Investments

In 2005 the Avon Pension Fund undertook an Asset Liability Study which was completed in 2006. This resulted in a revised asset allocation strategy, which led to a comprehensive restructuring of the investment management arrangements.

The new asset allocation was agreed in September 2006 and the new structure is now in place with the exception of property (where manager appointments have yet to be made).


If any further information is required, please contact the Investments Officer.

 

STATEMENT OF INVESTMENT PRINCIPLES

Types of Investment Held

  1. 1. Fund monies are invested in equities (both United Kingdom and overseas), index-linked and fixed interest stocks, Fund of Hedge Funds and property. Some of these investments are in segregated portfolios but the majority are now in pooled funds. In addition the Fund will normally hold a proportion of its monies in short-term bank deposits and money market funds.

    2. Asset Allocation and Expected Long Term Returns on Investment

  2. The Asset Liability Study specifically considered the following:

a) whether the Fund should vary the risk/return profile inherent in the customised benchmark (75% equities and 25% bonds); 

b) whether the Fund should be investing in any asset class which was not represented in the existing benchmark; c. whether there were any other investment products which the Fund could access and which might generate additional returns.

  1. The Asset Liability Study was conducted against a backcloth of some of the Fund's existing active managers having failed to achieve their performance targets.
  1. Acting on advice from its investment consultant, PSolve, the Avon Pension Fund Committee agreed the following customised benchmark for the Fund:
Asset Class % of Fund Expected Return

(long term, p.a.)
UK Equities 36% 7.4%
Overseas Equities 24% 7.4%
Index-Linked Gilts 6% 4.2%
Fixed Coupon Gilts 6% 4.4%
UK Corporate Bonds 5% 5.0%
Overseas Fixed Interest 3% 4.4%
Fund of Hedge Funds 10% 7.0%
Property 10% 6.8%
The inclusion of property and hedge funds should reduce the overall volatility of returns without significantly altering the Fund's expected long term return. The reduction in volatility results from property and hedge funds having a low correlation to both bond and equity returns. Using PSolve's long term risk and return expectations for each asset class, the expected overall return for the new Fund structure is equivalent to long-dated gilts +2.4% and the expected volatility (of the returns relative to liabilities) is 9%. (This compares to an expected return of long-dated gilts +2.4% and an expected volatility of 10.5% for the previous Fund structure).
  1. The expected returns set out in the table are consistent with the asset out-performance objective used by the Fund's actuary in the triennial valuation.
  1. Although the Fund has a customised benchmark, there is some scope for the expected returns set out in the table to be exceeded through the performance of the active managers (see paragraph 9 below).
  1. The Asset Liability Study did not consider private equity in detail as this investment option was reviewed by the Committee in 2004. Having taken advice from its investment consultant, Watson Wyatt, and having considered the prospective returns on private equity against the associated risks, the Committee resolved in March 2004 that it would not invest in private equity. This decision was confirmed in the recent Asset Liability Study.
  1. An Asset Liability Study is normally undertaken following the triennial actuarial valuation which establishes the value of the Fund's liabilities. Asset allocation will be reviewed on a regular basis in the interim period.

    Investment Management Structure

  1. The revised benchmark, together with the disappointing performance of some of the Fund's active managers, has resulted in a significant restructuring of the investment management arrangements. In addition to the Fund of Hedge Fund and property mandates, the new investment structure includes the following new mandates:

    a. Overseas enhanced indexation equities - this is a low risk active management approach that can produce incremental excess returns (net of fees) on a consistent basis.

    b. Unconstrained UK equities - an active investment approach where the manager does not constrain stock selection to an index or target a specific level of risk.

    c. Emerging markets - a specialist active mandate to exploit the market inefficiencies present in emerging markets.

    d. Corporate bonds active - a specialist active mandate to exploit opportunities in the corporate bond sector.

  1. The new investment structure is detailed in the table below:
Manager Mandate Performance Objective % of Fund Inception Date
Barclays Global Advisors (BGI) Passive multi-asset in line with customised benchmark 52% 1 April 2003
Jupiter Asset Management (Jupiter) UK Equities (Socially Responsible Investing) FTSE All Share +2% p.a. 5% 1 April 2001
TT International UK Equities (unconstrained) FTSE All Share +3-4% p.a. 5% July 2007*
Invesco Perpetual Global ex-UK Equities (Enhanced Indexation) MSCI Global ex-UK Index +0.5% p.a. 6.5% 19 December 2006
State Street Global Investors Europe ex-UK Equities (Enhanced Indexation) FTSE World Europe ex-UK Index +0.5% p.a.       14 December 2006
State Street Global Investors Pacific inc. Japan Equities (Enhanced Indexation) FTSE Developed Asia Pacific Index +0.5% p.a. 3.5% 14 December 2006
Genesis Investment Management (Genesis) Emerging Market Equities MSCI Emerging Markets Index 3% 13 December 2006
Royal London Asset Management (RLAM) UK Corporate Bond Fund iBoxx £ non-Gilt Index +0.8% p.a. 5% July 2007*
MAN Investments Fund of Hedge Funds LIBOR +4-6% p.a. 4.5% July 2007*
Gottex Asset Management Fund of Hedge Funds LIBOR +4-6% p.a. 2.5% July 2007*
Signet Capital Management Fund of Hedge Funds LIBOR +4-6% p.a. 2.0% July 2007*
Stenham Asset Management Fund of Hedge Funds LIBOR +4-6% p.a. 0.5% July 2007*
Lyster Watson Fund of Hedge Funds LIBOR +4-6% p.a. 0.5% July 2007*
To be appointed Property      10%       
Note: * - expected inception date

The performance objective for each manager is based on the manager's expectations which take into account the performance they have achieved historically. Although these are annual targets, the performance of the active managers will generally be reviewed over a longer period.

