STATEMENT OF INVESTMENT PRINCIPLES (SIP)

The Pension Fund is established under the Local Government Pension Scheme (Management and Investment of Funds) Regulations. Amendments to these Regulations in 1999 and 2002 require administering Authorities to maintain and publish a written statement of the Authority’s principles governing investment of the Pension Fund, and the extent to which the Authority’s principles comply with a prescribed standard of best practice, (the Myners Principles).

1.1Trusteeship:The Council of the London Borough of Merton is the designated body responsible for administration of the Pension Fund on behalf of constituent Scheduled and Admitted Bodies, and for practical purposes will act as quasi trustee.

1.2Policy: The Council delegates to the Authority’s Pension Fund Advisory Panel responsibility and authority for the direction of Pension Fund policy and for the making of arrangements for the fund’s investment. The Panel will comprise selected Council Members, supported in a non-executive capacity by the Authority’s Chief Finance Officer, (as defined by section151 of the Local Government Act, and identified in Section A on page 3), and the Manager of Treasury Services. Staff-Side and Pensioner representatives are invited to attend. The Panel will develop policy having obtained independent advice from suitably qualified professional sources.1

1.3Administration and reporting: The Authority’s Chief Finance Officer will be responsible for: arranging suitably qualified and adequate in-house and external professional support for the operation and supervision of investment activities; the assembly and distribution of reports on relevant issues including investment performance; the production of accounts; the collation of data for actuarial reviews; the publication of information to members; and the maintenance of appropriate liquidity in the pension scheme’s cash account.

1.4Appointments: The Pension Fund Advisory Panel is responsible for the selection and appointment of advisors and service providers, including investment managers; (having sought appropriate professional advice where relevant).

1.5Actuarial assessment: The Authority will appoint an actuarial advisor to be responsible for undertaking a triennial review of the Pension Scheme’s financing; (leading to the definition of the required level of Employer’s contribution, and an expected level of investment return). In addition the actuary will undertake an annual review to satisfy the requirements of the FRS17 accounting standard. The current advisor is Section A on page 3.

1.6Strategic Asset allocation: The Authority will obtain professional advice regarding an appropriate strategic asset allocation. The Authority’s current advisor is listed in Section A page 3. The Pension Fund Advisory Panel is responsible for overseeing the implementation of the asset allocation, with the Chief Finance Officer arranging and monitoring implementation and acting to correct any significant variances that may occur. The Panel will also give due consideration to investment balance; (i.e. the spread of funds across different investment styles/ techniques, investment markets, sectors and stocks).

1.7Investment: The Authority will appoint external investment managers to undertake the operational management of the fund's investment activities. The Pension Fund Advisory Panel and/ or the Chief Financial Officer will agree the investment strategy that is to be implemented by the managers for each quarter and onwards. Investment managers will be responsible for, and be given delegated authority to implement, investment selection and realisation decisions within the approved strategy, and in compliance with the requirements of the Statement of Investment Principles. This delegation will also allow the investment manager to make tactical adjustments to asset allocations, (within set limits), in order to exploit market situations in the short term. The current managers are listed in Section A on page 3.

1.8Custody: The security of investments held will be effected via the appointment of custodians who, independently of investment managers, are responsible for holding investment records via nominee arrangements, making settlements and arranging tax reclaims. The current custodians are listed in Section A page 3.

1.9Governance: The Authority intends to implement good practice standards of corporate governance, and expects to vote its shares as far as practicable. Whilst the voting process is delegated to investment managers, who are expected to vote within the parameters noted in this SIP, the Authority retains the right to issue specific voting instructions. The Chief Finance Officer is responsible for monitoring the application of Corporate Governance, and will report to the Pension Fund Advisory Panel for direction as appropriate.

1.10Performance monitoring: The Authority will appoint an independent performance appraisal specialist who will be responsible for collecting, analysing and reporting on the fund’s investment performance relative to the Authority’s, market, peer group and other benchmarks and targets. The current advisor is listed in Section A on page 3. The Pension Fund Advisory Panel is responsible for reviewing the reports and initiating any appropriate action.

1.11Cash Balances The Chief Finance Officer will be responsible for ensuring adequate cash liquidity to finance the payment of current scheme benefits; and, where contributions and other Superannuation scheme income produce a current surplus, for arranging appropriate short-term investment of such surplus pending expenditure or transfer to investment management.

1.12Compliance: Investment activities are expected to comply with Statutory Regulations, The Statement of Investment Principles, investment management mandates, and other specific requirements of the Authority. The Chief Finance Officer is responsible for monitoring compliance and reporting to the Pension Fund Advisory Panel who will act to correct non-compliance.

1.13Audit: The Authority’s internal auditors will be commissioned to review the administrative and accounting practices for the fund, and external auditors (Section A on page 3) will be responsible for certifying the accounts.

2.Investment objective

2.1The fundamental objectives of the fund’s investment are:

  • To maximise the return on the fund’s investments and achieve the investment return assumed in the Scheme’s actuarial review.
  • To achieve the required investment return through reasonably stable performance obtained at modest risk. (See also SIP section 6).
  • To achieve the investment objective with responsible Corporate Governance and compliance with the Authority’s policy regarding Socially Responsible and Ethical Investment. (See also SIP sections 8 & 9).

