It has been some time since my last blog – almost 8 weeks now. I haven’t been sitting with my feet up, in case you were wondering. I did, however, escape the country for a very nice festive period spent somewhere south of the equator, and then upon my return was pretty busy with client work and finalising, and then hosting, my social housing event. I do now, however, have time to put pen to paper – or rather fingers to keyboard – to write another blog entry.
The topic of this blog seemed to suggest itself – having paid passing attention to the financial news over the festive period and early January, some commentators were suggesting that the ‘safe haven’ effect that has driven the yield of UK Government bonds to historic lows could be coming to an end. The recent equity market rallies, and the weakening of sterling against the Dollar and the Euro (in particular), have been cited in support of this potential change of direction, as evidence of investors moving away from safe assets, and also the UK.
Whether this is indeed the case is not the meat of this blog – what is of more interest to me is, should this flow of assets occur, whether LGPS funds have the ability, mechanisms and skillset to make changes to fund asset allocation on what might be seen as a tactical basis. Or indeed if they even care about such considerations!
I used some WM information in some slides recently, one of which showed the ‘spread’ of LGPS funds’ asset allocation choices as at March 2012, from the WM Local Authority Universe.
Each of the 84 funds in the universe had some exposure to bonds, with the smallest exposure being about 10%, and the largest being somewhere between 35-40%. In the WM universe at March 2012, 'Bonds' were comprised of 58% UK (roughly 1/3rd Gilts, 2/3rds Corporate Bonds), 11% Overseas, 27% Index Linked, and 4% Pooled.
Again,using the WM data, bonds have performed very well recently, and particularly well since 2010.
So, if indeed the commentators are correct, and there’s an impending flood of assets out of bonds, what should LGPS funds be thinking about?
Most funds, if not all, undoubtedly have in place a strategy rebalancing policy, to deal with changes in exposure to different asset classes, that works on a regular basis. Some funds prefer to go with a mechanistic approach, to rebalance the actual allocation back to the fund specific benchmark. Others are willing to introduce some element of judgement in the rebalancing approach, making active decisions on which assets/geographic regions to actively over and underweight.
Each to their own, I say. My preference would be to attempt to take a view on the relative attractiveness of each asset class/region when compared against the other investment options open to the fund. In my past consulting life, I liked the fact that experienced investment colleagues were willing to give explicit views on how clients’ strategic asset allocations might best be ‘tweaked’. There was never a desire to move to a position radically different from the benchmark, but more a relatively small move to over/underweight specific asset classes or regions. Whilst it takes time to demonstrate skill in this area, it seemed to me to be worth the effort.
Some funds are, I believe, attempting to capture this kind of skillset with allocations to Diversified Growth Funds, which is fine in principle…..but what about the rest of the fund’s assets?
Looking at the performance of bonds over the last three years, my gut tells me to start getting nervous about leaving existing fixed interest allocations alone. If the market is indeed going to move, then surely it’s best to reduce exposure now, and then come back in at some point in the future? If funds have a de-risking strategy, or are thinking about creating a ‘flightplan’ back towards full funding, then the timing of any moves could be problematic, since they would be reducing ‘de-risking’ assets for a time. However, if indeed there is a steady flow of money out of UK Government bonds back in to risk assets, then it seems reasonable that the price of the bonds will fall as supply increases over demand.
There’s the complicating factor of Quantitative Easing (or rather the unwinding of it) lurking in the background – but I’ll leave that for the paid experts to estimate its impact on fixed interest markets
If bond prices do fall, and yields do rise, that will bring welcome relief on the pension fund liability value front. For fund strategies that don’t change, it would also bring with it capital losses on these assets that are rigidly held. If you’ve bought the bonds just for the income, then you might not necessarily be concerned about capital value moves. However, if you haven’t, you may well want to consider what your – or your consultant’s – gut is saying to you just now.
All of this speculation on bond price movements could of course be completely wrong – but only time will tell.
See you back here this time next year to see what actually happened?
I'm busy working on my blog posts. Watch this space!