  1. In the new structure 52% of the Fund is invested in passive mandates which rely on market returns to generate the investment return. In contrast 23% is invested in mandates (hedge funds and active equity) where the investment return is primarily derived from manager skill.
  1. The Fund's investment managers are remunerated either by way of an ad valorem fee, i.e. the fee is a percentage of the value of assets under management, or a combination of an ad valorem and performance-related fee. The principle of performance-related fees is that the base fee is lower and that the manager is only paid a higher fee if the performance objective set by the Fund is met.

    Risk Control and Diversification

  1. Risk is controlled through the diversification of investments across a range of asset classes that have low correlations with each other and across a selection of managers. Furthermore, a significant proportion of the investments is passively managed (or in enhanced indexation funds). 

    2. Regulatory Investment Limits

  2. The Local Government Pension Scheme (Management and Investment of Funds) Regulations 1998 (as amended) impose certain "prudential" limits on the way in which the Fund's assets can be invested. In principle these are designed to ensure diversification and reduce risk. For example there are limits on the amounts which can be invested in partnerships, unlisted securities, unit trusts and life funds. Following amendments to the regulations in 2003, there is now a two tier system of prudential limits. The first tier is the normal limit; the second tier is a set of higher limits which can only be utilised once the Committee has passed a resolution, having complied with certain conditions.
  1. Currently all the normal prudential investments limits apply to the Fund, except for the investment in Life Funds managed by BGI which, following a Committee resolution in March 2006, has been increased to the maximum limit of 35%.

    2. Realisation of Investments

  2. The Fund's investment policy is structured so that the investments which it holds can, except in the most extreme market conditions, be readily realised. There are longer "lock-up" periods for the investments in Fund of Hedge Funds (and potentially the property funds) given the nature of these investments. However, the Fund has sought to minimise the length of these "lock-up" periods. At the present time, the Fund's outgoings (principally the payment of pensions) can be met from income (principally employer and employee contributions) without the need for investments to be sold.
  1. The growth in indirect property funds has provided the Fund with the opportunity to invest in this relatively illiquid asset class and to build a well diversified property portfolio.

    Social, Environmental and Ethical Considerations
  2. BGI's mandate requires stocks to be held which will replicate the performance of selected market indices. In this case the manager has no discretion with regard to the stocks which are held. As the enhanced indexation managers are also required to hold a significant number of stocks for risk control purposes, similar considerations apply to these. In the case of TT International, Genesis and RLAM their mandates allows for discretion over stock selection and each manager has provided a statement setting out the extent to which they take social, environmental and ethical considerations into account in their investment processes. These statements are now included as Appendices.
  1. The Avon Pension Fund has a fiduciary duty to invest Fund monies in order to achieve the best possible financial return consistent with an acceptable level of risk. Operating within this framework, the Fund appointed Jupiter Asset Management in 2001 to manage a UK equity portfolio in accordance with Socially Responsible Investment criteria.
  1. Socially Responsible Investment (SRI) means investing in companies which contribute to, or benefit from, the trend towards more environmentally and socially sustainable economic activity. The Avon Pension Fund Committee was convinced by arguments that superior performance could be achieved over time from a portfolio constructed on this basis. However, it also recognised that, in view of the bias towards smaller companies and the more concentrated nature of the portfolio, the volatility associated with it would be relatively high.
  1. In their presentation to the Committee Jupiter stated that they will include in the SRI portfolio companies providing products which solve environmental and social problems and those which minimise the environmental and social impacts of their processes. The categories of stock which the portfolio would exclude are tobacco, armaments, nuclear power and animal testing of cosmetics and toiletry products.

    2. Exercise of Voting Rights

  2. The Avon Pension Fund recognises its responsibility as a shareholder to actively encourage good corporate governance standards in the companies in which it invests. In order to fulfil this responsibility, the Fund requires its managers to vote their UK company shares in line with their internal voting policy. The managers' voting activity is monitored by the Committee on a quarterly basis.
  1. For overseas markets voting is left to the discretion of the managers but they are encouraged to exercise the voting rights where practical.

Myners

  1. Having asked Paul Myners to carry out a review of institutional investment, the Chancellor of the Exchequer in 2002 endorsed the ten principles of investment for pension funds which Myners recommended.
  1. Regulations state that local authority pension funds are now required to make clear in their Statement of Investment Principles the extent to which they comply with these principles.
  1. Appendix 4 sets out the existing position with regard to compliance.

Appendix 1

Appendix 2

Appendix 3

Appendix 4

Approved by the Avon Pension Fund Committee at its meeting on 15 June 2007

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