2.2Since the investment return assumed in actuarial reviews is an assessment of returns over the long term, and in the short term returns may exceed or fall short of this, the Authority will consult its advisors to determine appropriate short-term targets that reflect and contribute to the longer-term objective.

2.3The fund’s overall investment objective relates to its actuarial need, and whilst subsidiary, interim, performance objectives/targets based on market and peer group benchmarks may be used for performance evaluation, these do not represent the fundamental performance objective.

2.4The Authority will establish practical, subsidiary, objectives for any sub-funds into which particular investment categories may be placed for practical purposes; (having considered appropriate professional advice.

2.5The fund’s investment objectives and performance targets to be reflected in the mandates given to investment managers.

3.Types of Investment

3.1 Only those types of investment allowed by the Local Government Pension Scheme (Management and Investment of Funds) Regulations are permitted, and all of the limitations specified in the regulations will apply.

3.2The major categories of investment are to be: Equities; Fixed interest and Index Linked Bonds; Property; Cash; and Development Capital. Other investments available within the Regulations may be used subject to the Authority’s specific approval.

3.3UK and Overseas investments, (primarily US, Europe and Japan), are to be made, and within the allocations and parameters set in investment mandates. Emerging markets investments may be used, subject to the Authority’s approval.

3.4Bond investments, which may include both Government and Corporate issues, are to comply with the minimum credit rating approved by the Authority.

3.5Derivative products, including options and futures, may be used given the prior approval of the Authority, and within limits approved by the Authority. Such usage may include:

  • Facilitation of asset allocation adjustments.
  • Hedging currency proceeds into Sterling.
  • Index futures, but exposure limited to 5% of sub-fund market

value, and appropriate securities/cash held to cover exposure.

3.6Warrants are permitted when attached to a purchased investment, or received via a corporate action on an existing investment.

3.7Borrowing is only permitted for settlement purposes, and limited to 2% of a sub-funds market value.

3.8Stock-Lending to third parties is not permitted.

3.9Collective, pooled, investment vehicles may be used within the limitations imposed by the Regulations, and subject to the Authority’s prior approval and conditions. Those managed by any one manager to be restricted to 35% of total investment value, which is the higher limit allowed by the Regulations; (see also Appendix 7). (Investment managers will have discretion to invest according to the vehicles’ Trust Deeds, and the specified prohibitions and limitations for segregated investments may not be applicable).

3.10Underwriting is permitted only where the prospective stock would be an acceptable and appropriate investment for holding in its own right.

3.11Investments in unquoted stocks, or those not easily realised, may only be undertaken with the Authority’s specific approval.

4.Asset Allocation and Investment Balance

4.1The fund’s Asset Allocation and the balance between different categories of investment will be determined by the key objective of: achieving or bettering the investment return assumed by the Authority’s actuary, and doing so via reasonably stable performance and at a modest level of risk.

4.2Asset allocation and investment balance will be set on the basis of professional advice:

  • to reflect the implications of asset/liability modelling.
  • to allow for and exploit the performance characteristics of different types of investment and investment strategies.
  • to limit risk by diversification of investments across types of investment, sectors, markets (UK and Overseas), and strategies.
  • to comply with the investment limitations of the Local Government (Management and Investment of Funds) Regulations.
  • to establish an appropriate balance between investment performance, risk and volatility, so as to obtain target performance with reasonable consistency.
  • to establish a dedicated Bond fund as a vehicle for ensuring that the allocation to Bonds is appropriate to the Pension scheme’s maturity.
  • to allow the allocation to each category of investment to be sufficient for the category to make a significant contribution to investment performance. Where this is not practical, usage of that category may be precluded.
  • to reflect the expectation that equities will out-perform bonds over the longer term; but to allow for the extent of the fund’s maturity and the Authority’s tolerance of performance volatility.

4.3The investment structure and asset allocation to be reviewed periodically by an independent advisor, to determine how well it provides the investment performance required to support financing of the Pension Scheme’s liabilities, and how it may be improved.

4.4The fund’s asset allocation / investment balance to reflect the Authority’s particular requirements and performance aspirations, and not drift toward that of benchmark funds used for performance appraisal purposes.

4.5The current asset allocation target is shown as Appendix 1, and the practical distribution across sub-funds, (together with variance parameters), is as shown in Appendix 2.

5. Performance (Return on Investment, targets and monitoring)

5.1The required performance for the fund overall is that it achieves or betters, over the actuarial cycle, the investment return assumed by the Authority’s actuary when calculating the Pension Scheme’s funding level and employer’s contribution. The currently assumed investment return is noted in Appendix 3.

5.2Since the fund’s asset allocation may be distributed across a number of sub-funds, professional advice will be obtained to identify appropriate performance targets for each sub-fund. (These together support achievement of the overall performance objective and target). (See Appendix 3)

5.3The performance targets for sub-funds will identify the extent to which the appointed investment manager is expected, over an appropriate period, to produce investment performance that matches or exceeds that of a set benchmark. These targets will be specific to each sub-fund / investment category, and set in accordance with independent professional advice. (See Appendix 4).

