Damien Pantling: “I don’t think anybody has been able to keep up with inflation and liability growth over the past three years.”

16 Oct 2023

The head of the Royal County of Berkshire Pension Fund talks to Andrew Holt about infrastructure, future proofing, maverick managers, a pensions skills shortage and funding.

Interviews

The head of the Royal County of Berkshire Pension Fund talks to Andrew Holt about infrastructure, future proofing, maverick managers, a pensions skills shortage and funding.

What’s in your portfolio?

We have about £3bn in assets, but more than £3.6bn of liabilities. Right now, we have three broad asset classes: equity, debt and real assets.

We have the highest combined exposure of public and private equities than any local government pension fund.
On the debt side, we invest in private credit, multi-asset credit, investment grade and government lending.

In real assets, we invest in real estate and infrastructure equity.

It’s probably worth noting that the bulk of our real asset exposure comes from infrastructure equity. We don’t invest in hedge funds or other low beta diversifying strategies. That’s perhaps something to look at in the future.

You mentioned infrastructure equity, which is on the government’s agenda. Is that commitment a result of this, or is it something you have always been keen to embrace?

We are not driven by the government’s agenda at all. Infrastructure has been part of our strategy since 2016. It’s largely the other characteristics infrastructure brings, such as index-linked cashflows, and a stable source of income which works with our long-term investment approach.

What is the philosophy that underpins your investment approach?

We have several objectives in our investment strategy statement, and a lot of them work in tandem with each other. But our philosophy can generally be categorized into three distinct areas.

The first is diversification. That comes from asset classes, styles, strategies and geographies. Second is a long-term approach or long-term focus. The opportunities that come with that are mainly in the liquidity premium. Third, it comes from good governance and an ESG focus, which speaks for itself. But, in essence, good companies will create and hold value over the longer term.

You have consistently matched the actuarial annualised benchmark of 6.5%: what do you attribute that to?

We set that 6.5% benchmark in March 2019. Annualised performance from then until July 2023 has been just over 7.5%, on a money-weighted basis.

The best performing asset classes during this period have been private equity and infrastructure. Since we set that benchmark, we’ve been able to achieve [the benchmark] largely by maintaining our focus on growth assets and liquid alternatives.

Generally, our performance has been held back by our exposure to real estate. We realigned our portfolio in March this year, not just for that basis, but that was one of the considerations.

In your investment statement you state the pension fund will progressively evolve to being cashflow negative. What is the rational here?

In simple terms, this is to do with the evolution of the membership and the membership profile of the fund. It applies to virtually all defined benefit schemes. With the passage of time, we see the proportion of retired members compared to our active and deferred members increasing.

With that, we have more money being paid out in retirement benefits compared to what we have coming in from member and employer contributions.

It is often said that this puts the fund in a risky position. Do you identify with that, or do you look at it another way?

It’s a great question. But I look at it in a slightly different way. When we discuss cashflow negativity, we are referring to our dealings with our members rather than our investment activities. So in our investment strategy, there is plenty of harvestable income: we simply reinvest to compound that up.

If we suddenly went cashflow negative tomorrow, we will be able to meet those demands without selling anything.
In essence, we can always start to harvest the income rather than reinvesting it, then over the long term we have the scope to amend and shift our investment strategy, should we need more assets with a higher income yield in the portfolio.

I don’t think our glide path to cashflow negativity puts us under any undue risk as an important part of this journey is closely monitoring the cashflow profile as our cashflow position progresses.

You mentioned your change in portfolio earlier in the year. How has the inflationary environment impacted your investments?

It is a highly relevant and topical issue. To answer it we need to think about when the high inflationary environment really began, and how the portfolio has performed since August 2020.

Over that three-year period, the consumer price index has inflated average consumer prices by just under 20%. But our fund has returned just over 24% in that same period.

Looking at that alone, one could say we’ve been highly resilient in a high inflationary environment. But being resilient to inflation alone is not enough as DB schemes in general need to outperform inflation by about 2.5% on an annualised basis to keep up with the pace of accumulation in their liabilities. But Berkshire needs to outperform by a further 1% to counter the historic under-funding position.

It’s probably worth noting that at Berkshire we have ranked in the top three funds for performance in the whole of the local government pension scheme universe [PIRC data set] during that period. If we were not in such a strange and uncertain macro environment, I’m sure you would agree that 24% asset growth over three years would have been considered excellent.

But like any institutional investor, I don’t think anybody has been able to keep up with inflation and liability growth over the past three years.

You must still be pleased with that type of performance.

We are, but as a DB fund, we don’t just look at our assets. We look at our funding ratio assets versus liabilities.

So liabilities are growing at more than 5% each year – even more when inflation is high – and our job is to match, or beat that, otherwise our funding level deteriorates. I guess that’s the real difference between DB and defined contribution schemes, where DC managers only look at one side of the funding equation.

So you’ve not had to respond too much in terms of adjusting your investments?

