Statement of
Investment Principles
July 2014
Contents
1. Introduction and overview of the LPFA
2. Governance Structure of the LPFA
3. Investment Principles and Beliefs
4. Investment Objectives
5. Investment Strategy
6. Risk Management
7. Expected return on investments
8. Liquidity of investments
9. Realisation of investments
10. Cash and Treasury Management
11. Responsible investment
12. Stock lending
13. Compliance with Myners Principles
14. LGPS investment limits
Annex I – Investment Committee terms of reference
Annex II – Risk Committee terms of reference
Annex III – LPFA fund managers & benchmarks
Annex IV – UN-back Principles for Responsible Investment
Annex V – Myners Compliance Statement
Annex V1 – LGPS Limits
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1. INTRODUCTION
The Board (“the Board”) of the London Pensions Fund Authority (“the Fund”) has prepared this Statement of Investment Principles (“the Statement”) in accordance with the Local Government Pension Scheme (Management and Investment of Funds) Regulations 2009 (“the Regulations”) and after taking appropriate advice.
This Statement outlines the principles and policies governing investment decisions made by or on behalf of the Fund. It also reflects the Board’s compliance with the ‘Myners Principles’.
As set out in the Regulations, the Board will review this Statement from time to time, but at least every three years, and revise it as necessary. Also, in the event of a significant change in relation to any matter contained in this Statement, changes will be reflected within six months of the change occurring.
This Statement is available to the public on the Fund’s website: www.lpfa.org.uk.
Overview of the LPFA and its Pension Fund
The LPFA was established in 1989 as a stand-alone public body, to take over the running of the former Greater London Council (GLC) Pension Fund following the abolition of the GLC on 31st March 1986. The LPFA is also one of the largest administering authorities of the LGPS, with agency contracts covering over 150,000 scheme members.
The Fund itself is a final salary (defined benefit) pension scheme with approximately 79,000 members and assets of £4.8bn as at 31st March 2014.
Full details of our history and activities can be found in the ‘About Us’ section of our website: www.lpfa.org.uk.
With effect from 1st April 2013, the two LPFA Sub Funds have been amalgamated to form a unitary fund for strategic reasons.
2. GOVERNANCE OF THE LONDON PENSIONS FUND AUTHORITY
The LPFA’s Constitutional Document sets out the decision making process, matters reserved for Board, and the delegation to sub–committee or officers. This document also sets out the procedures for managing conflicts of interest and Code of Practice for Board Members.
The document can be found on our website:
http://www.lpfa.org.uk/Who-we-are/BOARD-BOARD-REPORTS.aspx
The key elements relevant to the management of the Scheme’s investments are as follows.
Board
The Board is responsible for the strategic management of the Fund’s assets, including setting investment objectives, establishing risk and return targets and setting the overall asset allocation and strategic benchmark (performance target) for the Fund. The Board approves a hierarchy of delegation and clearly laid down procedures for the implementation of investment decisions and management of assets. The Board, through regular and systematic scrutiny ensures these procedures are adhered to. Further, the Board ensures that suitable Compliance and Conflict of Interests policies have also been put in place, appropriate to the more innovative investment approaches and wider range of asset classes currently being pursued.
The Board of the LPFA is appointed by the Mayor of London and Board members are accountable to the Mayor through the Greater London Authority. As with all Mayoral appointees, they are subject to scrutiny form the London Assembly. Details of each Board member can be found on the Fund’s website at www.lpfa.org.uk.
Investment Committee
The Board has established an Investment Committee to manage, consider and make recommendations on investment issues. The Investment Committee is accountable to the Board and has delegated power to determine tolerance ranges for sub-asset classes and implement the asset allocation strategy within those ranges.
The terms of reference for the Investment Committee are provided in Annex I.
The Investment Committee may delegate any aspect of the tactical implementation of strategy to a subgroup of its members and/or Principal Officers, provided that these decisions are in line with the authority given to the Investment Committee by the Board.
