• Home
  • About
  • Subscribe
  • LATIF
  • Conferences
  • Dashboard
  • Edit My Profile
  • Log In
  • Logout
  • Register
  • Edit this post

Room 151

  • 151 BRIEF

    What's New?

  • Inflation ‘biggest concern for LGPS professionals’

    May 20, 2022

  • LGA calls for government support as regulators face staffing issues

    May 19, 2022

  • WMCA signs £4bn investment agreement with L&G

    May 18, 2022

  • Bill will give UK Infrastructure Bank power to lend directly to councils

    May 18, 2022

  • £400bn pension group collaborates on climate transition initiative

    May 17, 2022

  • CIPFA rejects proposal for vote on publication of fraud hub report

    May 17, 2022

  • Treasury
  • Technical
  • Funding
  • Resources
  • LGPS
  • Development
  • 151 News
  • Blogs
    • David Green
    • Agent 151
    • Dan Bates
    • Richard Harbord
    • Stephen Sheen
    • James Bevan
    • Steve Bishop
    • Cllr John Clancy
    • David Crum
    • Graham Liddell
    • Ian O’Donnell
    • Jackie Shute
  • Interviews
  • Briefs

John Harrison: Rethinking asset allocation

0
  • by John Harrison
  • in LGPS
  • — 24 Jan, 2017

Photo: Federico Racchi,CC

With pooling on the horizon LGPS funds are entering a new era. John Harrison argues they’ll have a strategic role in asset allocation but with more underlying complexity.

In a little over a year from now the LGPS pools will become operational and quite quickly take responsibility for manager selection and monitoring. The only significant investment function retained by individual administering authorities will be asset allocation. But what will that mean in practice?


Subscribe to our LGPS Quarterly Briefing and be first to receive more content like this.


It is widely recognised that asset allocation is important. Indeed, most academic studies conclude that investment returns are mostly driven by asset allocation (the choice of markets) rather than by security selection (the choice of assets within markets). It is over 30 years since the seminal paper by Brinson, Hood and Beebower determined that asset allocation accounted for over 90% of long-term investment returns. The exact proportion has been regularly disputed ever since — academics have always loved a good argument — but most subsequent analysis has supported the view that asset allocation is significantly more important than security selection in generating long-term investment returns.

In the context of LGPS funds, however, the distinction between asset allocation and security selection is not always clear cut. Historically, most funds have focused their time and effort on establishing and monitoring manager mandates. Where this is a mandate in a specific market — UK equities, for instance — it is clearly security selection rather than asset allocation. But what about multi-asset or even global equity mandates? They devolve the choice of markets to the manager, albeit within the constraints of the benchmarks and risk tolerances chosen.

Choices

In the new LGPS structure administering authorities will have relatively little input into the selection and monitoring of manager mandates on a day-to-day basis. However, they will have some influence on the range of choices available, especially at the outset. Participating funds will need to agree with their respective pools what types of investment option will be made available — that is a live debate at present. For example, will a participating fund only be allowed a single asset allocation decision for global equities, or will they have flexibility to invest in regional portfolios in the US, Europe and Asia?

The trade-off between cost effectiveness and required flexibility will determine the number of investment options that are offered and therefore the level of granularity available to authorities in asset allocation. The pools will need to decide whether the choices available should be differentiated by asset category or by target relative return.

For example, if a pool could only offer three global equity buckets, should they be “US, Europe and Asia” or “passive, active and unconstrained”? This will be even more important in alternatives, where the potential range of choices is enormous and there is far less consensus on what should be included. It will not be possible to deliver the expected cost savings without limiting the choices available.

It is probably too early to determine the optimal range of choices required and it seems likely each pool will take a different approach. However, in my personal view, a number of key factors will shape the eventual outcome.

Factors

First, the focus of asset allocation at the authority level will be strategic rather than tactical. Individual authorities will have neither the time nor the internal expertise to attempt “market timing”. The role of asset allocation will be to ensure the long-term structure of the investments remains consistent with the funding position and liability drivers of the underlying schemes.

Second, it will be increasingly important for authorities to enable each employer to tailor investment strategy to their individual needs. The number of employers within each authority has increased substantially in recent years with many having maturity profiles or funding positions markedly different from the dominant employer. A “one size fits all” approach is no longer desirable. While it is unlikely to be cost effective to offer bespoke strategies to most employers, a high/medium/low risk range of policy options could be provided.

Third, liability risk management will become more important, not just for a few employers with more mature schemes but for all. The political toxicity of pension deficits means that LGPS funds will need to be seen to have defined a robust strategy to manage liability risks, which will include being able to react quickly if de-risking opportunities arise in volatile markets.

Fourth, to the extent that each pool will only be able to support a finite range of investment options, it will become less important to have multiple variations of developed market equities. Administering authorities will increasingly regard this as a tactical decision for managers. Instead they will want to be provided with more options in alternative asset classes and in liability aligned bonds.

In this new world, administering authorities will have more time to devote to strategic asset allocation, but with more complexity in how this is applied to the underlying employer funds. Reporting processes will evolve to focus more on funding level volatility and less on returns in isolation. And officers and advisers will need to have access to better strategy modelling tools.

John Harrison, independent investment adviser, Surrey Pension Fund.

Room151 Newsletters

 

Share

You may also like...