It’s an interesting point to consider. The investment community is aware of the two lagging asset classes over the past three years: debt/credit and real estate. Debt comes as no surprise, but we generally keep that in our portfolio as a diversifier rather than a growth asset.

What’s really been a surprise to us is real estate. This asset class has historically been attractive to investors because of its supposed inflation protection characteristics.

The past three years have gone to show this asset class simply has not performed in the way that it should. We have since reduced our allocation to real estate and we are continuing to evaluate its purpose in the fund going forward.

You mentioned earlier the benefits that ESG brings to your portfolio. What is your ESG approach and how important is it to the fund?

ESG underpins all of our decisions, as it does for most institutional investors. It’s generally about being future proof.

You don’t want to be holding a bunch of assets today that have no buyer or value in the future. Our liability duration extends beyond 2050. So these are important and real considerations for the fund’s performance and are not just arbitrary pen and paper models. This is also a hugely complex and multi-faceted area.

What do you make of recent negative headlines about ESG?

There’s a lot of headlines out there and a lot of them are not so friendly to the investment management community in general.

Do you have a divestment policy within your ESG approach, or do you see engagement as a better way to address such issues?

We have exclusions, clauses in our pooled global equities fund allocation: that’s exclusions from extractive fossil fuel companies. We also have exclusions from investments in Russia – that is a reaction to the events over the past couple of years.

But generally speaking, other than those two, engagement is viewed as the preferred and positive way forward. You can engage with the company to try to get them to change their behavior and this underpins our responsible investment policy.

The way I see it is if you divest, you encourage companies to go private, and then they can just continue that behavior behind closed doors with less scrutiny. Thus, engagement is almost always preferred.

Is your fund committed to net zero?

We haven’t made an asset owner commitment to net zero. But our pool [Local Pensions Partnership Investments], with which we’ve pooled almost 100% of our assets, have made the Institutional Investors Group on Climate Change asset manager commitment to net zero and we fully support that.

So you have pooled almost all of your assets?

It’s around 80% of our assets which are in the pool’s investment vehicles. The remaining assets are managed by Local Pensions Partnership Investments. In the industry, pooling is interpreted in different ways. But we have fully embraced the government’s pooling agenda from the early days.

Our relationship with Local Pensions Partnership Investments, especially through the delegating of the manager selection process, gives us significant time to focus on the more strategic priorities to build resilience and improve our funding position and tackle other pertinent matters.

So pooling has proven to be a good initiative?

It has absolutely been the best thing that’s ever happened to the LGPS in my opinion. The industry has seen quite a lot of questionable decisions in the past, perhaps being made by a few mavericks without proper diligence, scrutiny and challenge. That damaged performance, inflated fees, and, in some circumstances, actually influenced the LGPS’ reputation.

It’s crystal clear that putting qualified and experienced FCA-regulated managers in the decision seat is the absolute best thing from a governance standpoint for the LGPS and the asset management industry as a whole.

What has been your biggest challenge as a pension fund manager?

The biggest challenge has not been on the investment side of things but managing an increasingly complex administration environment within the context of diminishing and constrained resources and a skills shortage across the industry.

But probably the biggest challenge is working out where to go now in respect of climate change modeling.
There’s a huge divide between the scientific community and the investment management community, and we are in limbo trying to work out what to do next with that. There is so much new data, so many new studies, so many headlines, to the point where we are working through all that right now. It’s an incredibly difficult challenge.

On that modeling, what is the best way forward?

That’s what we haven’t quite established yet. We have done our modeling, but the

whole LGPS and asset management industry in general is in limbo on what to do next.

You mentioned resources and skills: what is the big issue?

This is more on the fund administration side. And there needs to be a two-step approach to this: one, getting people interested in pensions administration.

Secondly, grow your own. Recruit people at a graduate and apprentice level, train them up and ensure they have the appropriate skills.

What is the aim of the fund going forward?

The main aim of the fund is, and always should be, to pay pensions as they fall due.

What is your ambition as the pension fund’s manager?

My primary goal is to get Berkshire back to full funding.

How long do you anticipate it taking until you achieve that?

It depends, because we value our fund every three years and the timescale changes. But the absolute latest would be 2038 based on current deficit recovery plans.

whole LGPS and asset management industry in general is in limbo on what to do next.

You mentioned resources and skills: what is the big issue?

This is more on the fund administration side. And there needs to be a two-step approach to this: one, getting people interested in pensions administration. Secondly, grow your own. Recruit people at a graduate and apprentice level, train them up and ensure they have the appropriate skills.

What is the aim of the fund going forward?

The main aim of the fund is, and always should be, to pay pensions as they fall due.

What is your ambition as the pension fund’s manager?

My primary goal is to get Berkshire back to full funding.

How long do you anticipate it taking until you achieve that?

It depends, because we value our fund every three years and the timescale changes. But the absolute latest would be 2038 based on current deficit recovery plans.