Jack Jones examines changes to the Environment Agency pension fund's investment strategy.
New strategy: equities
The fund is targeting a further reduction in its equity holding - to 50% by 2014. Within this section though, it intends to double its allocation to actively managed emerging market shares and focus on low volatility equities.
Pearce says: "Where we are investing in equities we're going for the markets where we believe we can get the best returns and we think emerging markets have got the long-term opportunity to do that."
Mercer European director of consulting Nick Sykes - who advised the fund on its strategy review - says the fund's interest in low-volatility equity marks it out among other schemes at the moment.
This involves compiling portfolios of either highly operationally and financially stable companies like beer, pharmaceutical, or tobacco firms or of shares that have historically had a very stable price.
Sykes says: “The last few years have been favourable to this strategy, because you would expect it to underperform in a rampant bull market like we saw in the 1990s. But when you have conditions like we’ve had in the last ten years, with three big setbacks in the market, then the portfolio will only go down half as fast as the market and will have less far to rise.”
The scheme’s fixed income strategy has also undergone a major overhaul, driven by the continuing low gilt yields. The changes will see the fund more than double its allocation to corporate bonds to 28% by 2014. Gilt holdings will be cut to 5%.
Pearce says: “We’ve made a switch, but given ourselves the opportunity that if there is an upturn in yields to switch back into gilts. But in the short term we just don’t see gilts providing the same returns as corporate bonds.”
Sykes adds: “As an investor with a very long-term horizon they need to focus less on short-term volatility. Their need for assets that match liabilities in the short term, like index-linked gilts, is less so they can take a long view. They can say on a ten-year view, ‘we think we’ll get better overall returns from corporate bonds’.”
Perhaps the biggest shift in strategy is the intention to invest 12% in sustainable property, timberland and agriculture, and infrastructure projects over the next two years. Pearce says these investments will give the fund capital growth, with returns in excess of 5% targeted, and be a hedge against inflation and climate change. But he adds that the scheme will have to work with other LGPS or private sector funds to develop joint mandates.
He explains: “In some respects we’re only a very small fund and sometimes you need to have a number of funds working together to stimulate the market, particularly if you want to go into green property. We’re only putting up relatively small amounts and to get into some of these areas you might need some more leverage.”
Sykes adds that finding environmentally sound infrastructure projects will provide a challenge, with the fund’s stance on climate change seemingly ruling out airports and toll roads.
This attention to the sustainability of investments runs through the fund’s strategy, and Pearce believes it falls firmly within its obligations to maximise returns for members.
“We have a fiduciary duty to take account of financially material environmental risks and opportunities. We have a duty to take account of ethical, social and governance (ESG) issues and we ask our managers to do that and we specifically look for managers that have got skills in those areas,” he says.
Sykes adds that finding these managers who share the agency’s mindset – a task that was “extremely tough” when he began working with the fund – is becoming easier across most asset categories.
But the philosophy behind the fund’s latest strategy is reassuringly simple.
“It’s back to basics,” says Pearce. “We are avoiding some of the more esoteric financial products and sticking to things where we actually know what we’re investing in.”
Aegon UK’s pre-tax profits were up 17% in the first half of the year standing at £71m thanks in part to the success of its platform business.
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