Equities sell down

To better manage downside risk, the second-largest UK local government pension scheme has a plan to gradually alter its equity allocation.

Through the course of this year the UK’s £15 billion ($21 billion) Strathclyde Pension Fund will cut its equity allocation in line with its growing maturity and changing risk appetite.

New allocations will go towards diversifying assets in long and short-term enhanced yield to better manage downside risk.

Strathclyde is the UK’s second largest local government pension scheme and provides pensions for more than 200 Scottish employers, from local authorities and service providers to universities and charities.

In what Richard McIndoe, head of pensions at Strathclyde, calls a “step change in our maturity to do with public sector austerity” and “a big change in cash flow”, Strathclyde will gradually reposition. It is a theme common to many other local authority schemes, which are similarly having to balance the jump in people drawing pensions with a drop in contributions.

“We have a gradual plan to reduce our equity allocation and diversify across new asset categories. The pace won’t be dramatic. More a repositioning over time,” says McIndoe, speaking from Strathclyde’s Glasgow offices. He has been with Strathclyde since 1996, becoming head of pensions in 2003.

This year Strathclyde will shave 10 per cent off its current 72.5 per cent strategic benchmark equity allocation in favour of enhanced yield strategies, extending the equity paring to 20 per cent within three years and more going forward.

Within the context of a reduced equity exposure, Strathclyde will actually increase its allocation to global and emerging market RAFI indices from the current 7.5 per cent to 13.5 per cent of its total equity allocation.

The RAFI rationale, which weights companies according to their economic footprint based on fundamentals rather than market capitalisation, has grown in favour at the fund, explains McIndoe.

“The intention was always to increase our allocation to RAFI over time.” Strathclyde is also repositioning to be more equally weighted across US, European and Asian equity markets and maintain, but reduce, the UK bias.

“Historically we had a higher bias to the UK market, but this doesn’t hold good anymore,” he said.

As part of this strategy, Strathclyde will limit the weight of any one stock to a maximum of 5 per cent of the FTSE All Share index with the aim of reducing stock-specific risk.

Recent turmoil in FTSE heavyweights RBS and BP showed the danger of individual stocks affecting the index as a whole, said McIndoe.

Funds from the equity reduction will be re-portioned to a shortlisted multi-asset credit mandate with a value of around $430 million, and private debt investment opportunities focused on mid- to large-cap corporate lending, also with a value of around $430 million.

Going forward, Strathclyde will also grow its direct investment portfolio, begun in 2009 and a source of pride for McIndoe because of its impact, or “secondary return” characteristics, such as the new housing that has risen in view from his Glasgow desk.

Born from opportunities created by the financial crisis when pension funds stepped into the loan market vacated by banks, the portfolio includes local investments that will impact Strathclyde, like direct company loans, green infrastructure, social housing and university research, as well as global opportunities. So far the allocation is capped at 5 per cent of the fund, but when this ceiling is reached McIndoe expects it will be increased.

It is via the direct investment portfolio particularly that Strathclyde has applied ESG criteria in a more proactive, bottom-up strategy.

ESG is well established across the fund. Examples include the private equity portfolio, run on a “fund of funds” basis, managed between two Principles for Responsible Investment (PRI) signatory institutions, Pantheon and Partners Group; its UK direct property manager, DTZ Investors, is a PRI signatory and the property portfolio subscribes to the GRESB (global real estate sustainability benchmark).

Now McIndoe is planning for more “engagement, directness and means” to apply ESG which he says has historically been handed to external managers in a “hands-off” approach. Strathclyde will apply “more pressure and ask more questions itself”, particularly around the living wage and child labour. The fund has also employed engagement agent Global Engagement Services. “As a result engagement on responsible investment is now better informed, better focused and more productive,” he says.

McIndoe is characteristically sanguine and unflappable ahead of the challenge of downside risk and today’s difficult market conditions.

“Nervous markets can be uncomfortable short term and put you on your back foot. But being on the back foot creates opportunities and can be more profitable. We will live with what comes.”