Sandy Flight, chief exchequer officer, Dundee City Council in Scotland, tells David White that the main objective of Tayside Superannuation Fund is to maximise overall return within reasonable risk parameters, and that means having a clear asset allocation strategy and sticking to it

The Tayside Superannuation Fund is a £1.6bn (€2.37bn) defined benefit pension scheme for some 34,000 local government employees in the Tayside region of Scotland.

The scheme is administered by the City of Dundee, and comprises a main fund and a smaller transport fund. The main fund covers most employees within Dundee City Council, Perth and Kinross Council and Angus Council, as well as 40 other public bodies. The transport fund covers employees of the former Dundee City bus service.

Sandy Flight is the council’s chief exchequer officer and is responsible for the overall running of the scheme. “We’re quite unusual because we are employed by the city council, so part of our day is spent working for the city council in terms of their cash balances and treasury management, and part of the day is spent in dealing with the investments of the pension fund and pensions administration.”

Like other local authority pension funds within the UK’s Local Government Pension Scheme (LGPS), the Tayside pension fund faces the double challenge of ensuring that contribution rates are kept as near constant as possible while at the same time investing in riskier assets such as equities and property to achieve the returns necessary to reach 100% funding.

The fund has had some success in meeting this challenge, says Flight.

“Over the past 10 years we have seen employers’ contribution rates rise. Basically this is because at the start of the period they were at fairly historically low levels. Since then they’ve come back to a normal level and then increased as our liabilities have gone up, because of discount rates and probably mortality.”

Yet funding levels have improved, rising from 91% at the 2005 valuation to 100% currently. This will help steady contribution levels, says Flight. “Since we’re now back at a 100% funding level, we feel that we’ve probably reached the peak of employers’ contribution rates and we should stabilise at the level we’re at currently.”

The Tayside fund’s investment objective is to maximise overall return within reasonable risk parameters. “The main thing is to have a clear asset allocation strategy and to stick to it,” says Flight. This means no tactical tinkering with the asset allocation. “We’ve tended not to make any tactical decisions.”

The main plank of the investment strategy is the active management of equities, says Flight. “We have always believed in active managers and that active managers can add value.”

Consequently, the aim is to be fully invested at all times. “There is still a very small element of cash that we hold in house which is used to meet ongoing requirements of the fund. But as far as the managers are concerned they are fully invested.”

The fund tempers its belief in active management with a necessary caution, he says. “We’ve been relatively prudent in that belief. We aren’t looking for a particularly high alpha, and we have tended to set fairly realistic, core-plus sort of targets.” The Tayside fund switched from balanced to specialist managers in 2003. Part of the reason for this switch was the fund’s desire to maintain control of the strategic asset allocation, says Flight.

“In a balanced strategy the asset allocation is really being driven by the managers themselves, within the balanced mandate. That means they could make tactical moves to other positions, such as switching from bonds to equities, and they could hold those positions for some time.

“We felt that while that might be a good investment decision in the short term, it may not be in line with the long term objectives of the fund. With a system of specialist managers we remain in control of asset allocation. That means that we can ensure that our longer term strategy is being maintained.”

The Tayside fund exercises its control of asset allocation by giving different weightings to external managers with similar mandates, he says. “Although a couple of managers will be classed as global equity mandates, the weightings of those mandates, however, are quite different.

“And because we don’t have a UK-specific manager we’ve had to tailor each of the global equity mandates differently to make sure we still get the UK weighting that we’re looking for.”

Control of asset allocation also enables the fund to use the same managers for different investment strategies, he says. “We use a unitised arrangement to split the assets between the main fund and the transport fund. So as far as the manager is concerned he is just managing the one mandate, and it’s really only the asset allocation that we’re imposing over and above that which results in a different investment strategy.”

With the move to specialist managers, the fund also moved from peer group benchmarks to scheme-specific benchmarks.

Part of the reason for this was to more closely link in with the funds’ liability position, says Flight. “I don’t think the intention was ever to try to fully match liabilities but rather to keep some link there and make sure we had some control over that.”

The five specialist managers employed by the fund have generally performed in line with expectations, Flight says. “In the three years since we implemented the new strategy, the fund has had returns quite a bit above the benchmark that we set them. Obviously some managers have done better than others but that’s the reason we have more than one manager, to ensure that trade-off.

“Performance has probably has been better than the previous period of the balanced management, where returns were a bit flatter and probably more in line with their benchmark for that time,” he adds.

Managers work to a fixed fee arrangement, although there is a performance fee component in one of the mandates. However, Flight says this is likely to be the exception rather than the rule in future. “From what we’ve seen there’s no evidence that the performance fee structure has influenced better or worse performance up to now. Our standard approach would be to look for the fixed fee first.”

