Andrew Sheen speaks to Brian Bailey, director of pensions at the UK's West Midlands Pension Fund about how the credit crunch has accelerated changes in the £6.5bn fund's investment strategy and his views on cost-sharing in the Local Government Pension Scheme (LGPS)
Despite the stream of negative news about the economy over the past few months, director of pensions Brian Bailey remains upbeat about the prospects for the £6.5bn West Midlands Pension Fund.
Indeed, against this background, he has just completed a wide-ranging review of the scheme’s investment strategy.
“We have no choice but to live with what has happened. What we are saying is that the asset allocation should be reviewed to try and maximise future potential,” he says.
Over the short term, he says the fund has positive cash flow projections for the next 20 years, so it does not need to respond to meet immediate liability issues. As a result, the investment team has been able to look to future growth.
This means, 25% of the fund will be invested in what Bailey calls “complimentary equities” – a category that includes UK and overseas property, emerging market debt, commodities, infrastructure and a new allocation to absolute return strategies – up from an allocation of 16% today.
“We’ve been able to look at what’s likely to be the longer term position, and ask where we want to position ourselves to take advantage of what we hope will be the better performing areas in the future,” Bailey explains.
He says the fund is looking at allocating about 8% of its assets to absolute return strategies, and has been building up cash reserves to do so. It will also reallocate away from areas it sees as potential weaknesses.
“The current climate and problems have accelerated us looking at new areas. In earlier years we had a much larger exposure to equities,” Bailey says. “[But] we saw this high exposure as a risk and started to reduce [the allocation] because we anticipated downturns in equities could be offset by investing in other asset classes.”
He explains the scheme’s current equity allocation is around 67% – but says this will be phased-down to a benchmark of around 40% of the total portfolio over the coming years.
Bailey says a significant portion of the equity weighting was held in UK equities, which did not reflect global economic realities.
He says: “Traditionally we have been very significantly overweight in UK equities. What we are trying to do is move to rebalance our equities more in line with a combination of market and capital weights. We are not quite there yet.”
The scheme’s current allocation to UK equities is around 25%, which Bailey says will fall to around 14% in coming years. However, this doesn’t mean the West Midlands fund has turned its back on the UK.
“Some of the absolute return type strategies will be in UK company investments through bonds, so part of our commitment to the UK will be through other asset classes in the UK.”
Opportunity from a crisis
Bailey says that problems over the past few months have allowed the fund to separate the best and worst performing managers before deciding on which to appoint.
“This has been an opportunity to test managers and see who has performed well in the current difficult environment.”
Before any decision is made regarding investment managers, they have to be able to conform to a stringent series of suitability tests.
Key to the suitability test is the acceptability of counter party risks, the transparency and “auditability” of managers, lack of corporate governance conflicts and, with memories of Madoff still fresh in minds, the legality of investments.
Bailey says a lot of hedge funds will be ruled out by these criteria, but hedge funds are a “huge, diverse group” of investment strategies which means “some managers who use hedging techniques would meet our requirements and be acceptable”.
The West Midlands fund, it must be added, was not a Madoff investor.
More worrying, however, is the possibility the downturn will continue for far longer than many have predicted. This could cause problems for projected returns.
“The biggest threat is that the world governments will fail to bring stability to the banking sector and limit the length of the recession. Obviously we are assuming there will be a return to a pattern of investment and returns that we’ve historically seen in a few years time,” Bailey adds.
Bailey also says revised longevity assumptions for the fund have reignited debate over Local Government Pension Scheme cost sharing arrangements, in order to keep the fund viable for future generations.
“Is cost sharing between LGPS employers and employees a good thing?” Bailey asks. “If we accept that the employing body costs are close to the affordable limit, then significant increases could be very difficult for many employing bodies and these costs need to be shared with the individual if the current returns of the scheme benefits is to continue.
“If the cost of the scheme is too much for the employers and employees then the option of working longer, or benefit reductions will have to be considered.”
He adds: “Our solvency test for the next 20 years is very good – what we are looking to do is build up reserves so there are no problems in 25, 30, 40 years. So there is time to change the scheme over the long term.”
Brian Bailey CV
Bailey gained a degree in Chemical Engineering before qualifying as an accountant with Wolverhampton City Council where he was appointed director of finance in 1988. In reorganisations since, he become responsible for a range of other City services.
The positions all held responsibility for the £6.5bn West Midlands Metropolitan Authorities Pension Fund (UK), a public sector workers pension scheme covering the urban West Midlands with membership in excess of 210,000. The fund’s administration is carried out in-house, together with a significant element of investment management, combined with the use of a number of specialist external fund managers.
From April 2008 he became the fund’s first full time director of pensions and relinquished all his other council responsibilities.
The West Midland Fund provides support services for the West Midland PTA Pension Fund and assists with the management of their investments. The Fund is closed and of the order of £350m.
A number of company non-executive directorships have been held and Bailey was for many years an audit committee member of two US private equity funds. A non-executive directorship of PIRC Limited is currently held together with the honorary treasurer role for LAPFF (Local Authorities Pension Fund Forum) and a trustee position at the Birmingham International Airport Limited Pension Scheme.
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