The taxation of dividend income and not devolution is the challenge for Scotland's largestpublic sector fund. Geoff Singleton talks to Fennell Betson
Scottish devolution may be making the political headlines, but hardnosed investors there regard it as something of an investment non-event. For Geoff Singleton, who runs the £4.5bn ($7.2bn) Strathclyde Pension Fund, it holds no upside and no downside. We do not see devolution as having any impact on the running of the fund - so I think it will be neutral for us."
His concerns on the political front are dealing with the aftermath of the 'Brown Wednesday' bodyblow from the Westminster government's budget chang-es. This has altered dramatically the financial profile of his and of other Scottish local authorities' schemes.
Strathclyde is Scotland's largest public sector scheme covering 133,000 members, of which 67,000 are active and 53,000 are pensioners and the balance deferred. They come from 11 local authorities in the Stratchclyde region and cover around 200 other bodies providing public services locally.
Singleton is, in fact, depute director of finance at Glasgow City Council, which is the administering authority nominated to look after the scheme. "In law the fund is a fund of the citycouncil. It is a device by which employers set money aside to meet the pension promise." Local authorities are legally obliged to do this and to have three-yearly actuarial valuations to vet their financial condition. Unlike funds in the private sector, the fund does not have a separate legal status. The councillors and others responsible for their activities are not trustees, though they owe similar fiduciary to beneficiaries and local taxpayers, he explains. "We call them quasi trustees to remind them of their responsibilities."
The fund is answerable to Glasgow City Council, through a treasury management sub-committee and has assistance from a range of the council's legal, financial and property officers. Also vital to the funds success, says Singleton, has been the input the panel of three expert investment advisers, all external appointees, comprising the fund's actuary, an economist and academic, and a former private sector pension fund manager. The other local authorities in the scheme are formally kept abreast of developments through two meetings each year.
The defined benefits payable by authorities are stipulated by law, as is the contribution rates paid by employees, to be standardised at 6% of pay next year. Typically, local authority benefits cost 15-16% of pay to provide, so from an employer's point of view there is everything to play for on the investment side.
The treasury sub-committee sets the fund's strategic structure. "It does not go into detailed asset allocation which we leave to our external investment managers as we do not think that we are that well equipped to deal with asset allocation," says Singleton. The scheme is run on a core-satellite manager system with nearly half of the portfolio (48%) managed in the 'core' managed by Schroders, with a fully balanced brief, excluding property. This is the only portfolio managed against a universe-related bench mark, the others are portfolio specific. The next third is the equity portfolio which is divided amongst: PDFM (16%); Baillie Gifford (11%) and Gartmore (7%).
The balance of the portfolio is divided on a more specialist basis, with around 2% in UK smaller caps, where M&G was replaced by Hill Samuel as manager earlier this year, 3% in overseas smaller caps divided between LGT and Flemings. Another 2% is split between Pantheon, looking after private equity investments, and emerging markets handled by State Street, Genesis and Capital International.
Property is covered in a 'swing portfolio', ac-counting for around 12.5% of assets, also in-cluding index linked bonds. "We wanted to put the onus on the property manager to reflect on the fact that were other asset classes," he explains. The portfolio was originally managed by Scottish Amicable, but since its demise the property has been looked after by Argyll, which was bought by Robeco last year and the index section is managed by Britannia.
The core satellite system works "quite well," he says. The part that did not was the 35% equity component. "That's where there appears to be some weakness for managers of one sort or another," he says. "As a system, we think it is right and we would like to continue that way."
The pension fund does not have a rota for review of managers. "We only institute a search if we are dissatisfied with performance."
The fund has never felt the urge for an asset liability study, says Singleton. The scheme did adopt this year a comprehensive statement of investment principles, even though local authorities are outside the provisions of the Pensions Act, which makes statements manadatory for the private sector. He would like to see the act's minimum funding requirement apply to public sector schemes too.
The most recent valuation for March 1996 showed the fund had a comfortable 114% funding level. But the question is, what has the Chancellor of the Exchequer, Gordon Brown done to this? Singleton reckons that the value of the assets have declined by 10%, since income from UK dividends is now worth 20% less and about half of the fund is in domestic equities. "Oursurplus has gone down from 114% to 103/104%."
He says that the natural future service rate for the fund, on a no deficit and no surplus basis, is an em-ployers' contribution rate of 175% of employees' contribution. "In the current year we are paying 100% of the employees' contribution." So if the surplus is 104%, he asks if the scheme's employers should be taking the current contribution holiday of 75%? "One argument is that we should be increasing our contribution straightaway to the future service rate."
In addition, the fund will lose income of about £18m and this has to be replaced, he says. "Taking these figures together, we think employers are probably currently under-funding their scheme by about £58m." As employees are contributing about £55m, that means that the service rate has doubled more or less.
But he points to a number of uncertainties: The ac-tuarial profession's review of the valuation method and companies may decide to increase dividend payouts to mitigate the effects on pensions investors. "But the one thing we do know is that we have lost the £18m dividend income." So the fund is holding the current rate at 100%, but increasing next year's to 135% and the following year's to 170% of the em-ployees' rate, he says. "This will produce an amount to replace the ACT credits we won't be receiving. But after the next valuation rates might have to go to 200%, depending on the dividend policies of companies and the actuaries' conclusions on valuation."
Singleton has been active in involving the fund in corporate goverance matters for its UK holdings, though he believes it will be sometime before it can come to grips with overseas stakes.
But he feels the fund has to be much more circumspect on ethical issues." As an organisation with its roots in politics, ethics is something that crops up regularly. We have counsel's opinion that striking the balance between risk and reward, which is clearly something the quasi trustee should do, is of itself a difficult thing to do. In fact, it is so difficult as to leave no room for any other considerations."
Singleton acknowledges that many people would take issue with that view. "It is very difficult for a politically-based organisaton to try and exercise its conscience through its pension fund. Because it is by no means clear that the views that one organisation forms about what is right and wrong can be shared by those who are either going to be the beneficiaries of the fund, or who are footing the bill for it."
The safest thing in his view is to concentrate on maximising returns. "If we can maximise returns, we can lower the cost of the pension scheme, which is generating a large amount of money for employers to do good things with or to deliver extra services with." Before 'Brown Wednesday', Strathclyde fund was enjoying a partial contribution holiday worth £40m each year to the employers in the area. "I think that is the biggest contribution a pension fund can make to social responsibility, by making sure it is doing a good job by keeping down the costs to the employer. I don't particularly fancy compromising that!" "