Appendix 1
Shetland Islands Council
Pension Fund Investment Strategy
2014-2027
Securing the Best for Shetland
Pension Fund Investment Strategy 2014-2027
Page 1
Contents
1. Introduction..............................................................................................3
2. Current Investment Strategy....................................................................4
3. Proposed Investment Strategy.................................................................6
4. Comparison between Current and Proposed Strategy...........................10
5. Responsible Investment..........................................................................11
6. Estimated Timetable…………………………………………………………………………..12
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Introduction
1.1
The purpose of the Pension Fund Investment Strategy 2014-2027 is to set out the
overarching investment approach, which will contribute to the aim of achieving a fully
funded Pension Scheme by 2027. The significance of 2027 is that this is the year when the
Pension Fund is forecast to reach maturity. Beyond this point it is expected that payments
out of the pension fund will exceed contributions made into the fund for the first time.
1.2
The investment strategy will be reviewed periodically in line with actuarial reports, to test
whether the overarching objectives of the investment strategy compliment the long term
funding objective.
1.3
The Pension Scheme is a Local Government Pension Scheme (LGPS) and as such it is
governed by the LGPS (Management and Investment of Funds) (Scotland) Regulations 2010.
The Shetland Islands Council is the administering authority of the Shetland Islands Council
Pension Fund, and in this role the Council is required to make arrangements for the proper
administration of the Fund.
Pension Fund Objectives
1.4
The Pension Fund has the following objectives –
 To secure and maintain sufficient assets to meet liabilities which fall due by the Fund
under the Local Government Pension Scheme;
 To minimise the risk of assets failing to meet these liabilities, through an investment
strategy that is specifically tailored to the Pension Fund’s requirements;
 To maximise investment returns within an acceptable level of risk whilst, at the same
time, providing stability in the level of employers’ contribution rates;
 To reach a point by 2026-27 where the Pension Fund is 100% funded. This means that
the Pension Fund would be able to pay all liabilities due at that time and any in the
future;
Action Taken
1.5
As a result, a review of the Pension Fund’s investment strategy has been undertaken to
incorporate the points at 1.3 and 1.4 above, and external support was obtained from
Hymans Robertson, the Pension Fund’s investment consultants.
1.6
This strategy paper proposes some changes in the way in which the Pension Fund invests its
investments in order to better reflect the Pension Fund’s objectives.
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Current Investment Strategy
2.1
The current investment strategy has been in place since 2008-09 and has a strong focus on
long term growth with 80% of the invested reserves in equities, 10% in bonds and 10% in
property.
2.2
The fund managers who invest the reserves on behalf of the Pension Fund in the stated
asset classes and per the benchmark percentages are as follows:
Manager
Fund
% of Reserves
BlackRock
Equities and Bonds
90%
Schroders
Property
10%
2.3
The percentages above are the initial benchmark percentages agreed after the
reorganisation in 2008/09. Since 2008/09 these percentages have varied depending on
market movements, investment returns and lodgements. These fluctuations are expected
with long term investment strategies.
2.4
There is no intention to rebase back to the initial percentages, as this would incur additional
transaction costs. The fund managers continue to invest during 2013/14 as per their
investment percentage position, until the outcome of the current investment strategy
review is known and approved.
Fund Manager Structure
2.5
The investment percentage position is constantly monitored by the Council’s Treasury
function. The current percentage of funds under management for each fund manager at
the 31st January 2014 was:
BlackRock
93%
Schroders
7%
2.6
The equity / bond split within BlackRock’s fund is 90% to 10%, which is in keeping with the
initial benchmark asset split.
2.7
Schroders’ mandate has increased in value over the period but has fallen from an initial 10%
allocation to 7% at the 31st January 2014. This is due to equity and bond returns being
higher than property returns over the past few years.
2.8
BlackRock’s mandate is passively invested into equities and bonds. These investments track
the markets they are invested into, trying to replicate the exact market return. This is a
computer based process which has market risk but removes manager risk. BlackRock’s
benchmark for this fund is 45% UK Equities, 45% Overseas Equities and 10% bonds.
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2.9
Schroders’ mandate is an actively managed fund of funds property investment. This
investment model allows Schroders to invest in various unitised property products,
currently 13. This diversifies the investment over hundreds of varying types of properties.
