London Pensions Fund Authority’s opportunistic tilt

The £3.6 billion (US$5.9 billion) London Pensions Fund Authority (LPFA) chief executive, Mike Taylor, talks to Kristen Paech about the fund’s decision to suspend securities lending after the Lehman’s collapse, and some structural changes that have made it possible to invest on a more opportunistic basis.

The London Pensions Fund Authority (LPFA) knows the true meaning of what it is to be a long-term investor – its oldest pensioner is 110 years old.

It’s for this reason that the LPFA’s chief executive, Mike Taylor, remains unperturbed about the current investment climate, and sees the volatility as something the fund can ride out over time.

The defined benefit fund has, however, made a number of changes that are intended to assist it in investing on a more opportunistic basis in light of the financial crisis.

One of those was to revise the fund’s governance structure to enable the LPFA to make quicker decisions about investing in relatively small alternatives.

“If the investment is under £50 million, it doesn’t have to go through the full investment committee,” Taylor says.

“We have delegated an authority for myself as CEO and the chief investment officer to do it at short notice. That has made a difference, particularly for alternative investments. We’ve invested in distressed credit and some commodities
and infrastructure.”

The LPFA also suspended its securities lending program in September last year on the back of the Lehman Brother’s collapse, and has since resumed lending albeit within a stricter framework.

Taylor says the decision was taken to suspend the program, which is carried out with JP Morgan, because “we didn’t feel we understood the potential risk on the collateral we were receiving”.

“Some of our stock was lent to Lehman’s, and as it turned out everything came back quickly, but as a consequence we reviewed the risk.”

The decision was taken back to the investment committee at the end of 2008, but because the committee was undergoing a change of chairman, it was deferred until the new board was appointed in January this year.

“We resumed stock lending in February this year but we have improved the collateral requirements ” there is no cash collateral,” Taylor says.

“We don’t think there’s any evidence [securities lending] leads to short selling. The majority of the stock we lend is French and German shares in the dividend period of April to June, so we believe we are enhancing the yield we get on
European stocks through stock lending.”

The scheme’s assets and liabilities were managed as a single fund until 1993, when the LPFA was split into two sub-funds – the Active sub-fund and the Pensioner sub-fund.

The Active sub-fund includes employers that continue to accept new members, while the Pensioner sub-fund covers employers that are generally closed to new entrants.

Theinvestment strategy for the active fund is primarily equity-based, both passive and active global equities, and is supplemented with target-return, alternative investment and property.

The pensioner fund has a liability-driven investment strategy, where the objective is to achieve a cash-flow from investments that matches the cash flow in benefits.

“That has caused problems, particularly over the period when Libor was so high, because the fund is structured to hedge out interest rate and inflation risk, and the cost of hedging is usually Libor,” Taylor says.

“We’ve hedged via interest rate and inflation swaps. The collateral for the swaps is held primarily in fixed income “government or corporate bonds – and given the cost of the swap is Libor; you need to earn at least Libor on that collateral which has been difficult over the last 18 months. £219 million target return mandate terminated with UBS Global Asset Management about nine months ago is yet to be reallocated, with the majority still held in cash.

This has contributed to the rise in the cash component of the active fund, which has a zero cash target but currently composes 10 per cent cash.

“For opportunistic purposes we’ve kept cash quite high and reduced target return investments,” Taylor said.

“[The UBS money] is in cash at the moment but we have plans to invest in alternative areas. We’re very interested in some distressed credit, we just made a decision to increase commodities exposure because we believe there are opportunities there and we are continuing to maintain allocations to infrastructure and private equity.”

The LPFA is also considering investments that will enable it to have more of an ESG focus.

“Much of our private equity is already targeted towards clean energy, clean tech funds, infrastructure and we’ve been looking at the potential for increasing our mainstream equity allocations in those areas “quoted companies in funds
that have more of an ESG bias,” he says.

The fund already invests in the Sarasin OekoSar Equity Global Fund, which has a specific ESG target.