The Covid-19 crisis could mean that 2020 will be seen as a turning point for the Local Government Pension Scheme, writes features editor Martin George.
It has become a cliché to use the word ‘unprecedented’ to describe the coronavirus emergency, yet that does not make it inaccurate. But does it hold true of the situation that the Local Government Pension Scheme finds itself in?
Jeff Houston, secretary of the LGPS Advisory Board, thinks back to the turmoil of the 2008 global economic crash, Black Wednesday in 1992, and events of the 1980s.
“This is the only one I have ever seen that has hit admin, governance and funding and investment, all potentially as hard and all at the same time,” he says. And the shift that the pandemic will cause “will be as big as when the first computer arrived on my desk”.
Challenges in the first few months of the crisis have included continuing to pay pensions while staff have had to access important and sensitive systems from home, the tragic increase in the number of deaths among scheme members, ensuring there is proper decision making and scrutiny without the ability to hold in person meetings, and dealing with huge volatility in share prices, reduced income and employers that are facing financial difficulties.
Of this initial phase of the crisis, Mr Houston says that “local government does what it does best: it copes, and it has coped”.
Operationally, he says there have been lots of “workarounds” to do with challenges such as pension staff working from home. “The concern I would have is how long we can keep doing that, because if this is going to be a medium-term situation with lots of people working from home, we’re just not set up for that.”
During the first two weeks of April, 80% of administering authorities in the UK responded to an LGPS Advisory Board survey about cash flow.
Of these, 87% said they did not anticipate any cash flow issues for 2020-21, although 5% said they did, with a further 8% saying this was a possibility. However, the summary of the survey results noted that “a number of funds indicated that their ‘no’ answer may change should this situation continue, or get worse, for much of the year”.
There will be question marks, no doubt, over employer affordability, but we really can’t see what they look like at the minute
Areas of concerns raised included investment income and the reduction or suspension of dividends, falling rental income from property, funds whose employers include further and higher education institutions and charities “which are struggling with their finances. Some may even be unable or unwilling to pay their secondary, perhaps even primary contributions”, and a potential increase in death grant payments.
Indeed, 7% of respondents said that they had received requests from employers to delay or reduce their contributions. And some major employers that had been intending to pre-pay three years’ of contributions were now paying just one year’s upfront.
The board warned that the majority of those who answered this question said it was too early to say about employer contributions, and warned that “this situation may change for the worse if circumstances continue as they are for a period of months”.
Mr Houston says that since the survey was completed “the message is starting to come through that we are now [having] a few more employers starting to come forward”. He cites small private sector employers unable to afford to furlough staff for much longer, or those such as leisure services that have seen no income for months.
It is an issue very much on the minds of the LGPS Advisory Board’s Covid-19 practitioner group, which first met in April.
Rachel Brothwood, who chairs the group as well as being director of pensions at the West Midlands Pension Fund, says the “biggest thing we have on our radar” is what will happen to employers that pay into the LGPS, and the effects on them of the government’s financial support packages and furlough scheme, rules about reopening and when they will be able to start earning money again, as well as how they are affected by developments in the wider economy.
“There will be question marks, no doubt, over employer affordability, but we really can’t see what they look like at the minute, so that’s one that we are watching,” she adds.
Along with all other asset owners, her own fund “did see a dip” in March, and a rebound since then, but she cautions: “We are not complacent in any way that this is over. There are so many risks out there. We are anticipating an ongoing period of volatility which means assets do fall back down and shoot back up.”
The different ways the crisis has affected different funds has been seen at first hand by Phil Triggs, tri-borough director of treasury and pensions at Westminster City Council. He notes that the three funds are “remarkably different” in their asset allocations.
LGPS funds with higher proportions of investment in illiquid assets would be financially hurt if they were required to sell those
Kensington & Chelsea Pension Fund “has a high allocation to equities and was hurt by the initial market collapse in March, but its fund has since rebounded in the recovery”, and its committee recently switched equity assets to cash which will feed into a segregated direct property portfolio.
Hammersmith & Fulham Pension Fund had a much lower equity allocation, as well as being invested in a low carbon passive fund, and was “therefore protected from the worst impacts of the market crash”. Mr Triggs says its diversification strategy over the past 10 years also meant it was “far more protected than the average LGPS fund”.
And he says Westminster City Council Pension Fund “was partially protected as a result of its decision to move from UK to global equities late in 2019, with global equities recovering better since March 2020”.
Both Westminster and Hammersmith & Fulham will look to move a proportion of their passive funds to actively managed funds, and Mr Triggs notes that “active management is more suited for recovering markets where specific hard-hit sectors can be avoided”.
Cashflow is a consideration for Mr Triggs. Last year’s valuation resulted in many funds reducing deficit contributions as they moved to fully funded status.
“These took effect from 1 April 2020,” he says, “and combining this with reduced dividend flow could impact my LGPS funds in terms of the required cashflow to pay pensions. It could result in a sustained process of liquidating investments to pay pensions.
