LGPS: A year of growth hits and investment misses

Council pension funds returned to growth in 2023-24 but an LGC investigation finds this masked some disappointing investment returns.

For the Local Government Pension Scheme, 2023-24 can be chalked up as a year of recovery.

But although official government statistics outline a multi-billion pound growth in the scheme’s value, an LGC analysis of pension fund accounts shows this large gain concealed investment returns that often failed to hit their targets.

The year before was a difficult one for the LGPS, with the market value of the scheme in England and Wales dropping 2.6% amid the turbulence of the short-lived Truss premiership and Russia’s full-scale invasion of Ukraine. In total, 76 of its 86 open funds saw their value fall, while only 10 saw it increase.

In contrast, the scheme’s market value rose by 9% last year to stand at £392bn on 31 March 2024, a £32bn increase on the year before, with all pension funds seeing their market value increase.

Nevertheless, it was not a straight-forward period. As Greater Manchester Pension Fund’s annual report put it: “The year as a whole has been characterised by the ongoing fight against high levels of inflation by global central banks. The economic outlook has oscillated between narratives of a ‘hard landing’, a ‘delayed hard landing’ and a ‘soft landing’. This has all taken place against a backcloth of steadily increasing geopolitical issues and risks.”

For its annual review of the LGPS’s performance, LGC examined government statistics for all open funds in England and Wales – which this year included the first fund-level data on pooling by asset class – as well as a sample of fund annual reports.

The 10 funds selected represent the three biggest by value – Greater Manchester, West Midlands and West Yorkshire, and seven smaller and medium sized funds: Brent, Hounslow, Berkshire, Gwynedd, Somerset, Northamptonshire and Durham. They include members of all eight LGPS pools. Due to audit delays, some reports were in draft form.

Greater Manchester remained the largest pension fund, with its £31.3bn value more than £10bn higher than the second biggest, West Midlands. Of the 33 smallest funds, 31 were from London, although the two smallest were Isle of Wight and Powys. Both were among five LGPS funds with a value of less than £1bn.

The improvement in market values ranged from the 3.8% increase recorded by Kent to the 15.3% at Hillingdon. A total of 45 funds achieved a double-digit rise.

Missed benchmarks

While all LGPS funds saw their market value increase in 2023-24, the investment returns of many failed to hit the benchmark used to judge their investment performance.

Pension funds set benchmark returns for asset managers or asset classes, such as beating inflation by a certain percentage, which then determine the fund’s overall benchmark.

Gwynedd, whose 11.2% return narrowly missed its 11.4% benchmark, said in its annual report: “The average LGPS fund delivered a return of 9.2% for the year. While the absolute return delivered was strong, most funds failed to achieve their strategic benchmark return over the period. This was the result of a variety of factors, the key being relatively poor actively managed equity results and alternative assets delivering below many of the absolute return benchmarks set.”

Equity markets rallied over the year, dominated by a smaller subset of companies, such as the group of leading tech companies known as ‘the Magnificent Seven’

Berkshire Pension Fund

Other funds that missed their benchmark included West Midlands, whose 8.2% return was 2.8% under; Brent with an investment return of 10.9% compared with a benchmark of 12.9%; Durham which saw a 8.5% return miss its benchmark by 2.5 percentage points, and Northamptonshire, whose investment return of 10.7% compared with a benchmark of 12.3%.

Berkshire’s overall return of 8.9% was 4.8 percentage points below its benchmark. It said the global equity fund (GEF) of its pool, LPPI, was the “key driver” of its “relative underperformance” during the year. Although this fund achieved a 14.8% return this was still 4.8 percentage points below its benchmark.

“Equity markets rallied over the year, dominated by a smaller subset of companies, such as the group of leading tech companies known as ‘the Magnificent Seven’,” it explained. “The GEF holding a lower weight in the Magnificent Seven companies compared to the benchmark weight in those companies was the main detractor from returns over the year.”

Greater Manchester’s annual report says its 7.4% return exceed its overall benchmark, although it did not state what this benchmark was. However, seven out 10 asset classes were below their specific benchmark return, including equities, global credit, corporate bonds and property.

