Merseyside Pension Fund’s Peter Wallach: “It is not down to the government to determine what pension funds should do.”

20 Nov 2023

The director of pensions at the Merseyside Pension Fund talks to Andrew Holt about the search for income, being realistic about net zero, the problem with venture capital and the importance of being humble.

Interviews

What’s in your investment portfolio and why?

Our portfolio is one you would typically see in a pension fund such as ours. We have 50% in equities, 20% in bonds and 30% in alternatives. We are one of the most mature local government pension schemes (LGPS), in terms of liabilities. It means we have been thinking more about income.

And we have been increasing our allocation to alternatives, particularly income-producing alternatives such as infrastructure. Over the next 12 months, we expect to move more from equities into bonds to generate more income and to dampen risk.

How would you typify your investment philosophy?

I try to keep it simple: it is easier to lose money than to make it. So we try to avoid losses – the preservation of capital is important to us.

We take a long-term perspective and are sensitive to fees. We don’t mind paying fees, where the performance justifies it, but where it does not, we are reluctant to pay up.

What is your approach to ESG and net zero?

They are important to us as captured in our responsible investment policy. We believe ESG factors have a material influence over the long term, and it is important to consider them at the beginning, as well as throughout the investment process.

In terms of net zero, as a LGPS fund, we have a net-zero by 2050 commitment. We are working on managing climate risk and looking at ways in which we can set some milestones to measure and track our progress to net zero.

What will that mean in practice: divestment from some investments, perhaps?

At the moment engagement is what we are doing, and, in my opinion, it is the sensible way to manage ESG and net zero. There may be occasions where divestment needs to be considered. We are looking at putting some form of framework in place, which will enable structure and decision making on that.

Are the ambitions towards net zero by 2050 realistic and achievable?

The short answer is yes. They are achievable by 2050, providing the work with other investors and companies continues. But I do feel that it is very ambitious.

What challenges does that create for you?

A challenge in so far as aligning with Paris [Accord] benchmarks and relying on businesses that have sensible plans, can be justified and achieved.

We are investing globally, and in a world where there are good intentions, but there are other things that sometimes take priority over climate policy, which is understandable.

Therefore, and this is a key point: if there isn’t a real commitment from government and industry then there is a case that institutional investors like us can only go so far on the issue. We have to be realistic about that.

So there is a strong element of realism in terms of net zero?

It is not sensible to get too far ahead of the curve. It is absolutely sensible to do things in a more energy efficient way and to implement measures that are cost effective in terms of addressing climate risk. Spending money on virtue signaling in terms of having a low carbon portfolio, doesn’t necessarily stack up from an investment perspective.

Take carbon o sets, we have seen evidence that they are difficult to certify. If they are a mechanism for achieving net zero, then it is an example of how difficult things are going to be.

The government has been keen to push the message about pension funds investing in infrastructure. You have exposure here, so do you agree with the government?

As a pension fund, we have more than £900m in infrastructure. We started well before 2015 when the then chancellor started promoting pension fund investment. We continue to invest in infrastructure because we invest in long-term assets with characteristics that fulfill our requirements.

But it is up to each pension fund to determine what is right for it. It is not down to the government to determine what pension funds should do.

What do you make of other initiatives like the northern powerhouse and levelling up? Do they amount to much from an investor perspective?

I don’t believe they do. They have good intentions. But based on the levelling up criteria, we are invested in projects that already fulfill that. But as with infrastructure, we have done them for investment reasons.

Was the cancellation of the northern leg of HS2 a disappointment?

Personally, it was. It was a short-term decision, but it has no investment implications for us.

What I took away from it was the publicity about the way that costs spiraled versus the equivalent projects in Germany, France and Spain, which are typically much less expensive.

It is a question of why does infrastructure cost so much in this country. We need to get to the bottom of that. There are large projects needing to be undertaken, but at a sensible cost.