5.4Performance to be monitored and reported by independent performance analysts. (See Fund Advisors, Section A page 3).

5.5Performance to be reviewed quarterly. However, to allow for inevitable fluctuations in performance, the key performance review will be over rolling three-year periods. (Exceptionally, Development Capital investments will be allowed an extended, judgmental, assessment period agreed by the Panel.)

5.6The primary target used when considering fund performance will be the actuary’s assumed investment return. Performance relative to the market, peer groups and other set benchmarks will also be considered, but as a means to facilitate control of performance standards, rather than as performance objectives.

5.7Should performance fall below the required standard over a significant period, the Panel will consider the matter, and instigate appropriate action.

5.8Overall fund performance will be reviewed by the fund’s actuary as part of the

triennial actuarial review, and resultant conclusions on performance relative to the fund’s financing requirements to prompt appropriate action as necessary.

6. Risk.

6.1The fund’s investment objective includes the requirement that its performance target is achieved at a modest level of risk. To this end:

  • The implications of investment risk, and the appropriate parameters for its control, are established having taken professional advice.
  • The profile of investments in the various categories, (particularly the split between Equities and Bonds), is set to be compatible with the pattern of the fund’s liabilities, and adjusted or reaffirmed subsequent to actuarial reviews.
  • Investment is to be diversified across markets, sectors, investment types, strategies and stocks; (via the split of the fund into a structure of sub-funds), so as to limit the risk that any loss of value incurred on a particular investment or category of investment could have a significant effect on the fund as a whole.

6.2To facilitate control of risk, investment managers are required to maintain asset allocation within a degree of variance from a set benchmark and the Authority may elect to instruct managers to reduce risk when considered appropriate. (See parameters Appendix 1).

6.3To facilitate effective monitoring of risks, the processing of investments is split between the fund manager(s), who initiates the buying and selling of investments, and an independent administrator/custodian who settles the transactions, makes payments receives proceeds, and reports to the authority on investment activity and value.

7. Realisation Policy

7.1The objective of realisation policy is to ensure that there is adequate liquidity to support superannuation scheme payments, and to allow a dynamic investment strategy to be pursued.

7.2Virtually all investments are to be securities easily traded and realised (converted to cash) as required. This will usually mean those quoted on a recognised stock exchange. Stocks that are not quoted on a recognised stock exchange or otherwise actively traded, or are illiquid, may only be purchased exceptionally, and require the Authority’s specific approval; (whether for an individual case or a particular category such as Property and Development Capital).

7.3Since for the foreseeable future, the extent of the fund’s maturity does not require realisation policy to be governed by short-term liquidity considerations, investment managers have discretion to realise investments for investment reasons, rather than cash flow needs.

7.4 Whilst the process of realisation may in the short term generate cash for re-investment, the Authority may from time to time instruct investment managers to maintain cash balances at a level that anticipates a planned cash withdrawal.

8.Social Responsibility, Environmental and Ethical Considerations

8.1The Authority’s primary, statutory, responsibility for the fund is fiduciary; that is, to ensure that the fund’s investments produce the required return within the policy regarding risk. Good practice in terms of socially responsible, environmental and ethical issues is secondary.

8.2The ‘ethical’ nature of investments is nonetheless of concern to the Authority. Thus when considering the suitability of investments for the Superannuation Fund, appraisal of the nature of business, and the manner in which it is conducted, is to be integral to the investment managers’ investment selection process.

8.3Paragraph 8.2 states the Authority’s policy in general terms, to allow investment managers the flexibility to make judgements in the range of cases that will occur in practice. For operational purposes, investment managers will work within their own subsidiary guidelines, which will be discussed and agreed with the Authority and reviewed periodically.

8.4Where investment managers have doubts about the acceptability to the Authority of particular investments on socially responsible, environmental or ethical grounds, these are to be referred to the Authority for approval.

8.5It is recognised that in the case of pooled investments, referral to the Authority (and other individual investors) under 8.4 could be impractical, and so the fund manager will select investments within the terms of the relevant pooled fund agreement. The Authority will exercise control when it vets the vehicle’s agreement terms, and will periodically review the activities of the pooled fund, with appropriate action following as necessary.

8.6The examination and review of investments in respect of socially responsible, environmental and ethical considerations, is to apply to, and affect the retention or realisation of, both existing investments and the selection of prospective investments.

8.7Whilst the Authority will normally rely on the investment manager to select stocks that are acceptable within the Authority’s general policy, the Authority retains the right to implement a proscriptive approach and exclude particular stocks.

9.Exercise of Rights, including voting rights (Corporate Governance)

9.1It is policy for the Authority to be an active shareholder, and to exercise its rights (including voting rights) to promote and effect good corporate governance

9.2For normal cases voting is delegated to the fund manager on a discretionary basis, but voting is to take into account the Combined Code appended to the Stock Exchange Listing Rules. In the case of segregated investments high profile issues are to be discussed with officers, and where appropriate the Panel, before action. Voting actions are to be recorded in quarterly reports, and voting on contentious issues explained at Pension Fund Advisory Panel meetings.