2.10 Short–term investments are held in cash, either with the Pension Fund’s bank account or on
short-term deposits. These are managed by the Council’s Treasury function on a daily basis
to ensure the efficient operation of Pension activities.
2.11 All long-term investments are held for the purpose of achieving an investment return. To
this end all investments are managed in a way that minimizes the risk to the capital sum and
optimises the return on the investment consistent with those risks. This involves setting
benchmarks for each fund and for each unitised product within the funds. These
benchmarks (market indexes) are used to evaluate the performance of each investment
against their investment market, with large deviations both above and below these markets
questioned similarly.
2.12 BlackRock has a passive mandate and performance is measured against a benchmark, the
market return. Schroders has an active mandate with a target out performance of 1% after
fees, above the benchmark return. This target is seen as achievable with a low level of
measured risk. Schroders actively seek to produce investment returns in order to achieve
the stated target. Performance at or above target is desirable but any returns above the
benchmark will add value to the fund above the market return.
2.13 The pie chart below sets out the current strategy –
Current Pension Fund Strategy
Passive Bonds
10%
Active Property
10%
Passive Equity
80%
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Proposed Investment Strategy
3.1
The Council’s Treasury Service, Accountancy Team Leader and Executive Manager – Finance
have worked with Hymans Robertson to develop a proposed strategy that compliments the
Pension Fund’s objectives.
3.2
This resulted in Hymans Robertson preparing an initial report in September 2013. This
report was reviewed by the Pension Fund Consultative Panel on the 22 nd November 2013
and by the Executive Committee on the 2nd December 2013. Following this, the Treasury
Service, Accountancy Team Leader and Executive Manager – Finance discussed the
implications with Hymans Robertson, and agreed that Hymans Robertson should propose an
initial investment strategy based on the findings of their first report.
3.3
Hymans Robertson produced a second report which specifically provides analysis of the
proposed strategy, with two possible structures, and compares this to the current strategy.
That report has been attached as Appendix 2.
3.4
The proposals in the strategy are –
 Growth Assets – An allocation to growth assets is required if contributions are to be
maintained around current levels and the Pension Fund is to grow returns. The main
asset in this category is equities. The current structure is dominated by equities but a
strong weighting to equities needs to be retained with a greater diversification of
investment to help spread risk. This can be achieved by reducing the Council’s exposure
to equities, and also to large country weightings. Proposal – to reduce the overall
allocation of equities from 80% to 58%. Within this passive UK will be 18%, passive
overseas 20% and either 20% alternative passive or active global.
 Diversification – To spread the Council’s reserves over different types of asset class in
order to seek a smoother annual return, and have the flexibility to exploit short term
opportunities in volatile markets. Proposal – to introduce a diversified growth manager
and allocate 20% of invested reserves for this purpose.
 Matching – Pension liabilities are calculated against bonds and a fund can match their
liability through investing in similar bond investments. An allocation to Gilts can act as an
insurance asset/return stabiliser. However there are other opportunities within bond
markets that provide greater potential for stability in terms of their income stream.
Proposal – to have a 4% allocation to passive UK Gilts and a 6% allocation to
alternative credit.
 Stability – Certain asset classes have a similar long term nature to a Pension Fund.
Property fits this category with its steady annual rental income along with long term
capital growth. Proposal – to increase the overall property allocation to 12%.
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3.5
At present Gilt levels are very high and an expensive option to use to match liabilities. The
return expectations are projected to be low, and though they can be used as an insurance
asset/return stabiliser it was agreed with Hymans Robertson to move this 4% allocation for
a period of time to alternative credit. This change would be on a tactical basis to access
lower risk assets with different income return streams while avoiding possible falling Gilt
prices.
3.6
Within Hymans Robertson’s proposals they gave an option to invest 20% of the equity
allocation into alternative passive equities or in active global equities. Alternative passive
equities invest in the same equities as a passive investment but uses different models to try
and produce a greater outperformance return. An active equity investment is where the
fund manager will use their skill in investing to outperform the market.
3.7
After discussing this decision with Hymans Robertson it was decided to invest this 20% in
unconstrained active equities. There is already a large allocation to passive equities and an
alternative allocation is only a slight variation on this, whereas an unconstrained active
allocation allows a fund manager to only invest in companies they believe will produce a
good return. Typically the manager will only hold about 100 stocks worldwide, a high
conviction fund aiming at typically 3-4% outperformance of the market. This investment
approach again brings more diversification with the investments and returns from equities.
