Investment always draws an interested – and interesting – crowd, but the LAPF Strategic Investment Forum (LAPFSIF) held in London on 3 February was full of the great and the good from the local authority pension fund world.
The event was full, with many of the delegated grateful for an opportunity to meet people face to face.
“It’s nice to be able to look people in the eye, not up their nose or at their cat grooming itself in the background,” said one senior pension fund professional. “Online meetings are all very good, but it’s difficult to keep things dynamic, particularly over a period of two years.”
Blood, sweat and tears
The relief at being able to see people in real life didn’t mean delegates felt they could relax and have a day out. With so many weighty investment matters to be assessed and decided upon, they were clearly here to work, as could be seen by the industry of the group discussions during the roundtable sessions.
“It’s great to see friends and acquaintances,” said one fund delegate, “but you can’t beat the quality of networking at these events.”
“The ability to hear what the industry considers best practice and then discuss that with my peers while sharing real life scenarios is an invaluable tool in my management role. It is a key reason for attending an event like this.”
And so, to that content. The chair, John Harrison, remarked that this will see the start of “the first triennial valuation in England and Wales like no other in my career, because it will be one of surplus for many LGPS funds.”
Though in surplus, many will be moving cashflow negative and this has implications for sustainability, particularly around social and climate change, which are there for us all to see.
Buckle up, this could be a little bumpy
The first session was a presentation from Arif Husain, head of fixed income at T Rowe Price.
He said that macroeconomics is just an accumulation of the micro, and due to the pandemic, everyone has changed something in their lives over the last two years. However, everyone has been lulled into a false sense of security about investment strategies, as we’ve all got rather comfortable with how things have been and are not yet ready for a change. And there’s change coming.
The decade after the GFC (great financial crash) was not a good example of normal markets and things are about to get shaken up, and not just with inflation, but growth and unemployment, too.
“There is a tidal wave of money flooding the system well past the peak in stimulus that will drain and go negative,” said Husain. “We will go from quantitative easing to tightening and this is an absolute disaster for financial markets.”
“Even if your funds are all funded in excess of 100%, it’s still time to batten down the hatches. We need to be focused and we need balanced thinking.”
I’s not sufficient to import a correlation matrix based on what has been happening over the past decade, as the central banks will sell bonds, yields will go up and that will affect the correlation, says Husain. Quantitative tightening is “the only game in town” and investors need to be careful for the coming period.
“It’s not the rate hike today that matters,” adds Husain, “but the last rate hike we get and how quickly they come.”
“So buckle in, batten down, but don’t give up hope, as there will be great opportunities.”
Long term capital market assumptions: fading scars enduring policies
Rajesh Tanna, portfolio manager, international equities group, at JP Morgan Asset Management, continued on the theme of disruption while highlighting the strength of corporate balance sheets. Even European banks are engaged in share buybacks, something not seen much – if at all – in history.
The pandemic has sped up the process of disruption across industries, says Tanna, and warns against expecting everything to revert to mean based on the economic structure we had before.
China as a growth engine is facing some challenges such as demographics and that growth based on largely internal investment becomes more difficult to achieve.
Tanna also echoed JP Morgan’s chief global strategist, Dr David Kelly’s warning, “don’t stay strapped into the beta roller coaster”, because we’re looking at only 2% to 3% returns from a traditional 60/40 multi asset allocation.
“Look for opportunities across the asset class spectrum and consider international diversification when it comes to the equity allocation,” says Tanna.
“The equity market more broadly (notably in the US and Europe) has transitioned towards sectors that have a much more resilient earnings profile, with higher returns on investment and free cashflow generation coupled with stronger underlying balance sheets.”
“The asset class is one to look to buy on dips for the opportunity to compound returns over time.”
Sustainable infrastructure: not only possible, but available now
When it comes to sustainable infrastructure, everyone is faced with the same dilemma, said Peter Bachmann, managing director, sustainable infrastructure at Gresham House. “That is to balance fiduciary duty with the will of members, the government, and one’s own conscience saying there is a need to do more for society.”