Risk Committee
The Board has established a Risk Committee to monitor the application of the LPFA’s risk management system and to ensure that effective processes are in place to manage the most significant risks to the LPFA, most notably within the investment sphere. The Risk Committee has responsibility for oversight and advice to the Board on the current risk exposures and future risk strategy, including strategy for managing liabilities, and the embedding and maintenance of a supportive culture in relation to the management of risk throughout the Authority.
Section 6 highlights the main risks that the Board considers on a regular basis. The terms of reference for the Risk Committee are provided in Annex II.
Day to day fund management
The day to day management of the Fund’s assets, apart from cash, is largely delegated to external fund managers in accordance with the Regulations. The activities of each fund manager are specified in either detailed investment management agreements or subscription agreements. Compliance with these agreements is monitored regularly. All fund managers are monitored regularly by the Investment Committee. The Board is satisfied that the appointed fund managers have sufficient expertise and experience to carry out their role.
The Fund may take direct major holdings in quoted developed market equities. Internal management is expected to help support the Fund’s long term investment objective, benefitting from lowercosts, greater transparency andalignment ofinterests. Allocation to any internally managed equity holding is determined by the Investment Committee, with the execution of transactions within these authorised allocations being delegated to the CIO.
Similarly, it is expected that a proportion of the illiquid assets may require a varying degree of direct internal management.
The structures and processes for internally managed assets are overseen by the Risk Committee, with ongoing risk and performance evaluated by the Investment Committee alongside externally managed investments.
Custody
The Board has appointed JP Morgan Europe Ltd as the Fund’s custodian. The custodial services provided by JP Morgan include trade settlement and processing, portfolio reporting, cash/collateral management, proxy voting processing, stock lending, accounting and performance calculation. Custodian performance is monitored continuously by an external custodian monitoring service and reported to the Investment Committee regularly.
3. INVESTMENT PRINCIPLES AND BELIEFS
There have been a number of underlying investment beliefs and guiding principles which have shaped the evolution of the Fund’s structure and will continue to do so in the future.
The investment beliefs and principles are:
Investment Principles
· Understanding the cash flows the investment portfolio needs to generate to meet our liabilities is central to determining our choice of investments.
· Given the duration of our liabilities, we are responsible long term investors.
· Where prudent and affordable, the unrewarded risks associated with our liabilities should be hedged to increase the long term sustainability of pension promises.
· We wish to encourage environmental, social and corporate governance best practice in the companies in which we invest, as we believe this will deliver the best long term returns.
Main Investment Beliefs
· There is a link between investment risk and return.
· Prudent diversification can be used to minimise the risk required to pursue a given level of return.
· Asset allocation is the main driver of our fund’s long term performance.
· Strategic asset allocation must take account of our current and future liabilities and performance measures should ultimately relate to the behaviour of those liabilities.
· Equities are expected to generate superior long term returns given their linkage to economic growth.
· Being a long term investor enables the fund to capture illiquidity premia.
· For many asset classes, high-quality active management will enhance the net return of the fund without unduly increasing the risk.
· The price of assets and timing of investments matter.
· Fees, transaction costs and taxes are certain, good performance is not.
· Following the crowd can lead to diminished returns. Independent decisions based on thorough understanding are frequently rewarded.
· A fund management approach that incorporates the evaluation of ESG risks and opportunities is more likely to result in long term benefits for the Fund.
4. INVESTMENT OBJECTIVES
The Board’s main investment objective is to ensure that over the long term the Fund will have sufficient assets to meet all pension liabilities as they fall due.
In order to meet this overriding objective the Board maintains an investment policy so as to:
a. Maximise the returns from investments whilst keeping risk within acceptable levels and ensuring liquidity requirements are at all times met.
b. Contribute towards achieving and maintaining a future funding level of 100% on a minimum risk basis
c. Hedge unrewarded risk where affordable to do so, and
d. Enable employer contribution rates to be kept as stable as possible.
Along side this objective, the LPFA will use its influence as a large institutional investor to encourage responsible long-term behaviour. In particular it aims to support and develop best practice on ESG issues in the companies in which it invests, through the mandates given to fund managers and by collaborating with other like-minded investors.