Fund managers overall underperformed their own benchmarks

Simon Coles, Somerset Pension Fund

West Yorkshire saw its “relatively high” 62% of its portfolio invested in equities – which achieved a 14% return compared with a 12% benchmark – help it achieve an overall investment return that was 0.1 percentage points above its fund-wide benchmark.

Somerset’s 13.2% return meant it outperformed its benchmark by 1 percentage point. Simon Coles (Lib Dem), chair of the pension fund committee, noted “fund managers overall underperformed their own benchmarks” but said this was “more than compensated for by the fund gaining by underweighting UK government bonds relative to our strategic long-term target and overweighting global equities”.

Hounslow only just exceeded its benchmark by 0.5 percentage points, which it said was “largely as a result of poor performance within the equity, long lease property and fixed income portfolios”. Five of its eight fund managers did not meet their benchmark.

The state of pooling

For the first time, the government has published data from funds showing how much of their assets across different classes are pooled, under the management of their pool or not pooled.

The statistics come with a health warning: they should be “treated with caution” as submitting the data was voluntary. Of the 86 funds, 72 sent completed forms and 11 partially complete. The data release also warned that because it was the first time it had been collected, “limited validations have been made to the data”.

Even allowing for the incomplete and caveated nature of the data, they still suggest interesting trends about the state of pooling at 31 March 2024 – a year before the previous government’s deadline for all listed assets “as a minimum” to be pooled, and two year’s before the current government’s deadline for pooling to be ‘complete’.

 

It will come as little surprise that equities and bonds had the highest pooling rates, as they are the easiest asset classes to buy and sell and therefore transition to a pool. According to the fund level data, 86% of equities are either pooled or under pool management.

The majority of funds (50) reported 100% of their equities were either pooled or under pool management. Only eight funds are listed as having less than half their equities with their pool, with Kensington & Chelsea the sole fund shown as having all its equities outside its pool.

Similarly, 84% of bonds were pooled or under pool management. However, while 49 funds that held bonds said none were held outside of their pool, 11 – mostly London pension funds – said their bonds were completely unpooled.

The data for other asset classes suggests how far funds and pools will have to progress to meet the government’s March 2026 deadline.

[In-year savings are] now greater than anticipated but cumulative are still lower than anticipated

Somerset Pension Fund

Overall, 65% of infrastructure investment was pooled or under pool management with 30 funds reporting this was the case for all their infrastructure assets but 35 saying it was true of less than half their infrastructure. And of these, the infrastructure assets of 13 funds were completely unpooled.

Less than half of property (42%) was pooled or under pool management, with over half of funds (48) saying this applied to none of their property. Only 19 said all their property was with the pool.

And while 56% of private equity was either pooled or under pool management, of the 65 funds that reported having private equity investments, nearly half (28) said none of it was connected to their pool.

According to the government’s data, pooing delivered in-year net savings of £194m in 2023-24, and the government’s Fit for the Future consultation document on the future of the LGPS heralded net savings of £870m since the start of pooling.

But the annual report of Somerset Pension Fund, which is part of the Brunel pool, outlines where outcomes so far have differed from the original business case. It says ongoing overhead costs at Brunel are higher than originally estimated so it can “deliver the service required by their clients,” internal savings are “higher than anticipated,” and in-year fee savings are “now greater than anticipated but cumulative are still lower than anticipated”.

Asset allocation changes

In the light of the 2022 actuarial valuation, the outcomes of which were published in 2023, a number of funds either reviewed or implemented changes to their strategic asset allocations during 2023-24. For many, this meant a move away from equities.

For example, Gwynedd used the improvement in its funding position to “partially de-risk the fund by reducing its equity allocation and invest in income generating assets”. It added that under the new allocation strategy, “investments in private equity, private debt and infrastructure will increase over time”.

Similarly, West Yorkshire reduced its allocation to global equities by about 2% of the total fund’s value “to reflect a planned reduction in listed equities within the total fund benchmark following the actuarial review”.

Northamptonshire’s 12.5 percentage point reduction in equities, and the removal of its standalone UK equity allocation, was accompanied by a 10 percentage points increase in fixed income and 2.5 percentage points in alternatives – asset classes that “provide greater exposure to inflation linked, cashflow generative assets while protecting the strong funding position”.

