The improvement is primarily due to increases in asset values (mainly equities), partially offset by small reductions to UK government gilt yields. Of the 87 participating funds, 59 have funding levels of 100% or higher, with levels ranging from 69% to 164% funded.
At the previous actuarial valuation date, 31 March 2022, the aggregate low-risk funding position was 67% and none of the 87 funds had a funding level of 100% or higher on a low-risk basis.
Equity markets continue to perform well and gilt yields remain at very high levels, and in May the difference between the returns on equities and gilts reached its widest point since 31 March 2022 (the last actuarial valuation date). LGPS funds may question whether remaining in equities will deliver the performance they need, or if gilts are better to help them lock in funding levels, with different answers for different funds depending on their overall funding level.
Each LGPS fund is made of many employers, each of which have their own funding position, which is different to the average for the fund. Employers who are over 100% funded on a low-risk basis may have a different view on whether to stick with equities compared to employers who still need to make up ground through investment outperformance or more cash contributions.
If LGPS funds could offer their employers the ability to choose their own investment strategy on a more widespread basis it would avoid their employers exiting the LGPS unnecessarily, or the regret risk should markets move back to where they came from. While it might not be possible to do this quickly, Isio is recommending it is considered for future agility.
The LGPS continues to attract attention from the UK Government, with a particular focus on having much fewer schemes. The most commonly stated barrier to this is a lack of local investment control for councils, and so employer-specific investment strategies in new, merged schemes would provide the best balance between local control and operational efficiencies.
Isio has identified eight benefits of employer-specific investment strategies.
It believes they will:
1. Put employers at the heart of the LGPS’s future
2. Ensure investment strategies are tailored to funding strategies
3. Address the risk of not de-risking
4. Reduce employer exits
5. Pave the way for fund mergers
6. Remove the “postcode lottery”
7. Support the levelling-up agenda and UK investments
8. Protect the LGPS from being used as a sovereign wealth fund
Steve Simkins, Partner and public services leader at Isio, says: “The LGPS currently faces a structural issue in relation to its investments. No pension schemes planned for the huge increases in UK government gilt yields in 2022, which led to an immediate liquidity crisis for private sector schemes. And now the LGPS is facing its own challenge which has played out more slowly and is coming to a head.
“The current equity and gilt market divergence will cause LGPS funds to consider whether they stick with equities or switch to gilts. This is a significant risk decision on behalf of their employers, who are not all the same. Most councils might play the long game, but other employers who have been asked to pay more contributions might want to lock into their surpluses. This highlights the “postcode lottery” for employers whose investment strategy depends on the fund they are in, only some of which offer a lock-in option.
“Now would be an ideal time for all LGPS funds to be able to introduce employer-specific investment strategies. There is only so much that can be done quickly, demonstrating that the ideal LGPS fund of the future would be agile and able to offer this in readiness for another unexpected market change.
“At the same time, pressure is being applied by the UK Government for funds to create efficiencies through fund mergers. The most common point of resistance to mergers is the loss of local controls over investments. However, if each council could continue to have a say over its investment strategy in the scheme, this barrier is removed.”
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