TEESSIDE PENSION FUND
Administered by Middlesbrough Council
AGENDA ITEM 5
7 DECEMBER 2016
STRATEGIC DIRECTOR FINANCE, GOVERNANCE & SUPPORT – JAMES BROMILEY
INVESTMENT ADVISORS REPORT
1. PURPOSE OF THE REPORT
1.1 To update Members with the current capital market conditions, and set an appropriate short term asset allocation to best take advantage of these conditions.
2. RECOMMENDATIONS
2.1 That Members note the report and approve with the short term asset allocation.
3. FINANCIAL IMPLICATIONS
3.1 Decisions taken by Members, in light of information contained within this report, will have an impact on the performance of the Fund.
4. BACKGROUND
4.1 At each Investment Panel meeting, the Panel’s Independent Investment Advisors provide an update to Members on current global economic, political and market conditions, and recommend an appropriate short term asset allocation for the Fund given these conditions.
4.2 Attached as Appendix A & B are reports from the Panel’s Independent Investment Advisors. These reports represent the Advisors recommendations as at the dates of the reports and verbal updates will be brought to the Panel meeting should any significant events change or affect their opinions.
5. SUMMARY OF INVESTMENT ADVISORS’ SHORT TERM STRATEGY
5.1 Both Advisors continue to favour growth assets over protection assets. Bonds do not meet the actuarial requirements for the Fund at the current yield levels and should continue to be avoided at around these levels unless they are held as a short term alternative to cash. Cash should continue to be built up as divestments from other markets occurs, and invested when opportunities allow.
5.2 There is consensus that Equity markets will continue to be volatile into the near future, with additional volatility in currency markets. The Advisors would be happy to see a continuation of the previous activities of equity sales at higher market levels where opportunities allow and cash built up pending re-investment when market conditions allow. Both Advisors agree to a continuation of “stock-picking” equities wherever opportunities allow for investments, but they do favour the developed markets of the UK and US and express caution over Europe into next year’s elections in key European countries.
5.3 Both Advisors continue to favour further investment in direct property on an opportunistic basis and the property has a good covenant.
5.4 Investment in Alternatives, such as infrastructure and private equity, offer the Fund diversification from equities and bonds. They come with additional risks of being illiquid and traditionally have costly management fees. However, the Fund is considerably underweight its customised benchmark and, providing suitable investment opportunities are available, the Fund should look to increase its allocation to this asset class. Investment opportunities should only occur where the investment makes an appropriate rate of return for the Fund’s, and does not fulfil an alternative purpose.
CONTACT OFFICER: Paul Campbell (Head of Investments & Treasury Management)
TEL. NO.: (01642) 729024
APPENDIX A
Investment Report December 2016
Few people would have predicted that the election of a president who has no experience of public office, has managed to insult a large proportion of the electorate, wants to build a wall along the Mexican border, deport millions of people and rip up the North American Free Trade Agreement would have resulted in a sharp rise in the US equity market. Either markets on both side of the Atlantic are delusional (quite possible) or they appreciate that even a Republican-dominated Congress won’t let Mr Trump implement the more hysterical aspects of his manifesto. In fact while it is easy to deride Trumponomics as half-baked much of it is stock-market friendly; lower corporation tax, less regulation and massive increases in infrastructure spending for starters. The much more conciliatory tone of his acceptance speech and subsequent interviews will have lessened the concerns of those who favoured the more laissez faire environment promised by Mrs Clinton.
The promises on infrastructure, hinting at a spend of $1 trillion, will have wide support, given that figures show US infrastructure spending as a percentage of GDP is near an all-time low and the anticipated projects would also offer employment prospects to those sections of US society shown to be vocal Trump supporters.
The risk is that government debt will increase significantly, as will wages and inflation. But it is likely that the Federal Reserve won’t mind a bit of inflation as it will help it to normalise interest rates, which Chair Janet Yellen has indicated will rise “relatively soon”. What has happened as a result of the election outcome is that bond markets, not equity markets, have taken a significant hit. There has been a growing realisation that bond markets had become too expensive, with yields depressed to artificially low levels as a result of central bank stimulus programmes and, at some stage, this would have to be corrected. But with central bankers seemingly prepared to do anything to keep the bond bubble inflated analysts struggled to anticipate just what would be the cause of a correction. The election of Mr Trump may just have been that event.
It is not difficult to believe that we are undergoing massive change brought about by a coalition of anti-establishment groups and that Brexit and the US Election are symptoms of that change. While the US Election result could have adverse implications for the rest of the World, threatening trade wars and reduced growth, the greater risk in the Eurozone may well be political than economic. Eurosceptic, anti-establishment parties are surging in the polls ahead of elections next year in France, Germany and the Netherlands and the referendum in Italy. Brexit is not the only challenge to face European politicians.
In the UK there are clearly significant challenges ahead as Brexit negotiations begin. Sharp increases in retail spending and increased employment numbers suggest that confidence is recovering, but record levels of personal indebtedness and the failure to increase productivity levels leave the recovery very vulnerable to rises in interest rates which must be in the pipeline. We will have a clearer picture of the state of public finances after the Chancellor’s autumn statement. Given the worrying balance of payments deficit, around 7% of national income, the Bank of England will be hoping that Sterling weakness continues to assist exporters, although the danger is that inflationary pressures increase because of that weakness.
