Local Government Pension Scheme investment strategies – investments

for the new “normal”Finance

Roy Nolan

Slide 2

The New Normal?

Economic environment for schemes where low interest rates, higher inflation and lower investment

returns in developed economies depress schemes’ real asset

performance while keeping their liabilities high (PwC)

Slide 3

Newham’s Strategic Asset Allocation

5%

5%12%

10%13%

55%Equities

Property

Private Equity

Infrastructure

Diversifed Alternatives

Bonds

Slide 4

LAPF Investment Magazine 2012

• June – Newham ranked 1st of 107 authorities for investment income growth in year ended 31/03/2011

• December - Newham ranked 7th of 107 authorities, with three year average investment income growth of 22.53% (three year average investment income growth )

Slide 5

Everything’s Rosie?

Slide 6

Speaking of Liabilities……

2007 2013 Percentage Change

Active Members 7,180 6,381 11%

Deferred 4,016 6,799 69%

Pensioners 5,709 6,574 15%

Slide 7

Active Members Profile

74% of active members are over 40:

Age Group Percentage of Active Members

20-29 8%

30-39 18%

40-49 34%

50-59 33%

60+ 7%

Slide 8

Are we in the new normal? Asset prices are rallying…

• All developed economy indices are up sharply from mid-2012

• Nikkei up over 50% since November

• Bond yields continue to track downwards everywhere – not just in developed economies

Slide 9

…on paper only

• The equity rally is mostly about the debasement of paper money through QE: all real assets (including gold) have increased in cash value – because cash is losing value

Total return index, 1970 Q1 = 100

Global equity prices, in units of gold

Source: Thomson Reuters Datastream / Fathom

70 75 80 85 90 95 00 05 10

0

100

200

300

400

500

600

QE

Slide 10

Rally bought with monetary policy…

• Policy rates at all-time lows• Central bank balance sheets (cumulated QE) at all-time highs• Combined impact: unparalleled monetary stimulus

Per cent

G4 policy rates

US EA Japan UK

Source: Thomson Reuters Datastream / Fathom

00 01 02 03 04 05 06 07 08 09 10 11 12

0

1

2

3

4

5

6

7

USD, trillions

Central bank assets

Eurosystem Fed BoJ BoE

Source: Thomson Reuters Datastream / Fathom

06 07 08 09 10 11 12

0.0

2.5

5.0

7.5

10.0

12.5

15.0

Slide 11

…but fundamentals remain weak

Index, 1990 = 100

UK marginal product of capital

Source: Thomson Reuters Datastream / Fathom

80 85 90 95 00 05 1065

70

75

80

85

90

95

100

105

• Real fixed investment returns very low now thanks to the credit boom of the last decade

• Private banks in developed economies supplied that credit, and are now

sitting on large stocks of potentially bad assets.

Slide 12

Caution: zombies everywhere…

• The result of weak fundamentals and massively supportive monetary policy is creeping zombification of advanced economies.

• At old-normal monetary policy settings, these zombies would be financially dead. New-normal monetary policy keeps them alive, and gradually infecting the rest of the economy, locking us into the new normal.

• Zombies do not stay at home watching TV. They like to get out and about…

Slide 13

…except in the US

• Bad assets in the US banking sector have largely been written off (zombies have been slain), so the US economy is poised for growth

• Not so in the UK (or elsewhere in the developed world)

Per cent of disposable income

US debt writedowns

Secured Unsecured

Source: Thomson Reuters Datastream / Fathom

92 94 96 98 00 02 04 06 08 10 12

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Per cent of disposable income

UK debt writedowns

Secured Unsecured

Source: Thomson Reuters Datastream / Fathom

94 96 98 00 02 04 06 08 10 12

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Slide 14

What to avoid in the new normal?

• Missing the QE inspired rally in all asset prices: likely to be lots more QE now that Japan has entered the “ugly currency race”. Some yields could go negative.

• Being trapped in low or negative real portfolio returns after that.

• Ideally, go overweight in assets that participate in the QE rally but have a chance of generating positive real returns in the long run. US and EM equities fit the bill.

Slide 15

Macro matters, but is difficult

Index, January 2005 = 100

Hedge fund indices

DJ CS hedge fund

DJ CS hedge fund - global macro

S&P 500

Source: Thomson Reuters Datastream / Fathom

00 02 03 04 05 06 07 08 09 10 11 1250

100

150

200

• Outperformance has come not just from diversification but from macro views, in spite of the fact that consensus macro forecasts have been dreadful

• Vital to think not just about the mean but also (more importantly) the risks to the macro outlook

Slide 16

Looking ahead

• New-normal returns mean a huge increase in sponsor payments into the typical Local Government Pension Scheme, according to Fathom’s model

• Correspondingly huge benefits to improving on those returns