“We think we can allocate to assets that create impact.”
The global value of sustainable infrastructure is £92 trillion, said Bachmann, and there are a number of areas in which to achieve the greatest impact:
- Resource efficiency, from fish farms and vertical farming
- Digital inclusion, as the UK is currently a digital desert
- Waste solutions where, for instance, waste is used to generate energy
- Health and education – early stage dementia and specific autisms are two areas that could be greatly assisted by this
- Regeneration, which overlaps nicely with the place-based impact agenda
These sustainable infrastructure investments are generally of less than £50 million of local investment and so far have created more than 500 permanent jobs in fibre engineering and vertical farming, which all plays well for the levelling up agenda.
Assets are increasingly being valued in terms of impact, said Bachmann, and these projects are not only sustainable, but have impact.
Vertical farming can produce far more food on a much smaller scale. While there will be some electricity and construction waste generated, it uses 98% less land, 98% less water, uses no pesticides and produces 17,176 times less carbon and uses no pesticides.
Rocket is the current focus, but there’s more to it than just leafy greens, said Bachmann.
“It’s leafy greens now, but the next objective is to prove it with soft fruit, which makes up half the world’s fresh produce.”
“From there, we’ll move on to rice, wheat and soy over the next five years and should be considered by funds as its structure is 90% senior debt.”
Impact from real estate
In a presentation on real estate, Nick Montgomery, head of UK real estate investment from Schroders Capital, said that COVID-19 has highlighted social inequalities in society and suggested real estate can deliver tangible positive solutions to these social issues while delivering a risk-adjusted return for institutional investors.
There is huge variation in prosperity across the UK and deprived areas typically have multiple problems, said Montgomery. To address these concerns, he is focusing on investment in town centres and communities, affordable and social homes and affordable workplaces and these themes align to seven key UN sustainable development goals (SDGs).
“We will revitalise town centres by delivering mixed-use schemes. These combine right-sized retail units with convenience retail and independent traders, provision of community space, general needs housing or specialist housing, healthcare e.g. GP surgeries, improved public realm, such as lighting, green and safe and sociable spaces) and the town centre becomes a hub for the community to thrive,” said Montgomery.
For workplaces, affordable space for micro-, small- and medium-sized enterprises, and working with major tenants to support apprenticeships and other employment schemes is something he is implementing across his funds.
Finally, for homes – shared ownership, specialist supported, general needs and social housing are required and will be a key theme to bring about the type of positive social outcomes and address the needs of the deprived areas, said Montgomery.
“There is always a danger of doing change to communities rather than with them,” he added. “It’s important for us to communicate with the community in order to understand what they want, before we decide what we need to do. Engagement with stakeholders will be central to success.”
Private debt is not a closed ESG book
Private debt is getting a lot of attention of late and this panel looked on how investors can achieve ESG objectives within this asset class.
A straw poll was held asking which asset classes would see the largest increase in allocation of the funds present. Private credit came second with 23% to UK infrastructure’s 29%. Global infrastructure received 15%, while private equity and affordable housing each received 12%.
Doubts raised from the floor about the ability of private debt managers to get meaningful ESG data were rejected by Nicole Downer, managing partner of MV Credit.
“We generally deal with owners who have managed companies through various cycles,” said Downer. “Therefore we can be more selective because these are repeat transactions, so it’s a more equal and structured partnership.”
After all, she added, we’re lending about 50% of the capital, so if they’re unhappy with the owners, we won’t lend.
“We have an active role to play and I would argue there is more information in private companies as they’re owned by one owner, even though the data may not be transferred to investors in a standard report.”
“What really determines returns in private debt is control of losses and you need to be sure that the general partner is properly aligned.”
Eric Lambert, an independent adviser, said that any concerns about private debt being relatively short term and not linked to inflation should not dissuade investors from considering private debt.
“How much you need the private markets varies from fund to fund and how appropriate it is depends on the fund also,” said Lambert. “But they may deliver positive real returns unlike most of our matching assets.”