As can be seen from the Fund Manager’s report the Fund is heavily exposed to equity markets, with a strong emphasis on overseas markets. While this has led to a level of volatility which can be disturbing in the short term the recent equity market rally, coupled with the fall in Sterling has been beneficial to the Fund. I think that is important to understand that the Fund has kept faith in its basic investment philosophy whilst others have pursued a short-term strategy based on buying bonds at levels guaranteed to produce negative returns.
The Fund invests in order to achieve returns which, in the view of the actuary, will be sufficient, in the long term, to meet promises made to current and future pensioners and to maintain an employers’ contribution rate as low and as stable as possible. The current asset mix of the Fund, as set out in the Fund Manager’s report, reflects the advisors’ views that Growth investments, such as equities, property and alternatives offer the best prospect of achieving those returns. The very low weighting in bonds is a result of advisors’ advice that Government policies have distorted the value of those bonds and made them unsuitable to hold.
Considering short term strategy, Growth investments continue to offer the best value. Cash should be built up if it is a consequence of sales of equities and held pending better buying opportunities which will present themselves as a result of market concerns. The case for holding overseas equities rather than UK is less compelling than it was as Sterling has fallen but growth prospects remain better in the US and the Far East. I have particular concerns for European markets as Brexit and an increase in nationalism across the continent, coupled with President Putin’s aggressive stance have increased the level of risk to investors.
The property portfolio has been increased towards the target benchmark weighting and further, opportunistic purchases should be considered. However the dangers of a sharp fall in values cannot be discounted. There may be opportunities as companies reconsider their strategies around Brexit.
I think that the need to diversify into more non-traditional types of investment, given the anticipated modest returns from equities and bonds, is increasing. There are real issues to consider when investing in alternatives, such as infrastructure and private equity. Costs can be much higher, liquidity can be a problem and the Fund must be prepared to accept a higher degree of risk. I am wary of schemes where the primary concern seems to be to meet a need other than to achieve the best rate of return on the Fund’s investment.
Bonds should be avoided as they do not meet the needs of the Fund, unless they are being held as a short term alternative to cash.
Fred Green (21 November 2016)
APPENDIX B
INVESTMENT REPORT DECEMBER 2016
In my last report, the electorate was posing searching questions for the political establishment in the UK and Europe thereby creating an environment of uncertainty, since then they’ve managed to come up Trumps. It is futile as an amateur to try and predict what will now happen to the political environment in the USA or Europe and how this will impact on the rest of the world. However, one thing is clear the level of uncertainty has risen significantly in a short period of time.
The political environment is unlikely to become more settled for the next year at least. Voters in Italy, Holland, France or Germany all have the capacity to derail or at least increase momentum for a train crash in Europe. Brexit negotiations add a further level of anxiety over the medium to long term.
What is apparent is that Fiscal Policy in the United States and the UK will be loosened through tax cuts and infrastructure spending and, if this was happening in isolation it would be supportive to equity markets and negative, to some extent, to bond markets. It is not happening in isolation and the difficulty is to predict the extent to which the heightened level of worry will distort the market outcomes. The recent sterling devaluation of 15-20% has undoubtedly put upward pressure on consumer prices in the UK but will this be a secular turning point or merely an uncomfortable and annoying blip in 2017 followed by a further period of very low inflation. Inflation will not be a problem in countries which have not had large devaluations.
Let’s try to gauge the impact on markets of the changed economic and political order.
Massive uncertainties in China and the Far East from potential tariff changes and adjustments in China with its regional knock on effects should lead to safe haven currencies appreciating. The problem is in the absence of the Deutschemark perversely only the US dollar fits the bill so I would expect further dollar appreciation from here. The impact of Trump’s actions in the United States pales into insignificance compared to the effect overseas, especially on low cost manufacturing countries.
Bond markets have started to have a torrid time and the upward drift is likely to continue. Within bonds those associated with safe haven status should do relatively better than the rest. Sterling bond yields have behaved similarly to other markets but the strain has been taken through the exchange rate. The same is true of the US bond markets where positive investor preference has been and will continue to be reflected in the appreciation of the currency. German bunds are likely to rise significantly because here the inability of the euro to appreciate will be translated into the physical stock price rises rather than through the exchange rate.
Equity markets are likely to have much larger swings in value in this more unpredictable environment. However, the situation is relatively benign for equities in developed economies where fiscal policy has been relaxed and monetary policy is by no means tight. The US and UK would appear to be the major beneficiaries along with Germany. The huge impact of Trump’s policies on the manufacturing base of the developing markets makes it unlikely that these will perform as well as the developed world until it becomes clearer what his true intentions are.
Demand for property is likely to be driven positively by the economic performance in the UK but held back to some extent by falling bond valuations.
Commodities will suffer huge volatility as sentiment swings back and forth but the companies have, in the main, positioned themselves well through efficiency savings which reflect a testing marketplace.
Regarding alternative investments, it’s time to find those fund managers who are genuinely capable of capturing volatility movements.
Investment Policy Recommendations
Bonds
Despite any relative merits between bonds the absolute valuation make them an unattractive investment. Avoid.