Expertise and risk management key to LA bond investments

Expertise and a reluctance to invest in long-duration securities are preventing local authorities from accessing yield from corporate bonds, found one of the panels at Room151’s Local Authority Treasurers’ Investment Forum last week.

While some councils invest in government bonds over the short term, corporate bonds remain out of the picture for most, with a number of issues preventing investment.

Vishal Sharma, treasury manager at Westminster City Council, outlined their use of UK government bonds: “We buy very short duration stuff like tail-end gilts,” he explained. “It would cause all sorts of issues for our accountants if we went to further durations.”

Some councils had “done very nicely over the last two years,” said Surrey’s strategic manager for pensions and treasury, Phil Triggs, taking positions on gilts, putting risk on the table and doing well out of it. “Surrey is not that way inclined,” he said. “We see this as a short term operation, looking no longer than twelve months ahead in terms of investment periods.”

Payden & Rygel principal Robin Creswell asked why corporate bonds remain off the radar for some local authorities. “Today you can buy three, four, five year corporate bonds yielding 2.5-3% and more, 10 year gilts yielding 3%. In local authority world those are useful numbers, albeit with interest rate risk,” he commented.

“What is holding everyone back? The potential risk of loss on a bond or investment portfolio? Potential volatility? Or how to account for bonds that go up and down in value that we have to hold to maturity or that we might sell in the intervening period?”

Westminster’s Sharma said that a ten year duration was simply too long for his authority to consider. “It is understanding the risks, having the framework in place, there are factors in terms of the interest rate risk which would concern the council and the accounting problem is an issue.”

Expertise is also a factor, he added. “There may be a time when local authorities have the right expertise to do this and go to ten year buckets but members wouldn’t be comfortable with it at the moment.”

Triggs said that his council was able to invest in pooled funds or corporate bonds, “but given where we have been in terms of record highs in gilt markets it is not an area that we have ventured into. In a more normal situation it would be a distinct possibility.”

TfL treasurer Simon Kilonback said that to overcome the expertise problem councils should group together, the Tri-borough and Greater London Authority have the concept of clubbing together for shared services, he pointed out. “Rather than pooling investments perhaps councils could pool talent and staff?”

Sharma noted that industry bodies were keen to push bonds. “With Cifpa and Sector, all the advisers, corporate bonds are a hot topic. There is clamour for education and training in this area. When that comes and the understanding comes perhaps the expertise will come with it.”

HSBC Asset Management’s Jonathan Curry said that councils could turn to their asset managers for expertise. And Creswell noted that the image of a fund manager “making guesses with bonds that didn’t turn out right” was from a different time. “It is possible to sit down with a district and look at cash-flows and quite carefully match up a portfolio of investments that very closely meet their needs and then you can describe to the potential investor what risks they are actually taking. Then you form a judgment as to whether you trust that information or not. It behooves us as an industry to put that information in your domain and begin to build your confidence in the information that is available.”

But with interest rates likely to go up, Ealing’s group manager for treasury and investments, Bridget Uku pointed out that bond values could be eroded. “I just don’t think that this is the time for treasury managers to be looking at bonds,” she said.

UK local authorities have been allowed to invest in corporate bonds since last February’s changes to the capital finance system. Before that time their classification as capital spend rendered the asset class complicated to invest in.