3.8
The proposed new structure will have an adverse effect on fund manager fees. The main
driver for the cost of fees is whether investments are managed actively or passively. Passive
management fees are significantly lower than active, but there is a risk that you lose the
added value that fund managers may be able to provide. At present, 93% of the Pension
fund’s investments are managed passively which means fees are relatively low.
3.9
The proposed new strategy will have 38% of the Pension Fund managed passively with 62%
managed actively. This will increase fund manager fees paid by approximately c. £800,000
per annum. This is a big change but the proposed strategy is intended to not only cover the
added costs but produce a greater investment return that aims at achieving the long term
objectives at 1.4 above. If the Council continues with its passive management strategy, it
will mean that the fund manager fees are lower, but Hymans Robertson believe that there is
a significant risk that the Pension Fund will fail to become fully funded by 2027.
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3.10 Based on the rationale above, the pie chart shows the final proposed investment strategy –
Proposed Pension Fund Strategy
Alternative Bonds
10%
Passive
UK Equity
18%
Active Property
12%
Diversified Growth
Fund
20%
Active
Equities
20%
Passive
Global Equities
20%
3.11 Further details about each asset class can be found in Hymans Robertson report attached at
Appendix 2 to this report.
3.12 It is therefore proposed to adopt the above investment structure at 3.10 above as agreed
with, and based on, Hymans Robertson’s report at Appendix 2. The new investment
strategy will be reviewed periodically in conjunction with actuarial valuations over the
projected period up to 2026/27. This new investment strategy will focus on achieving a full
funded Pension Fund for the long term benefit of its members.
Fund Manager Structure
3.13 In order to implement the proposed strategy, a number of changes would be required to
the existing fund manager structure.
3.14 Included within Hymans Robertson report at Appendix 2 is a table comparing the current
structure against the two proposed structures (Page 3). Structure 2 is the preferred option
with one small alteration; passive UK Gilts being added to the alternative credit allocation.
3.15 The proposed new strategy will retain the fund managers BlackRock and Schroders who
already have investment management agreements with the Pension Fund. This will not only
help save costs but also reduce the time taken in the reorganisation of the investments from
the current arrangements to the proposed arrangements.
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3.16 From the suggestions in Hymans Robertson’s report at Appendix 2 the proposed fund
management structure to implement the new strategy is as follows:
Current Fund Managers
BlackRock
-
Passive UK Equities
Passive Overseas Equities
18%
20%
Schroders
-
Active Property
12%
-
Active Global Equities
20%
-
Diversified Growth Fund
20%
-
Alternative credit
10%
New Mandates
3.17 In line with the new investment strategy and fund management structure, 3 new mandates
require to be awarded. Before a mandate can be awarded to a fund manager a tender
exercise must be conducted in line with EU legislation. Each tender exercise is intended to
find the best fund manager for each mandate. The final decision on which fund manager
will be awarded each mandate is taken by the full Council, after hearing presentations by
the fund managers who are invited to the final selection.
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Comparison between current and proposed strategy
4.1 The table below sets out some information from the financial modelling that was performed
by Hymans Robertson in relation to the expected future results of both the existing
investment strategy at Section 2 and the proposed strategy as set out in Section 3. The 5
year figures are taken from a long term projection model and are approximate, as they are
based on a number of broad assumptions.
Current
Strategy
Expected Return (p.a.)*
Expected volatility (p.a.)*
Pension Fund value in 5 years (1 in 20 bad outcome)
Pension Fund value in 5 years (Expected) excluding fund
manager fees (median)
Estimated annual fund manager fees
Proposed
Strategy
3.7%#
10.3%
£230m
4.3%#
9.9%
£242m
£415m
0.10%
£422m
0.35%
*Returns and volatilities defined relative to liabilities
# Expected returns are gross of fees
4.2 The table above shows that the proposed strategy is expected to earn 0.6% more per year
than the current strategy, which over a period of 5 years could result in the reserves having
a value of £422m, as opposed to £415m under the current strategy.
4.3 The proposed strategy has less expected annual volatility than the existing strategy, and as a
result, in the 1 in 20 bad case scenario, the reserves would be estimated at having a £242m
value, compared to £230m under the existing strategy. The proposed strategy therefore
carries less risk than the existing strategy.