“While liquidating pooled units in passive equities can be achieved efficiently at low cost, LGPS funds with higher proportions of investment in illiquid assets would be financially hurt if they were required to sell those.”
Mr Houston describes the impact of the pandemic on the investment side of the LGPS as being a “fairly wild ride”, with volatility in equities “a serious challenge”. One asset manager has warned him that the recovery in the market does not seem to match the fundamentals as the world appears set to enter a recession. A second wave of coronavirus could send markets down again.
What should pension funds do in the face of this uncertainty? “Nothing is probably a really good thing to do. We are long-term investors,” Mr Houston says, although he acknowledges there is nervousness about what the situation will be in 2022 when the next valuation takes place.
“If it does just bounce around between now and then, how on earth are our actuaries going to makes any kind of forward forecasts? That’s the kind of thing that makes people nervous about where the equity markets are going.”
When it comes to investment strategies Ms Brothwood does not think there will be any knee-jerk reactions in the short term, but the crisis will have thrown a spotlight on two areas, which she describes as “the portfolio positioning relative to long-term asset allocation targets, and the extent to which you are using diversification or hedging strategies of one form or another”.
The other theme that is coming through… is how much sustainably focused investment strategies can make a difference
She also detects other changes: “There is a shift towards allocating more to income generating assets – that points to real estate. There’s also a growing awareness around the long-term inflation linked nature of the liabilities so again that’s where infrastructure comes into play because that long inflation linked cash flow is a real holy grail for pretty much all pension funds so I see that definitely starting to build.
“The other theme that is coming through, and the last quarter is quite important for this, is how much sustainably focused investment strategies can make a difference. Again, as a sector we have been a little bit ahead of the game in this from a responsible investment point of view, but more and more there’s very recent real evidence that sustainably focused investment strategies will outperform, and they have done less bad, if you like.”
Doug Heron, chief executive of Lothian Pension Fund, notes that LGPS investors “tend to have long-term stability in their investment beliefs and the implementation of those beliefs”, and so he expects allocations and strategies will have remained “material unchanged” over the past three months – something he says is “certainly true” at Lothian.
He adds: “The trend towards infrastructure and other real assets has been with us for some time and those funds with allocations in that class may be appreciative of those investments for the diversification value.
“Linked to the unknowns of the economics of exit from the pandemic, we might see changes prompted by policies to maintain low interest rates and a loss of income which could see infrastructure grow in appeal or a shift to equities where dividends are more resilient.”
I’d be disappointed to see us roll into rushed and sweeping benefit reform without a fuller consideration of the value of these roles to our communities and whether they are paid accordingly
And Mr Houston expects that the questions being asked about the long-term future of retail and office space will already have been the subject of conversations between managers and their funds.
There is another long-term issue which some believe could raise its head as the governments seeks to repay its huge pandemic bailouts of the economy: the generosity of public sector pensions.
It has already appear in the pages of the Times, with independent pensions consultant John Ralfe writing that the government could make savings in public sector pensions, while protecting the lower paid, by reducing the annual value of all public sector DB pensions to “an 80th of the salary, with increases at inflation. This would be on the first £30,000 of salary – protecting the lower-paid – with DC pensions on any pay above this”.
His proposal would see member contributions remain unchanged, and he wrote that “even with these changes, public sector pensions would be much more generous than most private sector DC pensions”.
For Glyn Jenkins, head of pensions at Unison, “any talk of a cut to the Local Government Pension Scheme would be a slap in the face of the mostly low-paid staff paying into it.
“For many the pension isn’t generous, but just about adequate. It’s a vital safety net for staff who’ve shouldered the lion’s share of burden of the pandemic. Suggesting that they should pay towards the cost of the crisis by cutting their future pension rights is simply wrong.”
And while Jeff Houston expresses sympathy with the argument that “it’s a really expensive scheme and it’s really difficult to afford”, he counters: “If someone could come up with a way we could pay an average pension of £6,000 year to a really low-paid person that costs less, I’m sure we would all jump on it.”
And Doug Heron stresses that “high earners are a tiny constituent in the LGPS membership”, and the scheme’s members are overwhelmingly “what we’ve come recently to recognise as key workers: community-based occupational therapists, waste operatives, bus drivers, social workers and school crossing guards”.
He adds: “I’d be disappointed to see us roll into rushed and sweeping benefit reform without a fuller consideration of the value of these roles to our communities and whether they are paid accordingly.”
It is now more than five months since the first cases of Covid-19 were recorded in the UK, and the word ‘unprecedented’ is indeed a good description of the pandemic’s impact on the LGPS. But while we can be sure that 2020 will be remembered as a turning point for the LGPS, the uncertainty over how the scheme will ultimately be affected goes hand in hand with the uncertainty over the course of the pandemic itself.
— to www.lgcplus.com