Global views spur LPFA’s bets on growth, diversification

With the ability to make investments of up to £50 million ($80.4 million) without board oversight, the London Pensions Fund Authority (LPFA) has boosted its exposure to emerging markets while also buying global infrastructure, commodities and solar energy. Chief executive Mike Taylor told Simon Mumme about some further opportunities, such as Brazilian agriculture, the fund is targeting.

The LPFA is implementing an increasingly globalised portfolio. The bulk of the $4.8 billion fund is invested in global equities, which Taylor says provides “the rightful home for pension fund assets”. But the risk natural to equity markets means that his fund is tempering this exposure with allocations to cash, bonds, and an array of diversifying assets for the long term.

“The assumption is that we’ll get better returns from emerging markets and overseas markets than just the UK.”

Last year the LPFA board gave its investment director, Vanessa James, the power to make investments of up to $80.4 million in consultation with Taylor and the chair of LPFA’s investment committee, enabling the fund to respond more nimbly to investment opportunities. James and her team -alternatives specialist Phillip Jones, responsible investment head Aled Jones and investment manager Runar Ellis – have beefed up the fund’s alternatives book.

The fund invested $80 million in commodities; $30 million in Asian infrastructure; $22 million in global infrastructure; and more than $100 million in solar and new energy assets. Delving further into the alternatives universe, the LPFA is carrying out due diligence on investments in global currency, housing, lease financing and agricultural land in Brazil, whose “climate and support for farming and infrastructure from the government” provide it with an advantage over other land markets.

The LPFA is also the lead investor in ‘Global Osiris’, a global property fund-of-funds managed by ING. To date, at least 74 per cent of this fund is invested in funds operating in Europe, North America and Asia.

For its alternatives portfolio, Taylor says the fund targets assets with strong economic fundamentals, low correlations to public markets and hedge inflation. However, its investment outlook seems to be increasingly aligned with the theme of demand for soft commodities, biofuels and changing diets.

“Agricultural land is not expected to keep pace with demand,” Taylor says. “We believe that land values will go up because of this demand”.

Sustainability is also a powerful determinant in the fund’s investment decisions. In its quarterly meetings with appointed global equity managers – Legal & General, which passively manages $835.7 million; MFS, which manages $739.6 million; Newton Investment Management, which manages $611 million; and Sarasin and Partners, which manages $64.3 million – the fund focuses on their progress in fulfilling ESG principles, Taylor says.

Newton and MFS, in particular, prioritise admirable governance and minimal carbon emissions in businesses, while Sarasin and Partners focuses more broadly on environmental, social and governance considerations. The fund’s private equity and infrastructure portfolios include cleantech assets, also reflecting the sustainability theme.

In recent years the fund has drawn on cashflows to pump more capital into absolute return strategies, bringing its exposure to $370.1 million, Taylor says. Its private equity portfolio now sits at $297.6 million, and it has $241.3 million invested in commodities and infrastructure.

After terminating a $352.2 million target return mandate with UBS GAM in late 2008 due to the departure of key investment staff, it put half of the redeemed capital into alternatives, and the rest into cash, a “fortuitous decision”, given the nosedive in public markets during the financial crisis the capital calls from unlisted asset managers.

“We’re not investing any further in private equity or infrastructure until the money starts coming back, which is difficult to predict at the moment, Taylor says. “Managers tend to be a bit pessimistic about what they take and optimistic about what they give.”

The longevity challenge

To serve the diverse age profiles within its membership, the LPFA manages assets in two sub-funds: a $3 billion ‘active’ sub-fund, and a liability-driven, $1.8 billion ‘pensioner’ sub-fund.

The active fund caters to employers who continue to accept new members, justifying its more aggressive asset mix, whereas the pensioner fund is closed to new members and manages a conservative mix of ‘cashflow-matching’ assets and a small exposure to equities.

The active fund invests about 60 per cent of its capital in global equities, with no mandate dedicated to UK equities. It runs a 50 per cent hedge in this exposure to mitigate the impact of movements in the value of sterling against other currencies.

The fund’s continuing ability to fund payments is being challenged by the longevity of its members: its oldest pensioner is 111, and in September 2009, the fund held 38 pensioners older than 100. Despite this, the LPFA has not bought any products designed to combat longevity because it is not convinced that a solution has been found.

“We’re not hedging against it. We are not convinced the market solutions on offer would take away the liability.”

While the LPFA is currently “marginally over-funded”, to better grasp its longevity risk, it joined Club Vita, a longevity ‘comparison club’ for occupational pension schemes. It shares the demographic data of member pension schemes, aiming to learn how lifespans vary between socio-economic groups, and their impacts on pension schemes.

It helps us to produce more accurate longevity tables for our fund, rather than [depend on] insurance fund data, which tends to be 10 years out-of-date.”

As it stands, the active sub-fund will generate positive cashflows until 2030, according to actuarial calculations, but only if its risk appetite does not diminish.

“If we weren’t re-investing the investment income, cashflow would be negative.”

Given the predominantly young age profile of the members in the active sub-fund, its liabilities are very long-term. The LPFA is confident that by 2024 it can achieve 100 per cent funding.

The pensioner sub-fund is not so strong. It runs a liability-driven investment approach by matching annual cash flows into the fund with predicted pension payments out.

“It will run out of cash unless we have another income in another 20 years,” Taylor says. “We’re talking to the government about supplementary income sources. We could be charging the taxpayer for that.”

Between 2004 and 2007, the funding gap within the pensioner fund widened, largely due to the improving longevity of its members. To help close this gap, the London Boroughs began paying an “appropriate” levy, from April 2009, which is scheduled to exist for 22 years.