Delivering real returns in a Local Government Pension Scheme is no easy feat amid changing policy, austerity measures and against the current macro-economic backdrop. Sebastian Cheek talks to Merseyside Pension Fund head of pensions Peter Wallach to find out how he keeps the £8.5bn fund on track to deliver benefits.
“I certainly don’t agree with a wholesale move to passive but it does have a place in our portfolio. One example is index-linked gilts, because there aren’t a great number of instruments available.”
Peter Wallach
What is the current asset allocation of the portfolio? The portfolio breaks down into three chunks: equities (53%), bonds (19%) and alternatives, including property (28%). In terms of asset allocation we are running fairly tight to benchmark because we are cautious of markets at the moment and only very modestly overweight in equities with a commensurate underweight in bonds and effectively neutral on alternatives. We are 77% funded.
Why are you underweight bonds? We feel bonds are pretty fully-valued and the market is distorted by quantitative easing (QE) and we don’t see interest rates rising fast or soon. Taking a medium-term view, i.e. five to 10 years, the returns on government bonds are not attractive – 2% on UK government 10 years is not attractive – so we are happy to be modestly underweight (3%) to bonds and express a modestly positive view on equities, although we are only 1% overweight equities. We still think equities are pretty fully valued but they are better value than bonds and so within that we are being more choosy about which markets we favour and which we don’t.
Which markets do you favour at present? We invest regionally with our equities and our strongest view is on Japan, so we are 3% overweight (7% of the total portfolio is in Japan) and we have a small overweight to Europe and an underweight to the US and UK. In terms of Japan, firstly we think the reforms by [prime minister] Shinzo Abe have had some effect and it has been a strong market over the past 12 months. Secondly, the market is less correlated with other equity markets so at a time when we are not too sure about the direction of markets it brings a bit of diversification. Thirdly, we think on a valuation basis there is quite a lot of latent value in Japan; companies are inefficiently managed which is why valuations are low, but the third arrow of Abenomics is corporate reform and as return on equity improves, there is a lot of capital that can be moved more efficiently. Although it will be slow we are starting the see the benefits.
What about the Europe overweight? Europe is a small overweight which is driven by QE and the fact a weaker euro will help European exports and, again, shares offer better value in that on a valuation basis they look cheaper than US stocks. As economic growth picks up we think Europe will be a beneficiary from the simu-lative economic activities QE will provide.
Does short-term volatility in the eurozone concern you? It is not a major concern and we think it should wash through, but we recognise there has been a bit of a pull back in stock markets as a whole as a result of Greece. However, a lot of European companies are quite international in their sales and will benefit from stronger US and UK economies.
Where is the bond portfolio invested? We have 11% in index-linked gilts, so that is the matching part, and the other 8% is 50/50 UK sovereign and UK corporate. They are very plain vanilla mandates and there to give a bit of liquidity and match our liabilities.
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