All pension funds have to balance risk and return, but for local government pension funds, there is also another balancing act involved - the ability to deal with political pressure. In spite of these conflicting requirements, the Clwyd Fund has, in only three years, raised its funding ratio from 65% to 80% through a series of rigorous fund structure reviews and diversification into alternative assets. For this achievement, it has won the IPE Award for Best Pension Fund - UK.

The Clwyd Fund is a local authority pension fund (LAPF) mainly for employees of three councils in North Wales - Flintshire (the fund administering authority), Denbighshire and Wrexham.

The fund structure is reviewed every three years, and the results are then scrutinised by the Pension Fund Panel (PFP). This is made up of councillors from the three main council employers and approves all major investment decisions.

The structural review is carried out by an experienced in-house team, made up of two serving council officers, a fund consultant and former council officer, who previously worked on the fund, and an independent financial adviser. On average, each of the four has over 20 years' experience with the fund.

FUNDING CHALLENGE
In 2004, funding fell to 65%, largely because of market impacts and an earlier government 75% funding instruction. This was not a disaster, since the fund has a positive cash flow and can also take a long-term view, as it is considered to be government-backed.
B

ut there was pressure for a quick return to 100% funding so as to reduce the employers' contribution rates. At this stage, the fund's liabilities were growing at around 8% a year because of factors such as improving mortality. So investment returns needed to be maximised.

However, there was also pressure coming from the opposite direction. The fund's actuary was pushing for an increase in bond exposure, and there was in any case political pressure to reduce risk, to avoid shocks and bad publicity.

So there were two competing demands: to maximise returns and minimise volatility. In addition to all this, PFP members needed training in the increasing diversity of asset classes and products which would be needed to deliver the desired results.

GRADUAL RESTRUCTURING
The fund restructuring therefore had to be gradual and was developed over a series of review exercises. The first took place during 2000, with the results implemented in 2001. Two further reviews took place in 2003 and 2006, each with its recommendations being put into place the following year.

A glance at the fund's asset allocation for each year from 1998 to 2007 shows little change in the allocation to bonds and equities, which dominate the portfolio. The property weighting has increased to 8%, but other alternative assets account for only 2%.

Unlike most LAPFs, however, the fund had moved to specialist management in the early 1990s, and saw property and private equity as important asset classes. In the mid-1990s, the fund, with the help of BGI, had developed its own optimisation model to help determine its strategic benchmark. This model utilises risk, return and correlation assumptions to test asset mix scenarios and predict the resultant risk, return and IR at total fund level.

This approach endorsed the benefits of diversification in reducing risk, and focused increasingly on alternative assets as a means of doing this. It also allowed the fund to target the return level (9-10% absolute) required to exceed its liability needs and move back towards 100% funding.

ALTERNATIVES EXPOSURE
The strategic benchmark structures produced from the last three reviews highlight the fund's increasing exposure to alternative assets, most recently commodities.
Although the benchmark weighting for alternatives is now 32%, the exposure is currently 44%, as some UK equity active exposure is made through portable alpha, using hedge fund of funds as the alpha engine.

At each review, the notional IR has been raised, through a combination of increased return and reduced risk, and the current structure is targeted at delivering a 9.7% return at 10.6% risk. Manager risk has also been reduced, with no manager holding more than 15% of the fund, most much less. Despite the strong performance of equities in recent years, Clwyd's more diversified approach has held its own on returns. However, its main benefit is clearly in lowering downside risk when there is market volatility, as seen recently.

While most LAPFs have used asset/liability modelling in broad terms, Clwyd was the first to use specific modelling techniques to test asset mix scenarios in determining its strategic structure. It has also led the way on risk assessment, diversification, the use of alternative assets and other developing strategies.
In fixed interest, Clwyd was the first LAPF to invest in high yield and emerging market debt, and one of the first funds to adopt an unconstrained approach.

In private equity, it stayed committed in the early 1990s and increased its exposure at a
time when other LAPFs were pulling out. It was the first LAPF to invest in hedge funds and now has a 17% exposure through hedge funds of funds; it also beat the rest to investing in currency as an asset class. It was the first LAPF to invest in commodities on an active basis, although the second to invest in the asset class as a whole.
Clwyd is the first and still the only LAPF to use portable alpha instead of traditional active management. It is also the first LAPF to use global tactical asset allocation funds to gain its GTAA exposure.

HIGHLIGHTS AND ACHIEVEMENTS
Clwyd Pension Fund has successfully resolved the risk/return dilemma through its use of cutting-edge strategies. In three years, the scheme has raised its funding ratio from 65% to 80%. A rigorous fund restructuring exercise and the innovative use of alternatives have both played pivotal roles in this achievement. The fund determines its strategic benchmark using its own optimisation model which tests asset mix scenarios to predict risk, return and IR. The benchmark now contains a greater weighting in alternatives than before, and with its revolutionary approach to investing in private equity, hedge funds, currency funds and GTAA funds, Clwyd is blazing a trail for other local authority pension funds.