28 JUNE 2017
STRATEGIC DIRECTOR FINANCE, GOVERNANCE & SUPPORT– JAMES BROMILEY
INVESTMENT ADVISORS REPORT
1.PURPOSE OF THE REPORT
1.1To update Members with the current capital market conditions, and set an appropriate short term asset allocation to best take advantage of these conditions.
2.RECOMMENDATIONS
2.1That Members note the report and approve with the short term asset allocation.
3.FINANCIAL IMPLICATIONS
3.1Decisions taken by Members, in light of information contained within this report, will have an impact on the performance of the Fund.
4.BACKGROUND
4.1At each Investment Panel meeting, the Panel’s Independent Investment Advisors (the Advisors) provide an update to Members on current global economic, political and market conditions, and recommend an appropriate short term asset allocation for the Fund given these conditions.
4.2As Members are aware, a review of Advisors was carried out and as part of the tender exercise the previous Advisors’ last Panel meeting was March 2017. Progress has not enabled new Advisors to be present for this meeting to provide advice to Members.
4.2Attached as Appendix A is a report from the Head of Investments and Treasury Management. The report sets out the political, economic and market background since the previous meeting.
5.SHORT TERM ASSET ALLOCATION ADVICE
5.1In light of no Advisors to provide advice, it is considered appropriate to continue with the previous short term asset allocation. The current political, economic and market conditions are similar to previous advice provided at meetings and do not suggest any need to make any major strategy changes. Currently, the key component when setting the short term asset allocation is the Bond yield level. Most other asset classes are basing their levels from this yield as with yields currently low, investors are seeking returns wherever they can find them. Also, the only issue of note on the medium horizon is the US Federal Reserve statement on cutting its bond holdings. It is envisaged that this will be carried out very carefully so as not to spook the US economy and markets and so is worthy of watching but not requiring immediate attention or changes to the short term strategy at this time.
5.2Therefore, it is proposed that the Fund continues to favour growth assets over protection assets. It is considered that in the long run, Bond yields will rise, but at present and while central bank intervene in the Bond markets, through quantitative easing, yields do not meet the actuarial requirements for the Fund and should continue to be avoided at around these levels unless they are held as a short term alternative to cash.
5.3Cash has built up as divestments from other asset classes have occurred, and is primed to be invested when opportunities allow. It is always preferential for cash to be invested in higher returning assets, but at this time high cash levels can assist in protecting the Fund,as a diversifier, from Equity market downturns. However, at the current level of 12%, cash should not rise too much further in the short term to above the maximum short term level set at the customised benchmark for protection assets (15%). It is accepted that if the value of other asset classes fall, particularly Equities, there is a possibility that the short term cash level will rose over the maximum set below.
5.4Equity markets have been volatile, with additional volatility in currency markets, which have recently been beneficial to the Fund with its high weighting in this asset class. The short term allocation strategy and range provide flexibility to continue and either increase or decrease investments when market opportunities arise.
5.5Investment in direct property to continue on the same basis as previously presented to the Panel; on an opportunistic basis where the property has a good covenant, yield and lease terms.
5.6Investment in Alternatives, such as general and local infrastructure and private equity, offer the Fund diversification from equities and bonds. They come with additional risks of being illiquid, traditionally they have costly management fees and investment in the type of investment can be a slow process. However, the Fund is considerably underweight its customised benchmark and, providing suitable investment opportunities are available, the Fund should look to increase its allocation to this asset class up to the customised benchmark level.
