John Wood on borrowing, bonds, hedge funds and property

John Wood is head of financial and commercial services for Staffordshire County Council. He started out at the council advising on Revenue Support Grant and worked on internal PFI projects before taking responsibility for pension fund investments and treasury among tother things.

Room 151: Your Treasury Management Strategy goes into quite a lot of detail about borrowing risks. What are the biggest risks to your borrowing strategy and how do you manage them?

John Wood: The way that we look at it is that you have to separate out the decisions that you are making now and the decisions that you’ve made in the past. We look currently at the way we borrow now, and our decision at the moment is simply to use cash when borrowing. Our treasury management strategy explains that but it explains it also in the context of alternative strategies should we wish to look at those. Using cash takes advantage of the shape of the yield curve and reduces the exposure on the investment side, so in a sense it is a relatively simple strategy and the advantages far outweigh any disadvantages. If you look at the past borrowing decisions you then start to look at exposure to changes in interest rate and especially if you are fixed into long term loans, once you’re in it’s quite difficult to manage those other than if you can reschedule them, which we were able to do with the PWLB but clearly the rules have changed more recently in relation to that and they’ve introduced a premium and made it more difficult to do that, especially with a change of interest rate environment as well.

Room 151: What are your feelings on the market of local authorities lending to each other?

JW: Because we are using cash we’re not accessing that market but we are aware of it. Because we’d use so much cash in the year from time to time we might run out of money for short periods of time and have to borrow and we would be happy to borrow from other local authorities. I’m assuming most of the loans would be short term and the interest rates are lower at that short end but in my view it would make sense. PWLB loans have had a premium of 1% above the market rate and though the budget statement said they’re considering taking 20bps off that which is helpful, I don’t think it affects that local authority lending market because there is still sufficient margin, that 80bps margin, to find an advantage with local authorities lending and borrowing to and from each other. What we don’t know about that budget statement is what the details are yet, and there is some mention of a different body being created and we don’t know what hurdles you might have to go through to get the 20bps off. It undermines – to some extent – the issue of local authority bonds. It’s watch this space.

Room 151: Do you think Treasury doesn’t want local authorities to go into the retail bond market?

JW: Well if the PWLB hadn’t had such a margin it wouldn’t have even arisen, so they put themselves in that position. But I think that from figures we’ve seen, that 20bps does take away the advantage of doing the bond yourself. I don’t know why the Government would or wouldn’t want a retail bond market, there’d be no harm in it, but there are costs involved, getting credit ratings and all the admin costs. From my point of view it makes much more sense for local authorities to borrow from the Government.

Room 151: Turning to pensions, are you happy with the levels of volatility and return you’re getting from your funds of hedge funds?

JW: We’ve had our toe in the water for a few years now and experience is a little bit mixed. In the financial crisis of 2008-9 hedge funds really disappointed and ultimately everything was correlated with everything else and and it turned into a bit of a shocker with the losses linked to market reasons. Although hedge funds didn’t go down as much as market funds they did lose some money and that was disappointing from our point of view. If we take that financial crisis as an exception and accept the correlations were simply caused by the crisis then generally hedge funds do broadly what they say on the packet in the sense that you do get reasonably steady returns, but perhaps not as high as the target we’re aiming for.

Room 151: Would you increase your allocation any time soon?

JW: I think that is under review. Our investment consultants have got a benchmark of around 10% alternatives and we’re currently around 7.5%. We haven’t made any decisions yet about increasing the 7.5 to 10 and where we might put that but hedge funds is one of the places we could put some extra money. It’s not ruled out. The whole area of alternatives you could argue is flavour of the month and certainly a lot of funds are putting more money there. It’s a complex area because apart from hedge funds you have private equity, property – which is more mainstream – commodities, high yield etc etc. Whether or not hedge funds are the appropriate way to access it from our point of view the jury is out.

Room 151: Do you see risk appetite going up at the moment?

JW: It depends what you mean by risk appetite, the way our investment consultants put it these alternatives are less risky because they are diversifying away from the big equity bet that we have got so they’re ultimately less risky to the investment strategy.

Room 151: Property makes up 10% of your strategic asset allocation. Can you tell us a bit about your investments there and your expectations for them?

JW: We invest in property through a property adviser and have a range of mainly direct property investments in the UK but we have a couple of funds which are a relatively small part of the overall portfolio. The rest are individual properties and they range across from office blocks, we have a fair number, particularly in and around central London, but we also invest in some small retail units and some industrial units. So we have a range of asset classes within property and the fund gives us access to larger retail units. Following the correction in property prices our allocation was underweight and we have been bringing that back up to target over the last few years, one or two big purchases have been in the offices in central London.

Room 151: What sort of return do you expect on the direct property investments?

JW: Our adviser is looking for 6% per annum over the next few years, but maybe between 4% and 6%. Ideally the fund is aiming to match its discount rate which is a little over 6%.

Room 151: You mentioned at a conference that you had invested in Bloomberg – what benefits have you seen from investing in technology?

JW: Yes, you effectively rent a screen which gives you access to Bloomberg data. You have access to almost real time data so we use that in a number of ways. With treasury management we are able to keep up to date with all the news that is happening so if we are discussing the current economic environment in a meeting you can see the spreads, you can monitor the Libor spreads, see the stories, get the share prices. On the pension fund side we are able to keep a much better track on where our strategic asset allocation is because we can plug in last months numbers from the custodian and update them on the basis of index movements straight from Bloomberg, so we keep up to date and make decisions on moving funds around from time to time. We are able to access the currency market and see rates there so when we invest in private equity which is usually priced in dollars or euros even on the day we can see the right market rates. So there is a whole range of areas where having access to up to date market news allows us to take advantage.