Image © Ink Drop/Shutterstock
We’re at the midway point in the LGPS triennial valuation cycle, an excellent opportunity for LGPS employers and their funds to consider their longer-term circumstances.
Current market conditions also present an opportune time for employers and funds to discuss how pension costs and risks are managed in preparation for the next valuation on 31 March 2025.
The changing LGPS employer landscape
In simpler times, the LGPS was quite a straightforward vehicle. It delivered pension benefits to employees working predominantly in councils, schools and other council-run services, and all serving a core part of the business of local government. The contributions were funded by council budgets and invested in the local LGPS fund.
A few decades later and the number of LGPS employers has exploded. They now top 1,000 in the larger LGPS funds and have become hugely diverse in terms of financial strength, number of current and former employees, and length of time participating in the Fund.
Most of these employers are still recognisably public sector employers, but an increasing number are private contractors, education providers and third sector bodies.
The profile of these employers looks very different now. Every LGPS fund will be trying to meet the needs of a wide range of employers with, unsurprisingly, an equally wide range of objectives and priorities.
The case for tailored employer investment strategies
Every three years, each LGPS fund sets the required contributions for every one of their employers individually, with contributions then invested by the Fund.
The return on investments is absolutely critical to keep LGPS contributions at a manageable level for employers; without any investment return, average employer contributions would need to be around 70% of employees’ pay. This is an unrealistic burden for most employers.
The Fund keeps the balance of risk, investment return and employer costs under close review. However, there is a significant weakness in the tools traditionally available to achieve that balance.
This is because contribution plans are set at an employer level but investment strategies, typically, are not. This makes financial management tricky for employers.
For example, an employer may be able to accelerate the pace of their own contributions to improve their funding position, but then can’t do anything to protect that position from market volatility.
Alternatively, an employer with a strong covenant and a long-term outlook may be willing to accept more investment risk, and potentially higher contributions later to benefit from lower contributions now, but participates in a Fund which is strategically reducing its investment risk.
There is an increasingly strong case for introducing one or more additional investment strategies as a tool to better meet employers’ diverging circumstances and requirements.
This means that, instead of a single investment strategy for all employers in an LGPS Fund, one or more additional investment strategies are established for small groups or even single employers.
These additional investment strategies are designed with the same rigour as the Fund’s main strategy, just with a different balance of priorities. The Fund still maintains a core or main investment strategy which remains appropriate for the majority of its open, long-term employers, with perhaps two or three employer investment strategies targeted to the employers that would benefit.
Nonetheless, funds will always have to consider the cost and practicalities of creating and running multiple investment strategies. The fund’s budgets, longer-term strategic objectives and its duty to all employers, can’t be overridden by the needs of any one employer.
However, the immediate impact on the fund’s overall asset allocation is often minimal and technology-based tracking solutions are often readily available. This means the implementation of additional investment strategies is much more straightforward than most expect.
Employer investment strategies won’t be necessary or appropriate for all employers, or even in all LGPS funds. It isn’t a solution in search of a problem, only a tool that can be used by funds to help employers to manage their risk in the LGPS, whatever that risk looks like for them.
Is the time right to consider additional investment strategies?
As reported in PF in April, many LGPS funds in England and Wales are in a strong funding position following the 2022 triennial valuation. Similarly strong results are emerging for the Scottish 2023 valuation.
With so many LGPS employers now in a funding surplus, de-risking is the most popular reason for an employer seeking to manage pension costs. However, the principles also apply for employers looking for more risk.
This may be because they currently have a poor funding position but an otherwise strong covenant so the Fund can consider a higher-risk investment strategy to accelerate a funding position improvement.
Alternatively, an employer may not be able to afford contribution increases that go along with a fund’s wider de-risking strategy, and so need a little more time with higher equity exposure, say, before they can also align with a lower-risk investment strategy.
Many employers are now keen to engage with funds about managing surpluses and, in particular, are planning to exit the LGPS.
While there are arguments for reviewing strategy during an actuarial valuation, it can be challenging to create the time needed alongside the competing valuation demands on funds and employers.
We would therefore encourage the analysis, consultation and governance groundwork to be carried out now, meaning efficient implementation during the valuation process.
With increasingly widespread use in LGPS funds, flexing investment strategy has moved from an innovative solution to the everyday toolkit.
There is no doubt it helps funds and their employers to better meet funding objectives, and to respond as employers’ circumstances and priorities evolve over time.
