Agenda item

The Committee considered the Equity Protection Strategy.

The Chief Financial Officer introduced the report and made the following comments:

·         The Fund was now approaching a fully funded position and therefore needed to review its funding strategy

·         The valuation of the Fund was £442m ahead of the funding plan and consideration needed to be given as to how to protect that gain

·         If the Fund decided to protect that gain, consideration needed to be given as to how the assets would be invested in the future

·         The pace of change was important – any decision could and should be made relatively quickly. It was considered that the increase in interest rates would affect the currency markets which in turn could have a negative impact on the equity markets. It was therefore considered that there was a window of opportunity to make the change.   

Ian Kirk and Adam Lane from Mercer, the Pension Fund's actuary introduced their equity protection report and indicated that the fund had a deficit but was c£442m ahead of the funding plan. It was difficult to predict the expected position at future valuations with accuracy and in reality there was a spread of potential outcomes. Given that most of the improvement since the 2016 valuation was attributable to the rally in equity markets over the period, their recommendation was to consider using an equity protection strategy to reduce the likelihood of further deficit contributions would be required at the 2029 valuation, and seek 'to bank' some of the recent upside with a view to potentially reducing contributions at future valuations. Their report set out the various options open to the Council to achieve these aims.   

In the ensuing debate, the following principal points were raised:

·         In response to a query, Adam Lane explained that the dynamic equity hedging strategy would operate in a similar fashion to an insurance policy. If the Fund took the option to renew the policy on a monthly basis he considered that it would be a cheaper option for the Pension Fund in the long term

·         What would happen if the Pension Fund adopted a dynamic equity hedging strategy should there be crash in the first month? Adam Lane advised that although there would be a loss, there would be a pay-off in terms of a reduction in the cost of insurance

·         Adam Lane explained that the key issue for the Fund to consider was mitigation of its operational risk. The Fund needed to decide whether it was prepared to pay for a more expensive insurance to provide downside protection but at the expense of higher returns. This would provide the Fund with a structured investment approach to meet its precise needs. It was a different approach and required different skills sets. The challenge was to determine the appropriate level of operational complexity and to ensure that it was achieved in the right way   

·         Phillip Hebson commented that it was up to the Committee to determine its approach to equity protection bearing in mind the detailed option review provided by the actuary in the report. The Fund had already agreed its strategic allocation approach. It was important therefore that any plans for equity protection were suited to the Fund's specific requirements. There were a number of Funds in a similar position however they had different strategic asset allocations and it was not appropriate to replicate their approach. It was important that the approach was kept as simple as possible and that Pension Fund was clear about what was happening at each stage and that members were comfortable with the strategy. He had no particular view as to which was the right strategy but it was important to give in-depth consideration before coming to a conclusion

·         It would appear that there was very little benefit in dynamic hedging of equity in active portfolios given the approach taken to investment in those markets. Phillip Hebdon indicated that the passive portfolios were the most appropriate markets for the proposed approaches to equity protection

·         If the Fund adopted the dynamic equity protection approach, it could leave the fund in a difficult position in terms of its open-ended nature. Adam Lane acknowledged that the static equity protection had the benefit of being a time-limited approach however although the dynamic approach was open-ended, the Fund did have the option to end the arrangements at any time. The advantage was that the dynamic approach would enable the Fund to respond to market conditions

·         It was important to be clear by April next year what approach the Fund was taking to equity protection given the finalisation of the pooling arrangements. From a practical point of view, the static approach would seem more prudent than the dynamic approach at the point of handover

·         The principal of equity protection was right and the Fund needed to be mindful that the public sector was subject to budget reductions. The Pension Fund had a duty to the council taxpayers to protect the gains made to date. There remained market conditions that could lead to a crash

·         In response to a query, Philip Hebson commented that the approach could be agreed instantly however it was essential to ensure that the Fund was taking the right approach

·         Equity protection should remain the responsibility of the Pension Fund not LGPS Central as the Fund had responsibility for the strategic asset allocation

·         The Chief Financial Officer requested that he be granted delegated authority  in consultation with the Chairman and Vice-Chairman of the Committee and the Chairman of the Investment Advisory Panel to work with advisers and implement an equity spread protection strategy for the Fund's equities. A report would be brought back to the December Committee on the implementation of the Strategy.

RESOLVED that:

a)    the equity protection report provided by the Fund's Actuary be noted; and

b)    the Chief Financial Officer be provided with delegated authority in consultation with the Chairman and Vice-Chairman of the Committee and the Chairman of the Investment Advisory Panel to work with advisers and implement an equity spread protection strategy for the Fund's equities.