What did you make of Jeremy Hunt’s so-called Edinburgh Reforms, encouraging pension funds to invest in illiquid assets, such as venture capital?

One has to consider whether venture capital is suitable for pension funds, because it is higher risk and higher cost. So for institutional investors to be interested, venture capital needs to come with some additional incentives.

As we have the whole range of private equity-type investments to choose from, from a fiduciary perspective, why would we choose to invest in UK venture capital over other opportunities?

Your illiquid assets make up 30% of the fund, including private equity, infrastructure, private credit and property. Why those are in your portfolio?

We have been invested in private equity for more than 30 years. We have a well-developed private equity programme that has provided very good returns. Strategically, it has grown to be a larger part of our portfolio than we want it to be, so we will dial it back. Infrastructure and property are held through a number of funds and direct investments. The latter helps us in taking long-term buy-and-hold positions.

You are part of the Northern LGPS pool. How does that relationship work for you?

It works well. It enables us to concentrate on where the biggest savings are for us, like in private markets and private equity – we helped establish the northern private equity pool which has commitments of more than £2.5bn.

There is also within the pool the GLIL infrastructure platform, which enables us to invest into direct infrastructure projects, cost effectively. LGPS pooling helps us to work together to improve scale, resource and manage overall costs.

As a pool, the Northern version is the one that probably gets the least publicity. Is this a good thing?

No, because a number of the initiatives we undertake are overlooked and don’t get the recognition they deserve. Equally, we are able to get on and deliver our objectives without being interrupted.

Is there a negative side to pooling?

Initially, I was dubious. But, in aggregate, it has delivered. It, among the other things I have mentioned, has also improved investment governance. But it is not a one-size-fits-all approach. It needs to allow for different approaches by LGPS funds. And I would like to see that flexibility continue.

What do you make of funds having to pool all of their assets by April 2025?

I can see why the government wants to see it completed expediently. But, as some of the pools and funds have said, the deadline is too soon. And, for example, passive management doesn’t t the pooling system. It would add cost without a commensurate benefit.

Between now and then there may be a change in government, so it may change.

I anticipate that whichever administration is in power there will be a similar approach to the LGPS. There will be a pragmatic solution to recognise that it is not just about achieving full pooling, and so, some form of compromise will be reached.

How do you view the pooling system overall?

The LGPS has always been a great place to channel ideas and for collaboration. I would not want to see that diminished as pooling develops.

You are a member of GLIL’s investment committee. What does that involve?

It involves a great deal of reading. GLIL’s investment committee is the governance body which oversees the activities of the investment and asset management team. As a minimum, we have monthly meetings and other meetings when needed. GLIL offers us great insight in terms of activity and pricing of infrastructure as- sets. Its portfolio gives us good exposure to renewable energy and low carbon transition-type assets in a cost-effective way.

What have been the biggest challenges you have had to deal with as director of the fund?

Although investment crises get the headlines, administration is the heart of the pension fund, and that is often one of the biggest challenges. Administration is far more complex than appreciated, the ever-changing regulatory environment does not help, and importantly, which is often overlooked, the people doing it have a particular knowledge and skill which is difficult to replace.

Do you see the high inflationary environment being a problem going forward?

I do. Our liabilities are indexed to inflation. It means that persistent inflation means higher liabilities. High interest rates are a temporary phenomenon for us, whereas inflation is a permanent challenge because it is baked in.

So how do you see equities in this environment?

They are the lowest cost of the engines of growth for pension assets over time.

What other economic or geopolitical challenges do you foresee?

The main one, given the global situation, is governments servicing their debt costs. Which probably means taxes are going to remain structurally high and that will be a challenge for financial markets, industry and us.

What are your primary aims for the fund?

They are twofold. I mentioned climate risk and ESG in terms of embedding them more into our investment strategy, but alongside that there is a need to increase income from our investments and to improve the inflation linkage of our liabilities.