Agenda item
Review of Investment Strategy
To consider the review of the pension fund’s investment strategy.
Minutes:
The Committee
considered a report from officers that reviewed and proposed changes to the
pension fund’s investment strategy.
The
LGPS is a ‘defined benefit’ scheme so benefits are calculated based on age,
length of membership and salary, not investment performance. Benefits are funded from contributions from
scheme members and their employers, and from the returns from investing these
contributions before they are needed to pay pensions. Contribution levels are set nationally for
scheme members and locally for scheme employers, so effectively the risk of
investment underperformance is borne by scheme employers.
Every
three years the actuary sets contribution rates for employers based on
assumptions about the pension fund’s assets and liabilities and expected
investment returns. Following the
results of the latest triennial actuarial valuation, investment consultants,
Mercer, were engaged to review the current investment strategy and strategic
asset allocation
Mercer’s concluded that the discount rate of 5.0%
used would be challenging to achieve with the current target allocation. Some changes to the strategic allocation were
therefore recommended in order to improve the chances of achieving this target
rate of return without unduly increasing risk.
Members of the committee had attended a training session where Mercer
explained the reasons for these proposed changes.
The
main recommended changes were to increase overall equity exposure from 45% to
50% of total assets, reduce the proportion of UK specific equity holdings,
increase the proportion of actively managed equity holdings and reduce the
allocation to corporate bonds.
Mercer
also considered two potential approaches to enable the pension fund to move
towards a low carbon future - divestment, which meant completely divesting from
companies involved in the sourcing and refining of fossil fuels, and
decarbonisation, which meant a reduction in allocations to companies which are
high carbon emitters and looked to influence the demand for fossil fuels and
their financing, not just their supply.
Mercer’s
favoured approach was decarbonisation as opposed to divestment from all fossil
fuel companies. Decarbonisation could
deliver significantly greater reductions in the ‘carbon footprint’ of
investments, it allowed for continued influence with companies, and would be
more straightforward to implement.
The Chairman
highlighted that the proposed investment in the Brunel sustainable equities
portfolio would substantially reduce the carbon footprint of the pension fund,
as would the reduction in UK and passive allocations. This was the start of a process which was
likely to see over time further reductions in UK and passive allocations and
further increases to sustainable equities as confidence in this product grew.
The Independent
Adviser explained that the proposed changes were the result of a number of
iterations between him, officers, the Chairman and Mercer. The result of this process was a good
balanced strategy.
There was a fairly
even split of actuary firms used by the ten Brunel Pension Partnership clients
and discount rates ranged between 4% and 5%.
If the actuary had set a lower discount rate at the last triennial
review, this would have resulted in increased contribution rates for scheme
employers.
A member agreed
with the proposed increase in allocation to equities and the transfer of
emphasis away from the UK but felt the case for more active management required
more evidence and proposed that this decision be
deferred until the next meeting of the Committee in November 2020.
If the proposals
were agreed 30% of equity exposure would still be through passive investments. The changes would target areas where active
managers were more likely to add value, such as emerging markets and smaller
companies as opposed to core strategies.
The Brunel active portfolios either don’t yet have a track record or
they have a very short track record. The
pension fund’s legacy active managers, Schroders and Wellington, had
outperformed the market as had Brunel’s global high alpha portfolio, albeit
over a relatively short period of time.
An active approach was also better able to meet the low carbon desire.
The Vice-Chairman
said that the Committee’s primary responsibility was to ensure investment
returns are sufficient to fund pensions and, whilst not mutually exclusive,
there was some tension between this and the desire to help tackle climate
change. A higher allocation to active
management was the only way that progress could be made to reduce the pension
fund’s carbon footprint and still generate the required investment returns.
A proposal to defer
the decision to increase active equities and reduce passive equities until the
next meeting of the Committee in November 2020 was not agreed.
A member spoke in
favour of keeping investment not only in the UK but in Dorset
specifically. The Independent Adviser
replied that it was very hard to get the scale required by investing locally
and it also raised potential conflicts of interest. However, local investment could be
appropriate if the right opportunity came up.
A member
highlighted that the importance of fossil fuels for investment returns had
fallen from 29% of the main US equity index in 1980 to approximately 5% in
2019. It would therefore now be a much
smaller task to implement a divestment approach that it would have been in the
past, and it was proposed that an independent assessment of a potential fossil
free portfolio be commissioned.
The Independent
Adviser said that Mercer had been engaged to provide an independent opinion and
they proposed a decarbonisation approach not blanket divestment. The proposed move to global and sustainable
equities will help decarbonise the pension fund, and its investment managers
would also reduce exposure to fossil fuels if they think it is a bad
investment, as had always been the case.
Decarbonisation is the approach followed by Brunel, one of the leaders
in this area, and the Church of England Pensions Board, one of the co-founders
of the Transition Pathway Initiative (TPI).
A proposal to
request an independent assessment of a fossil free portfolio was not agreed.
It was proposed
that the Brunel Pension Partnership be asked for a schedule of the pension
fund’s investments in organisations on the Global Coal Exit List, and that the
pension fund divests from those companies within eighteen months.
The Chairman was hugely
sympathetic for the desire to divest from fossil fuel companies. The Committee had to take action to reduce
the pension fund’s carbon footprint but divestment was not the right approach. A combination of investing in sustainable
equites, with a two thirds reduction in carbon footprint, and the other Brunel
active funds, all committed to a 7% year on year reduction, would have a more
positive impact than the proposal to divest from all fossil fuel
companies. The sustainability
credentials of Brunel were described by one member as second to none amongst
the LGPS investment pools.
A member thought
that whilst the case for decarbonisation in the report was compelling it was
not an ‘either or’ choice between divestment and decarbonisation. The decarbonisation approach should be taken
but the Committee should also look to see if the pension fund can be made
fossil fuel free.
Concerns were
raised that divestment was a blunt instrument that did not distinguish between
companies that were making changes, such as Shell, and those that were not,
such as Exxon. Divesting from companies
investing billions of pounds in new technology and fuels could have a
detrimental effect on the shared desired outcomes of the Committee. Divestment should be part of a gradual
process rather than a sharp knife.
The loss of
influence over companies following divestment was also raised as a
concern. It could lead to the sale of
assets to other investors, companies or countries less concerned about the
environmental impact of their investments.
It was agreed to
remove the timescale for divestment from the proposal, and the revised proposal
to ask Brunel for a schedule of the pension fund’s investments in the Global
Coal Exit List was agreed.
Resolved
i)
That
the proposed changes to the investment strategy and strategic asset allocation
are agreed.
ii)
That
officers implement the changes to the investment strategy and strategic asset
allocation.
iii)
That
officers to update the Investment Strategy Statement (ISS) as necessary.
iv)
That
the Brunel Pension Partnership are asked for a schedule of the pension fund’s
investments, through its holdings in Brunel managed portfolios, in
organisations listed on the Global Coal Exit List.
Supporting documents:
- Agenda Item 7 - Investment Strategy Review, item 63. PDF 88 KB
- Item 7 Appendix - Mercer Investment Strategy Review, item 63. PDF 3 MB