  • Ryan Boothroyd: Post-covid world holds opportunity for long-term LGPS investors 28th Apr, 2021
  • Why should LGPS be concerned about rising inflation? 8th Apr, 2021
  • LGPS webinar: Governance the key to TCFD implementation 1st Mar, 2021
  • Why build to rent has remained resilient despite Covid-19 28th Apr, 2021

Leave a Reply Cancel reply

You must be logged in to post a comment.

  • Register to become a Room151 user

  • Latest tweets

    Room151 2 days ago

    2022 LGPS valuations: difficult discussions in uncertain times: Michelle Doman looks at the impact of inflationary pressures, the war in Ukraine, climate risk and Covid-19 on employer contributions. At the start of 2022, for Local Government Pension… dlvr.it/SQlvy9 pic.twitter.com/Dd0lrHjWNb

    Room151 2 days ago

    Investing today: nowhere to hide: Partner Content: Alex Stanley from Ardea Investment Management suggests that investors have few places to hide amid a synchronised sell-off in both bonds and equities. However, there are catalysts that[...] dlvr.it/SQlNVC pic.twitter.com/KkGGnduzPL

    Room151 3 days ago

    Treasury to restrict PWLB loans to councils at risk of non-repayment: The Treasury has released new guidance that restricts local authorities’ access to Public Works Loan Board (PWLB) advances if there is a “more than negligible risk” of a council’s… dlvr.it/SQhLTV pic.twitter.com/vBsS7xMJdb

    Room151 3 days ago

    Mixed reaction to proposed government intervention powers: There has been a mixed reaction to the government’s legislative plans to strengthen its intervention powers over local authority finances. The Levelling Up and Regeneration Bill has proposed… dlvr.it/SQhLMB pic.twitter.com/50foWxpPGs

    Room151 3 days ago

    Post-Brexit struggles for national and local government regulators. @LGAcomms @NAOorguk Click the link below to read 🔻🔻 room151.co.uk/brief/lga-call… #Brexit #government pic.twitter.com/s3c8ySGy5G

    Room151 3 days ago

    CIPFA: a question of transparency: Roman Haluszczak’s campaign for publication of the independent report into the collapse of CIPFA’s London Counter Fraud Hub has been rejected again by the institute. He is now calling for[...] dlvr.it/SQgC5V pic.twitter.com/08fWsHFF4g

    Room151 4 days ago

    Back to the future for the PWLB: The Public Works Loan Board is tightening its lending criteria to ensure that loans will be repaid by local government borrowers. But, asks Peter Findlay, shouldn’t they have been doing[...] dlvr.it/SQcmmm pic.twitter.com/bVv4fe0Xlv

    Room151 4 days ago

    Great piece from Peter Findlay on the PWLB’s tightening of its lending criteria. He raises some pointed questions for the Treasury and explains why the ‘casino council’ characterisation was simplistic and inaccurate. #PWLB #localgov room151.co.uk/treasury/back-…

    Room151 4 days ago

    The Queen's speech highlighted the need for accelerating UK infrastructure investment into levelling up projects and cutting emissions. @UKInfraBank #QueensSpeech #ClimateAction #emissions Click the link below to read 🔻🔻 room151.co.uk/brief/bill-wil… pic.twitter.com/hFmF2veVIa

    Room151 4 days ago

    Huge funding heading to the @WestMids_CA from @landg. @andy4wm #LevellingUp #netzero #regeneration Click the link below to read 🔻🔻 room151.co.uk/brief/wmca-sig… pic.twitter.com/ajhZhia6mx

    Room151 4 days ago

    LGPS governance, Cagney and Lacey style: What regulatory response can be expected following the publication of the Good Governance project’s Phase 3 report and the closure of the Single Code of Practice consultation? Susan Black offers[...] dlvr.it/SQbfXf pic.twitter.com/xwqHOEu2AP

    Room151 5 days ago

    More evidence of the importance of emerging markets in the journey to net-zero. @BordertoCoast @BrunelPP @northernlgps @EAPensionFund @WYPF_LGPS Click the link below to read 🔻🔻 #LGPS #NetZero #NetZeroCarbon #EmergingMarkets room151.co.uk/brief/400bn-pe… pic.twitter.com/qCm0EGxzLn

  • Categories

    • 151 News
    • Agent 151
    • Audit
    • Blogs
    • Business rates
    • Chris Buss
    • Cllr John Clancy
    • Council tax
    • Dan Bates
    • David Crum
    • David Green
    • Development
    • Education
    • Forum
    • Funding
    • Governance
    • Graham Liddell
    • Housing
    • Ian O'Donnell
    • Infrastructure
    • Interviews
    • Jackie Shute
    • James Bevan
    • Jobs
    • Levelling up
    • LGPS
    • Mark Finnegan
    • Net Zero
    • Private markets
    • Recent Posts
    • Regulation
    • Resources
    • Responsible investing
    • Richard Harbord
    • Risk management
    • Social care
    • Stephen Fitzgerald
    • Stephen Sheen
    • Steve Bishop
    • Technical
    • Transport
    • Treasury
    • Uncategorized
    • William Bourne
  • Archives

    • 2022
    • 2021
    • 2020
    • 2019
    • 2018
    • 2017
    • 2016
    • 2015
    • 2014
    • 2013
    • 2012
    • 2011
  • Previous story Terry Crossley: Pooling is like a rugby ball, the bounce is unpredictable
  • Next story The improving financial health of the LGPS

© Copyright 2022 Room 151. Typegrid Theme by WPBandit.

0 shares