The Local Government Pension Scheme withdrew more than £1bn from fixed interest securities in the past year, signalling that the sector is preparing for an interest rate rise, investment experts say.
Low interest rates typically have a greater effect on corporate schemes than public sector ones, but consultants said methods for controlling risk such as liability-driven investment had increasing appeal to local authorities.
The £192bn sector-wide scheme had £10.6bn invested in fixed interest securities at March 31 2014, compared with £12.1bn for the same day in 2013. This represents a fall to 5.5 per cent of the overall portfolio, from 6.7 per cent.
“LGPS schemes have been looking at their exposure to growth assets and interest rate-sensitive assets,” said David Lyons, principal at consultancy Aon Hewitt.
“[They have been] reducing some exposure to fixed interest securities, where we expect there to be monetary policy tightening at some point in the future.”
More and more schemes have been turning away from fixed income due to low yields, said Gavin Orpin, partner at consultancy LCP.
[They have been] reducing some exposure to fixed interest securities, where we expect there to be monetary policy tightening at some point in the future
David Lyons, Aon Hewitt
“From a long-term perspective, they’re thought of as being not attractive,” he said.
However, Orpin added schemes were tempering a falling interest in fixed income with an increased appetite for LDI strategies, which often involves fixed income assets.
He said a lot of its clients' lower-risk or fixed income allocations are to LDI.
"My understanding is the local authorities don’t have that level of take-up," he said. "They prefer to take a longer-term perspective.”
The shift away from fixed interest assets by 1.2 percentage points has grown since 2013, when the allocation only fell by 0.1 percentage points.
The report also showed LGPS schemes increased their allocation to property, particularly through the use of pooled investment vehicles.
Allocations to property grew close to £13bn by March 31 2014, compared with almost £11bn the previous year.
Orpin said the increase reflected a wider trend in the market.
“We have some clients with segregated mandates of £100m, but that’s the minimum size and it’s difficult to get diversification,” he said.
Cross-sector collaboration
For the past year the LGPS has been waiting for the outcome of the Department for Communities and Local Government’s ‘Opportunities for collaboration, cost savings and efficiencies’ consultation.
Lyons said this had prevented local authority schemes from making more substantive changes to their investment strategies.
He said: “The degree of change that’s been going on from an investment perspective… wholesale changes have been put on the backburner against this backdrop of uncertainty.”
During the past 12 months the LGPS was also required to implement a profound change to its structure by switching to career average accrual from final salary.
Liam Robson, analyst for the Local Government Association, said this was the biggest challenge faced by the LGPS in the period. However he added the impact of the change would initially be difficult to gauge.
“When we get to three or four years, we’ll be able to look at trends,” he said.
Robson added the LGPS advisory board annual report – now in its second year – would next year introduce further detail on the cost of running the scheme, which may shed more light on the wider impact of the change.