5. INVESTMENT STRATEGY
The Board sets the long term investment strategy by taking into account the nature and timing of future liabilities, the investment objectives listed above and by reference to the Fund’s investment principles and beliefs.
These factors drive decisions over asset allocation (i.e. the overall mix of equities, bonds etc. in the Fund) which the Board believes has a significant influence on its ability to achieve its investment objectives. The Fund’s investments are highly diversified by asset class, geography, and industry.
Quantitative and qualitative investment approaches are employed to capture investment opportunities and maximise returns within an accepted level of risk. Innovative investment ideas and asset classes are reviewed and assessed for their suitability and appropriateness as potential Pension Fund assets. A mixture of passive and active mandates is also used to capture the returns required to meet the Board’s objectives.
The table below sets out the asset allocation and the tolerance ranges for the Fund. This was approved by the Board in July 2013.
Asset Class / Benchmark Allocation% / Board
Tolerance Range %
Liquids* / 55 / 50-60
Illiquids** / 30 / 25-35
Total Return / 15 / 10-20
Cash / 0 / 0-10
*Liquids: easily tradable investments such as listed equities, bonds, QIF and simple pooled fund vehicles.
**Illiquids: investments which cannot be easily converted into cash within 3 years, without making LPFA a forced seller.
Adherence to the target ranges is subject to ongoing market opportunity. Having increased the allocation to illiquid assets, the Board expects that the Fund will have completed its transition to the new asset allocation range by 2016 provided that attractive investment opportunities can be found with suitable target risk, return and cashflow profiles, subject to LGPS regulations and limits. The transition process may also involve a reassessment of currently outsourced assets being managed in-house if this would benefit the Fund’s long term performance.
From time to time tactical opportunities may present themselves; the Board remain flexible to changes in the asset allocation should it be felt that alterations would deliver a superior risk adjusted investment return or are required to meet obligations.
A full list of the LPFA’s fund managers and their benchmarks is included in Annex III.
6. RISK MANAGEMENT
There are various risks to which any pension scheme is exposed and that cannot be entirely eliminated. For that reason, the Board focuses on clearly identifying these risks and adopting mitigation strategies that minimise their impact on the Fund. To this end, the Risk Committee has been tasked with creating and enhancing the corporate risk culture and working closely with the executive officers to manage risks.
Below is detailed a non-exhaustive list highlighting some of the risks that the Board considers on a regular basis:
Funding risk
Assets may increase at a lower rate than the liabilities, resulting in a deteriorating funding position. The Board prepares a Funding Strategy Statement (FSS) every three years as part of the triennial valuation and monitors the Fund’s investment strategy and performance relative to the growth in the liabilities at least annually.
Financial mismatch risk
Assets and liabilities have different sensitivities to changes in financial factors, in particular inflation and interest rates. The Board sets an investment strategy that provides exposure to assets providing real (inflation protected) growth as well as cash flow generating assets that match the Fund’s liabilities.
Liquidity/Cashflow Risk
A shortfall in liquid assets relative to short term liabilities (e.g. pension payments) could create the risk of selling assets at an unreasonably low price. The LPFA manages its cashflows to ensure that future payments can be met and that sufficient assets are held in liquid investments (realisable in three months or less).
Manager Risk
Fund managers could fail to achieve the investment returns specified in their mandates. This is considered by the Board when fund managers are selected and their performance is reviewed regularly by Officers and the Investment Committee as part of the manager monitoring process.
Concentration Risk
This refers to the risk that the performance of a single asset class or investment has a disproportionate influence on the Board’s ability to meet its investment objectives. The Board mitigates this risk by establishing a well diversified strategic asset allocation, reviewing the investment strategy regularly and following a regular fund manager review process.
Longevity Risk
Demographic factors including the uncertainty around longevity / mortality projections (e.g. longer life expectancies) can contribute to funding risk. The Board recognises there are limited options currently available to fully mitigate or hedge this risk, but has subscribed to a specialist service (Club Vita) which provides a comprehensive analysis of the Fund’s longevity data to enable them to understand and manage this issue in the most effective way. The Funding Strategy Statement, formal triennial actuarial valuations and periodic updates allow the Board to keep track of the Fund’s liabilities.