Agenda item

Review of Investment Strategy

To consider the review of the pension fund’s investment strategy.


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.



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.



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