4.4 The fees will increase with the proposed strategy but with 93% of the current strategy
passively invested almost any change to the investments would increase fees. With a more
diversified and less volatile investment strategy it is better placed to achieve the long term
Pension Fund objectives. Hymans Robertson state “when considering implementing any
changes the Committee should be aware of the potential for changes to fees, running costs,
transition activity and procurement requirements. However, we believe that the
improvement in the risk return profile should be sufficiently attractive to warrant the costs
incurred during and after implementation”.
4.5 Hymans Robertson initial report stated that if contributions were to be maintained around
current levels the fund would need to retain an allocation to “growth” assets such as
equities. The new structure has a mix of growth assets and has broadly maintained, or
marginally increased the level of returns but reduced the volatility of these returns to
provide a more efficient balance of risk and return.
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Responsible Investment
5.1
The issue of responsible and ethical investment is challenging for all local authorities. This is
because of the competing objectives of complying with legislation to ensure that Members
seek the highest returns possible, but at the expense of being able to promote a truly ethical
policy, because the highest returns often come from those companies that Members may
not find socially desirable.
5.2
As a result, the Pension Fund is limited in this regard. However, the following policy
statement as proposed in the Pension Fund’s Statement of Investment Principles seeks to
promote a responsible approach, whilst still ensuring that the statutory duty to achieve the
best returns is adhered to –
Whilst the fund managers have delegated powers for the acquisition and realisation of
investments, fund managers will be expected as part of their investment process to consider
all factors, including the social, environmental and ethical policies of companies in which
they may invest, to the extent that these may materially affect the long term prospects of
such companies. The fund managers will also be expected to enter into dialogue with
companies in which they invest, in relation to the pursuance of socially responsible business
practices, and report on these activities.
Corporate Governance is a key responsibility for institutional shareholders and as a matter
of principle the Pension Fund will seek to exercise all of its voting rights in respect of its
shareholdings. It is recognised however that in practical terms this may not always be
possible for overseas holdings. However for UK stocks all voting rights will be exercised in a
positive fashion, i.e. no abstentions.
The Pension Fund’s fund managers must have signed up to the United Nations Principles on
Responsible Investment. The principles reflect the view that environmental, social and
corporate governance (ESG) issues can affect the performance of investment portfolios, and
therefore must be given appropriate consideration by investors, if they are to fulfill their
fiduciary (or equivalent) duty. The Principles provide a voluntary framework by which all
investors can incorporate ESG issues into their decision-making and ownership practices,
and so better align their objectives with those of society at large.
Any fund manager employed by Shetland Islands Council Pension Fund must act in
accordance with this policy.
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Estimated Timetable
6.1
All tender processes have time requirements built into them to allow sufficient scope for all
interested parties to apply. There are different procurement options depending on the type
of mandate but the main procurement route can take up to 6 months, due to the OJEU
required procedure.
6.2
A full OJEU tender timeline for each of the tenders required in the proposed new strategy
could follow this possible timetable:
Description
Timetable (Restricted)
Agree Notice and post with OJEU
Mid April
Indications of interest and PQQs received (+37 days, +30
if electronic only)
End May
Report recommending lists of managers to receive RfPs
and potential meeting with Officers to discuss
Mid June
RFP’s issued to managers
Start July
RFPs received back from managers (+40 days)
Mid August
Report recommending short lists of managers to make
final presentations and meeting with Officers or
Committee to discuss
End August
Final manager presentations to Officers or Committee
Start September
6.3
The above is an example of a timeline for a tender process. There are three possible
tenders required with the proposed new strategy, which will all be going through the tender
process at about the same time, all having their own issues to resolve.
6.4
The tender process should culminate in the Council awarding mandates to the successful
fund managers. The next step is for officers to meet with the fund managers and discuss all
the mandate requirements, e.g. scope of investment, reporting, fees, client contacts,
investment targets, custody arrangements etc. After agreement of the operation of the
mandate both parties need to ensure they are satisfied with the actual Investment
Management Agreement (IMA), only then is the IMA signed by the fund manager and the
Council.
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6.5
At this point the Council’s Transition Manager, BlackRock, is used to plan and ultimately
execute any transfer of funds in a safe and controlled manner. This is in conjunction with
the Pension Fund’s custodian, Northern Trust, and the new fund managers.
6.6
The aim is to have all tender exercises completed, all IMA’s agreed and signed and all funds
transferred before the end of 2014. This would allow investment performance monitoring
to commence at the start of January 2015.
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