To provide suitable investment strategies for the differing employer requirements, the Fund currently operates four investment strategies. The strategies at 30 June 2021 are presented in the table below. The total fund strategy is simply a weighted average of the four individual strategies.
Strategy at 30 June 2021
|Main strategy||Mature employer
|50/50 Strategy||Buses strategy||
|LDI (formerly Gilts)||10.0%||100.0%||55.0%||50.5%||13.3%|
More than 90% of employer liabilities are funded under the Main Strategy, which adopts a long-term investment strategy aiming to generate relatively high investment returns within reasonable and considered risk parameters and hence reduce the cost to the employer.
A small number of employers are funded in the Mature Employer Strategy, which invests in a portfolio of UK index-linked and nominal gilts to reduce funding level and contribution rate risk to a level appropriate to their circumstances. The liabilities funded by the Mature Employer Strategy represent less than 1% of total Lothian Pension Fund liabilities.
Just over 1% of liabilities are funded by the 50/50 Strategy, which is a combination of the above two strategies. The 50/50 Strategy is for employers who are closed to new members but who don’t yet qualify for the Mature Employer Strategy.
Finally, the Lothian Buses employer is funded with a combination of the Main and Mature Employer strategies in a proportion of 55/45. The liabilities associated with the Buses Strategy represent approximately 7% of Lothian Pension Fund liabilities.
The total fund strategy in the table above is the long-term target allocation to the five policy groups (or asset classes).
Lothian Pension Fund Actual Asset Allocation (%) at end March 2021
18.2% Real Assets
9.2% Non-Gilt Debt
A key objective of the fund’s investment strategy is to avoid unrewarded risk, and significant steps were taken more than seven years ago to achieve this. The current equity strategy evolved by shifting from a regional to a global manager structure with a significant proportion of assets managed internally. The intention was to create relative stability appropriate to a long-term pension fund. The current equity investment strategy has remained broadly unchanged for several years now and there were no significant changes over 2020/21.
Just under 90% of the fund’s listed equities are managed internally, with the majority of this in low cost, low turnover strategies which are expected to enhance the fund’s risk-adjusted returns over the long-term. The fund also hedges exposure to the currencies of overseas listed equities with the explicit aim of reducing volatility rather than seeking to generate improved returns. The fund therefore maintains exposure to currencies that are expected to reduce volatility, such as the US Dollar and Japanese Yen which tend to fall as equities rise, and hedge exposure to currencies that are expected to increase volatility, such as the Australian Dollar, which tends to rise as equities rise.
Over recent years, the fund’s strategy has been to increase the actual allocation to the Real Asset policy group, which includes investments in property, infrastructure and timber funds and assets. The long term and defensive nature of most of these assets provides an element of diversification to the overall investment strategy and the objective is to provide attractive risk-adjusted returns that are expected to be somewhat lower than listed equities over the long term. Most of these investments are unlisted and increasing exposure is dependent on sourcing attractive opportunities. The fund’s longstanding commitment to infrastructure investing has resulted in a large and diverse portfolio of real assets.
While the fund continues to make new commitments to infrastructure, the actual allocation to real assets has decreased somewhat this year from 22% to 18% at 31 March 2021. This reduction in weighting is predominantly as a result of an exceptional 27% gain in equities over the prior twelve months against broadly flat performance from real assets. Almost 60% of this exposure is invested in infrastructure and approximately one third is invested in property. While the COVID-19 pandemic has hit the property sector hard, the in-house team have worked proactively with tenants to agree rent holidays, deferments and other concessions to help manage the impact of the pandemic on assets and maximise long term tenant retention and income collection.
The Non-Gilt Debt allocation has been increasing modestly in recent years as the fund strives to improve diversification and secure returns in excess of gilt yields. The actual allocation was increased gradually over 2020/21 from 7.8% to 9.2% with additional investment in investment grade corporate bonds and a new allocation to US Treasury Inflation Protected Securities (TIPS). Given very low sovereign bond yields and historically low spreads in credit markets, the fund remains below the long-term strategic allocation.
The fund’s allocation to Gilts declined over the year, from 5% to 4.2%, which, in common with the Non-Gilt Debt allocation, remains below its long-term strategy target. There were no significant changes over 2020/21. The UK government confirmed plans to align the RPI with the CPI from 2030, following a consultation with bondholders in which we took part. The fund retains exposure, as index-linked gilts provide some insurance against an unexpected rise in inflation and a return broadly in line with the fund’s liabilities. However, having benefited from uncertainty following the EU referendum and subsequent Brexit, real yields and inflation expectations are comparatively low and high respectively in an international context. As a result, the fund added to diversification within the Non-Gilt Debt allocation instead.
The Fund’s performance over the last year and over longer-term timeframes is shown in the table below.
Annualised returns 31 March 2021
|1 year||5 year||10 years|
|Lothian Pension Fund||15.5||8.5||8.8|
|Average Weekly Earnings (AWE)||4.1||2.7||2.1|
|Consumer Price Index (CPI)||0.7||1.8||1.7|
The investment objectives of the Fund are to achieve a return on Fund assets which is sufficient over the long term to meet the funding objectives as outlined in the Funding Strategy Statement. In effect, the Fund aims to generate adequate returns to pay promised pensions and to make the scheme affordable to employers now and in the future, while minimising the risk of having to increase contribution rates in the future. The Fund aims to achieve a return in line with its strategic benchmark allocation, over the long term, with a lower-than-benchmark level of risk.
The Fund return was relatively weak over the past year but remains broadly in line with its objective of meeting the strategic benchmark return over five and ten-year periods with lower risk. It should be noted that the Fund is not expected to behave like the benchmark in the short term for two main reasons: portfolios are not constructed to track the market capitalisation benchmarks and private market benchmarks are not readily available nor assets well suited to short term measurement. UK CPI and Average Weekly Earnings have grown at low and relatively stable rates for many years, although liability values have grown faster than asset values as interest rates have almost reached zero.
View the manager mandates as at 31 March 2021 within the Annual Report 2020/2021