be beneficial.
The Chair asked for further clarification to be provided around timescales for an alternative investment option. Phil Triggs said that further discussions around potential options could be discussed as part of the weekly calls with the Chair, with the view to present a few other products at the next meeting.
Phil Triggs (Director of Treasury and Pensions), explained that following the disinvestment from the LCIV UK Equity Fund, completed in December 2019, the Fund’s 45% strategic allocation to equities was entirely invested in the Legal & General World Low Carbon Equity Index Fund. As at 31 March 2020, the Fund had £411.5m of its investment portfolio invested in the passive Fund. In April 2020, the Sub-Committee, met with the pension fund’s officers and investment consultant to discuss how best to position itself to minimise its downside risk exposure and take advantage, via active management, of the prevailing uncertainty in the financial markets at the time.
Subsequently, the Sub-Committee decided to allocate a third of the pension fund’s equity allocation (15% of its overall investment portfolio) to an active equity manager and requested its investment consultant to present a shortlist of suitable strategies for the pension fund. On 11th May 2020, four investment managers presented their strategies to the Sub-Committee. Following this an agreement was reached to appoint Morgan Stanley, who managed the LCIV Global Equity Sustain Fund, as the pension fund’s new active equity manager. This decision was taken outside of the Sub-Committee and this paper had been brought to this Sub-Committee for formal ratification and approval.
The Sub-Committee expressed a clear preference for Morgan Stanley’s investment process, citing the concentrated portfolio and lower correlation to the market. The Sub-Committee was particularly impressed with how the investment manager integrated environmental, social and governance (ESG) factors into their investment process. The pension fund considered ESG related risks to be a significant factor in the long-term sustainability of the global environment.
The Chair asked for an update to be provided on how this investment had an impact on the Fund’s overall carbon footprint. In response Phil Triggs said that the Council’s ESG dashboard was being monitored and updated on a regular basis. The exact figures would be included as an agenda item for the next Sub-Committee meeting.
THAT, the Sub-Committee
a. Formally approved the investment decision to investment 15% of the pension fund’s investment assets into the LCIV Global Equity Sustain Fund.
b. Approved the decision to a full disinvestment from the M&G Inflation Opportunities Fund and commence the search for a replacement manager.