5.7The Fund’s long and short term asset allocation strategies are summarised below, together with the short term asset allocation ranges for each asset class:
Asset Class / Customised Benchmark% / March Weighting % / LT Asset Allocation Strategy / ST Asset Allocation Strategy / ST Range %
GROWTH:
UK Equities / 30 / 32 / Reduce / Market dependent / 29 – 35
Overseas Equities / 40 / 47 / Reduce / Market dependent / 45 – 51
Property / 10 / 7 / Increase / Opportunistic increase / 7 – 9
Alternatives / 5 / 2 / Increase / Opportunistic increase / 1.5 – 5
PROTECTION:
Bonds / 12 / 0 / Increase / Hold / 0 – 2
Cash / 3 / 12 / Reduce / Hold/Reduce / 5 – 15
CONTACT OFFICER:Paul Campbell (Head of Investments & Treasury Management)
TEL. NO.:(01642) 729024
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APPENDIX A
Investment Report June 2017
Geopolitical Background
The period since the last Panel meeting has been eventful to say the least.
In the UK, we have now seen the results of two elections. In the local elections in May, the Conservatives gained hundreds of seats with a 7% swing in their favour. A snap election was called for June with the Conservative Party’s intention of providing a stronger margin in the House of Commons from which to negotiate Brexit. The outcome was somewhat different, with the result a hung Parliament. The government are now due to start Brexit negotiations from a weaker than before. In addition, terrorist attacks in Manchester and London halted election campaigning and have heightened security across the UK.
In Europe,the new French President, Emmanuel Macron, was elected from a new (centrist) political party in the run off against Marine Le Pen. This electoral win is seen by markets and economists as removing the risk of a near term market shocks in France and Europe in general. All eyes on Germany next with federal elections due in September. Good results in the latest two regional elections (Schleswig-Holstien and North Rhine Westphalia) for current Chancellor, Angela Merkel’s CDU party and not so good for her main rival (SPD) also assisted in stabilising European markets.
In the US, questions are still asked of President Trump’s conduct and connection to Russia. Questions deepened with the dismissal of FBI Director, James Comey, raising concerns over the independence of the bureau’s investigation into links between the Trump campaign and Russia in the run-up to last year’s US presidential election. On a wider front, the US President made his first overseas trip since taking office, visiting the Middle-East and Europe. During his visit to Europe, the US President announced the withdrawal of the US from the Paris agreement on climate change, saying he wants to "renegotiate" a fairer deal that would not disadvantage US businesses and workers.
In non-Trump US news, the US Senate passed the $1.15 trillion spending bill to fund the federal government through the end September. This bill includes an additional $15 billion for the Pentagon and $1.5 billion in emergency border security funds, but does not provide for starting construction of the southern border wall with Mexico.
In the Middle-East, tensions rose between Arab states with Qatar who are accused of allowing terror financiers to operate within its borders. These allegations were denied by Qatar, who claim they have taken more robust counter-terrorism measures than some of its neighbours. In the Far East, North Korea continued with its programme of missile tests in the South Japan Sea, heightening tension between them and the US further since the last Panel meeting.
Economic Background
The headline economic news since the previous Panel meeting is the increase in interest rates in the US. The US raised its interest rates by 0.25% for the second time this year, with many market commentators suggesting a third rise by the year’s end. The central bank voted to raise its key rate target to a range of 1% to 1.25%, the highest level since 2008, when policymakers cut rates to encourage borrowing and spending after the financial crisis. The central bank also said it would begin cutting its bond holdings and other securities this year. It cited continued US economic growth and job market strength as reasons for raising its benchmark interest rate.
Across the other major world markets, central banks left monetary policy on hold, with no other major interest rate rises and a continuation of quantitative easing programmes by central banks. Overall, most Gross Domestic Product rates held steady or rose slightly on previous periods. The exception to this was the UK where quarter on quarter GDP dropped by 0.5%.
OPEC struck a deal to extend it production cuts, agreed in November 2016, for another nine months in order to step up efforts to shore up prices following a three year glut of supply. Together with the US decision to withdraw from the climate change accord, it was hoped this action would ensure the oil price moved back over the pivotal $50 a barrel level, however, this was not the case. Currently, the cost of Brent is under $46 a barrel, from a position of over $52 a barrel at the beginning of 2017 and over $50 a barrel at the beginning of April 2017.