The strategic asset allocation (SAA) for the main fund, implemented in December 2006, follows an ALM study based on liabilities valued in 2005. The SAA benchmark is currently 70% UK and overseas equities, 18% bonds and cash and 12% property.

The transport fund’s strategic allocation is significantly different, with 50% allocated to equities, 40% to bonds and 10% to property. This reflects the fact that the fund is closed to new members, and is comparatively mature, paying out more in pensions than it is collecting in contributions. The main fund, in contrast, is still generating heavy cash balances.

The main fund’s SAA represents a small reduction in the allocation to equities, a small increase in its allocation to fixed income and a significant increase in its allocation to property funds, says Flight.

“Over the longer term we’ve been about 75% in equities, 16% in bonds and 9% in property. We have always had a high exposure to equities, so there has been a slight reduction in the equity exposure. We have also put more into fixed income.

Yet the increase of three percentage points in the allocation to property is the most significant change, Flight says.

“Over the past 10 years property has performed really well, although it appears to be slowing at the moment. We saw that, in some way, property has bond-like characteristics, in terms of a regular income coming through. What we also liked about it was that we were getting slightly higher returns than from bonds, and they were slightly less correlated with the returns from other asset classes.”

Investment in property is indirect, via property funds, and mainly UK. “It’s only in the last year that we’ve invested in a continental European fund, and it’s a little early to say how that has gone,” says Flight.

 

Within its equity allocation, the main fund has switched the balance of UK and global equities from 60:40 to 40:60. “This was a first step, an initial move away from our home market,” Flight explains. “There was a feeling that there was a lack of opportunities in the UK, for two reasons. First, it was becoming a very concentrated market, with some very large firms making up the bulk of the FTSE 100, so that we were almost forced to invest in certain companies.

“We also felt that our managers might find it more difficult to add value there, and that, given we believe in active management, we felt there was more scope for them to add value from some of the overseas areas.

“In more general terms, there is also a view now that the regional approach has become less valid. Where companies are listed is becoming less and less relevant compared with where they are actually making their earnings.”

No further reduction in exposure to UK equities are planned in the short term, Flight says. “In the longer term maybe that could change, but at the moment we’re comfortable with the level as it is.”

Equity managers are expected to conform to the Tayside fund’s socially responsible investment (SRI) policy. “We set a SRI policy a few years ago which was really just ensuring that our managers were engaging with the companies we invest in,” says Flight. “So we get a quarterly report on engagement activities they have undertaken and we report that back to our investment sub-committee.”

Managers are also expected to engage with the companies they invest in. “On the engagement side, there are four broad areas that we identified which we expect our managers to ask about - employees care, human rights, sustainability and environment. So that gives them quite a wide scope for questioning.

The fund uses PIRC, a UK research and advisory consultancy, to advise fund managers on how they should vote in FTSE 350 companies in these areas. “We review all votes that have been cast to ensure that things have been done correctly,” says Flight.

The Tayside fund has been wary of investing in alternatives. Although it considered investing in private equity as part of its search for higher returns, it decided against it. The main concerns were the liquidity and transparency of private equity, says Flight.

“There was also a worry about getting all the funds placed and how long we’d sit with commitments. Ideally the committee would have liked to have got all the money in as quickly as possible and it was obvious that that was not going to be possible.”

It was also felt that the additional compliance, monitoring and administrative costs of private equity investment would outweigh any additional potential benefits, he says.

“The intention was that we were going to be putting in, at the very most, 5% of the fund into private equity, so we had to decide whether the cost of doing that was going to be justified by any additional return we could expect to achieve from such a small percentage holding.”

The Tayside fund is looking to active currency management as a possible way of adding basis points to returns, says Flight. “We are looking at whether we should have a purely passive overlay just to hedge or whether we should be looking at something a bit more active.

“Active currency overlay management is probably the most pressing item on our agenda at the moment in terms of making any changes. In the next six to nine months we want to firm up on what we want to achieve from that.”

The fund also participates in a stock-lending programme. “In terms of the fund its fairly insignificant, but it is a bit of extra revenue coming through,” says Flight.

Here again, the fund ensures that it retains some control over voting rights. “From the sub-committee’s point of view there have been some concerns in the past about the loss of voting rights through the stock lending process.

“We’ve always given out instructions that we can never lend out 100% of any particular security, so at least we have still some voting rights.”

Although LGPS regulations impose some restrictions on the Tayside fund’s investments, Flight believes the fund has all the freedom it needs to invest in the way that it thinks best. “Certainly we don’t feel restricted in anything we do. We’re in the position we would want to be in, at the levels we want to be in, and there’s no pressure to change anything.”