The London Borough of Tower Hamlets Pension Fund has purchased protection for around £700m of equities in the run-up to its March 2019 triennial valuation.
The risk management solution, implemented by Schroders and advised by Mercer, will help to protect the local authority scheme from a significant fall in equities, after its funding level improved on the back of rising markets.
Like other funds in the Local Government Pension Scheme (LGPS), Tower Hamlets has a large exposure to equities of around 50% given it is still open to accrual unlike most private sector pension funds.
It follows a string of other LGPS funds that have adopted similar strategies to stem the pain from market falls in the months leading to their 2019 valuations, including Worcestershire and Cumbria County Council Pension Fund.
It is the second LGPS win of its kind for Schroders' portfolio solutions team, after implementing a £2.6bn strategy for South Yorkshire Pension Authority earlier this year.
London Borough of Tower Hamlets acting corporate director for resources Neville Murton said: "This investment strategy provides more certainty around the outcome of the 31 March 2019 formal actuarial valuation and protects against the risk of a significant fall in equities given increased volatility in markets and concerns regarding stretched valuations.
The scheme's funding level increased from 71.8% in the 2013 valuation to 82.8% in 2016.
"The funding level has improved materially since the last valuation, so the fund implemented the equity protection strategy from a position of relative strength," added Murton. "The strategy implementation was just in time to lock in high market levels before the recent market fall; therefore the strategy is in a good position to deliver additional savings."
The equity protection strategy was implemented before the end of September, after a procurement process that followed talks which began back in June.
Schroders head of portfolio solutions group Andrew Connell added:
"LGPS funds have experienced some gains but to support their actuarial assumptions, they need to maintain their strategic exposure to equities. They face a dilemma given that equity markets are high and the best times are behind us. They can keep some exposure to the equity risk premium but put some risk control around that especially in the run-up to the 2019 valuations, so they can have a much greater certainty what the value of their equities will be at that point."
Mercer partner Steve Turner said the protection has already helped insulate the fund from equity market volatility in recent months. "Key stakeholders can sleep a lot easier with the strategy in place, while still retaining good levels of return upside," he added.
Connell said this is a "growing trend" and expects more LGPS funds to go down this route.
"There has been a steady flow of conversations with LGPS funds going through a procurement process, which shows they are thinking very carefully about what the right risk profile is to have through the next cycle," he added.
Other ways to manage or reduce equity risk include selling equities or diversified into other asset classes such as alternatives.
According to Tower Hamlets' 2017/18 annual report, it reduced its allocation to equities from 60% to 50% and increased the allocation to its diversified growth fund from 10% to 20%. The fund also has 12% in bonds, 6% in multi-asset credit, and 12% in property.
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