Market Background
Equity markets, in general, has performed positively since both the start of this quarter (to 16 June 2017) and the beginning of 2017 (to 16 June 2017), as shown in the table below:
YTD % / QTD %FTSE All-Share (UK) / 8.03% / 3.85%
S & P 500 (US) / 5.96% / 1.49%
Euro Stoxx 600 Ex UK (Europe) / 15.57% / 8.09%
Topix 500 (Japan) / 7.78% / 4.315%
Bloomberg Asia Pacific Ex Japan / -5.16% / -4.11%
The above returns are all rebased back to GB Pounds, and take into effect both the currency and index moves. The only area where returns are negative is the Far East (ex-Japan). The strength of the Euro, particularly in the period since the last Panel meeting has assisted the European market’s total returns, which contracts with the weakness of the US Dollar over these periods and acted as a drag on performance of US markets.
In the past it has been reported to the Panel that Bond yields are not sufficient to meet the actuarial rate of return, as calculated by the Fund’s Actuary. The table below sets out the yields of the major market’s 10 year bond yields for the 31 December 2016, 31 March 2017 and 16 June 2017:
10 Year Bond Yields / 31/12/2016 / 31/03/17 / 16/06/2017UK / 1.235 / 1.138 / 1.017
US / 2.445 / 2.421 / 2.152
Germany / 0.204 / 0.325 / 0.275
France / 0.681 / 0.966 / 0.630
Switzerland / -0.224 / -0.120 / -0.176
Japan / 0.041 / 0.065 / 0.051
Australia / 2.765 / 2.701 / 2.407
As seen from the levels shown, yields widened after in the first quarter, but have subsequently tightened, and for all markets are not close to the required rate of return of 4.7%.
Short Term Asset Allocation Advice
In light of no Advisors to provide advice, it is considered appropriate to continue with the previous short term asset allocation. The current political, economic and market conditions are similar to previous advice provided at meetings and do not suggest any need to make any major strategy changes. Currently, the key component when setting the short term asset allocation is the Bond yield level. Most other asset classes are basing their levels from this yield as with yields currently low, investors are seeking returns wherever they can find them. Also, the only issue of note on the medium horizon is the US Federal Reserve statement on cutting its bond holdings. It is envisaged that this will be carried out very carefully so as not to spook the US economy and markets and so is worthy of watching but not requiring immediate attention or changes to the short term strategy at this time.
Therefore, it is proposed that the Fund continues to favour growth assets over protection assets. It is considered that in the long run, Bond yields will rise, but at present and while central bank intervene in the Bond markets, through quantitative easing, yields do not meet the actuarial requirements for the Fund and should continue to be avoided at around these levels unless they are held as a short term alternative to cash.
Cash has built up as divestments from other asset classes have occurred, and is primed to be invested when opportunities allow. It is always preferential for cash to be invested in higher returning assets, but at this time high cash levels can assist in protecting the Fund, as a diversifier, from Equity market downturns. However, at the current level of 12%, cash should not rise too much further in the short term to above the maximum short term level set at the customised benchmark for protection assets (15%). It is accepted that if the value of other asset classes fall, particularly Equities, there is a possibility that the short term cash level will rose over the maximum set below.
Equity markets have been volatile, with additional volatility in currency markets, which have recently been beneficial to the Fund with its high weighting in this asset class. The short term allocation strategy and range provide flexibility to continue and either increase or decrease investments when market opportunities arise.
Investment in direct property to continue on the same basis as previously presented to the Panel; on an opportunistic basis where the property has a good covenant, yield and lease terms.
Investment in Alternatives, such as general and local infrastructure and private equity, offer the Fund diversification from equities and bonds. They come with additional risks of being illiquid, traditionally they have costly management fees and investment in the type of investment can be a slow process. However, the Fund is considerably underweight its customised benchmark and, providing suitable investment opportunities are available, the Fund should look to increase its allocation to this asset class up to the customised benchmark level.
Paul Campbell – Head of Investments & Treasury Management
19 June 2017