Hounslow’s nine percentage point cut in its equities allocation included a big shift away from the UK, cutting its allocation from 31% to 10%, while overseas equities rose from 28% to 40%. Overall, this meant the fund’s total allocation to equities fell by nine percentage points. In its place, long-dated bonds and infrastructure were among the increases, while the fund added a new 5% allocation to affordable housing.

Climate

Climate change remains a vital challenge for the LGPS, with many funds reporting on their efforts to reduce their carbon exposure, while highlighting the ongoing challenge of measuring their emissions.

West Midlands’s listed equities’ emissions fell by 15% in 2023-24 while its reference benchmark stayed “broadly the same”. Its climate-related exposure report said this portfolio “has lower exposure to fossil fuels compared to the benchmark, which can be attributed to an underweight exposure to the energy sector”.

In particular, WYPF will not be lending to the oil, gas and coal sector

West Yorkshire Pension Fund

And Northamptonshire highlighted changes to its passive equity portfolio in early 2023 “with the objective of improving the portfolio’s climate characteristics”. It said this was “the key driver of the material reduction in the listed equity portfolio’s carbon footprint over the year to 30 June 2023”.

Divestment from fossil fuel companies remains a major flashpoint between environmental campaigners and LGPS funds.

West Yorkshire’s report says it was undertaking a review of its equity holdings in the oil and gas sector, and will not use its assets to fund new fossil fuel development. “In particular, WYPF will not be lending to the oil, gas and coal sector and will continue to work with other like-minded investors to demand a similar approach from the banking industry.”

Gwynedd acknowledged “requests to set an ambitious timetable for total disinvestment of fossil fuels,” but reiterated its position that “as a pension fund, it is more responsible to us to plan properly, take real action, and influence where possible for the benefit of our environment”.

It reiterated its net zero 2050 target, while saying this was “supported by a commitment to assess the feasibility of the fund reaching net zero five, 10 or 20 years earlier”.

The challenges of accounting for a fund’s greenhouse gas emissions were apparent from some reports, with the lack of reliable data limiting how much of a fund’s portfolio could be included in the calculations.

Greater Manchester’s data covers just over half of its assets and it said it “intends to expand to other asset classes as methodologies and guidance improve”.

The carbon data published by West Midlands is restricted to listed equities. It said: “While data has been collected for the fund’s fixed income portfolio, at this moment in time the level of coverage is not deemed to be sufficient to include in the analysis. Going forward, we plan to work with our providers to increase data coverage and expand the range of asset classes to be included in the analysis.”

And Northamptonshire says its climate metrics will move beyond emissions from its listed equity portfolio to include corporate bonds from 2024, and from the same year it would expand the metrics it uses to include alignment with the Science Based Targets initiative.

AI, typos and late payments

While the annual reports outline the biggest and most consequential developments of the year, they can also reveal interesting details of a fund’s work.

In the year before Kensington & Chelsea RBC’s employer contributions were controversially reduced to zero for a year in between three-yearly valuations, Greater Manchester’s report revealed that “a handful of employers” expressed interest in interim valuations. It says “these were ultimately rejected as they failed to meet the criteria outlined in our policy on interim valuations”.

Somerset’s report outlined how Peninsula Pensions, a shared service for Somerset and Devon pension funds, is planning to add “an AI video annual benefit statement for members” to its online portal.

A potentially expensive typo inflated by £10,000 the value of a lump sum that one member of Northamptonshire pension fund was told they were entitled to.

They made a complaint after the fund refused to pay the difference between what they were actually entitled to and “the lump sum that had been shown in a letter providing option details which overstated the lump sum in one of the options by £10,000 due to a typing error”.

The fund’s report says the adjudicator ruled that the complaint should not be upheld.

And Hounslow LBC was recorded on Hounslow Pension Fund’s breach register for late payment of monthly pension contributions on one occasion in 2023-24.

But while theses smaller details are of interest, the bigger picture remains of most importance. With potentially seismic changes to the world economy and geopolitics in 2024-25, we will have to wait for the current year’s data to see whether 2023-24’s recovery was a blip or trend.