Can’t afford to miss climate change targets
Impact investing was the theme to close out the morning session, with Violeta Hvamb, investment director at Tikehau Capital, outlining in stark terms the absolute need for carbon emissions to be halved in the next 3,000 days – that’s just eight years and two months.
“The nine fundamental planetary boundaries are completely interdependent.”
“Like a domino effect, this means if we transgress just one of these boundaries, the risk of abrupt and irreversible damage sharply increases.”
Plenty of work to do
At the start of a roundtable on climate risk reporting requirements, Jeff Houston, board secretary to the Local Government Pension Scheme Advisory Board, warned delegates that TCFD has already moved on and that in addition to those requirements, funds should also watch out for the Boycott, Divestment and Sanctions Bill designed to prevent public bodies imposing their own approach on matters that concern international relations.
He advised that the levelling up agenda will only require funds to have a plan, not an investment strategy. But as the government is looking to funds for new investment, consultation should be expected later this year, meaning that delegates will have to deal with consultation on this, regulations, pooling guidance, making for a hectic end to an already busy year.
Making impact with social and affordable housing
Many LGPS funds are looking at how real estate investments can not only deliver returns, but also contribute to achieving impact within the portfolio.
Angela Gooddings, research director, strategic insights at Nuveen began this session with an assertion that real estate is “a natural home for impact”.
“It’s not just about focusing on better quality and affordable housing,” said Goodings, “it should be more”.
“We believe there is an opportunity to deliver impact within education, health and the in local environment through commercial and mixed use property.”
This also satisfies requirements for place-based investing, as different towns have different needs.
“We prefer to be the key mover, taking an institutional approach to benchmarks and local wages, and not looking to increase rates a lot over time.”
Peter Hobbs, managing director, head of private markets, bfinance, urges funds to remember that finding the right partner is essential to success.
“There is a range of providers who can get very reasonable returns plus growth options, but will it also deliver impact? This is where the market has changed in the last few years.”
“Social housing, healthcare, social care homes, education such as nurseries and even shared ownership have been identified by real estate in recent years as well as offices and logistics hubs.”
Jeff Dong, head of finance, City & County of Swansea Pension Fund outlined how the fund approved a decision to reduce equity assets in favour of real yielding assets after the last valuation showed it to be more than 100% funded. Although originally he hadn’t considered affordable housing as part of the portfolio of yielding real assets, he soon realised they could provide acceptable yields and yet have a positive social impact as a result of the investments.
“It was an inclusive process which the committee, local board and employer reps bought into,” said Dong.
The investment thesis is clear as to what we expect from these investments.
“To be viable, they must clear the yield hurdles we expect of these types of investment.”
“Despite the stigma associated with affordable/social housing, these projects are architecturally award winning and aesthetically appealing, energy efficient, made of quality materials, and where there is community energy provision, can even take families out of fuel poverty,” added Dong.
Plenty of opportunities to build upon
The last panel session focused on infrastructure, one of the key themes for the day.
It is such a hugely diverse asset class that ranges from physical such as airports to technical like telecoms.
Some areas have thrived over the pandemic while others like construction have struggled, but they have an ability to provide income and have done well over that period.
John Carey investment director, IFM investors, said funds are going cashflow negative and should be considering the potential for investment returns.
Risk is always important, but they may not be as risky as some think, he suggested.
“We’re looking at sub-investment grade – ie BB in ratings terms – where returns are higher and even then, you still have the tangible assets backing it,” said Carey.
LGPS funds are a long way ahead of corporate pension funds and there are opportunities to invest in modern clean technologies, said one panellist.
The reason there is so much focus on the UK when talking about infrastructure, is not because the returns are any better than elsewhere, but, because advisers have a lot of experience of bringing institutions into infrastructure and the UK has many opportunities.
The only thing lacking from the LAPFSIF event was more time. Many stayed well after the event closed for the drinks reception, keen to maximise their opportunity to pick the brains of colleagues and share experiences in what is going to be a trying year.
If that and the high turnout for the closing dinner are included, LAPFSIF can be said to have been a total success when measured against every benchmark.