The Local Government Pensions Institution (LGPI) has considerable autonomy in the running of its affairs, and this includes investment policy. This is a function of the tradition of independence that local government as a whole has enjoyed for many years.
Ari Huotari, CIO of the fund, explains that “there are no regulatory constraints concerning our investments because LGPI is an independent public authority; the LGPI Act of 1964 only has a couple of words on investments. So it has been our council and especially the board that decide investments of this scheme.”
The absence of the annual requirement to cover liabilities which applies elsewhere in the compulsory sector, and the strict solvency requirements associated with it, is a major advantage.
But given the responsibility of the fund towards its members is the relatively light regulation a healthy state of affairs? Huotari says: “I think it is. The fact that there is no legislation has caused the council and the board always to be very interested in the investment side of the business and the guidelines they give us are very thorough. We meet with the board every three weeks.”
He adds: “Each year the board sets the guidelines for the investment committee and then the investment committee can decide what investments. Some special matters like a new mandate must be approved by the board.”
The fund was established in 1964 to cater for all local government employees. It has a membership of 470,000.
The total value of invested assets currently stands at E15bn compared with E13.8bn last year. The cumulative real return of the fund since it was established 16 years ago is 3.9%. Huotari notes that “this is a bit below the target but this is because of the difficult years of 2001 and 2002.” Last year the return was 8.6%, but the year before it was
-10% and in 2001 it was -5%.
Evidence of the greater investment freedom enjoyed by the LGPI as a result of the absence of an annual solvency requirement can be found in the asset allocation, in two important respects.
Firstly the allocation to equities is well above the average for the compulsory sector: at the end of last year 44% of the fund was invested in equities compared with 39% a year earlier.
Secondly, asset allocation has tended to be stable. Huotari: “We focus on 20-year cycles and less on difficult years.”
The increase in exposure to equities has been accompanied by a decrease in the exposure to bonds, from 49% at the end of 2002 to 45% at the end of last year. There is a gradual move towards corporate bonds which account for 20% of the bond portfolio; the rest is in government bonds. LGPI has a minimum rating based on an average for the portfolio. There are also high-yield mandates.
Real estate is seen as a protection against inflation and is less volatile than some other asset classes. It accounted for 8% of invested assets at the end of last year. The portfolio
consists of direct holdings in Finland but Huotari explains that the fund is also searching for ways to invest abroad through for the purposes of diversification.
Huotari sums up his asset allocation strategy: “We have a very neutral view; it reflects the uncertainty in the markets, and in our thoughts too. I don’t expect any major changes in our asset allocation during the next few months.”
He adds: “In the equity portfolio we will increase the portion of Asian equities but balance the allocation by decreasing European and US equities.”
The LGPI manages 82% of the fund in-house. Investments that are managed outside include US small and mid cap, European small cap and high yield, in other words “all the markets which we know we can’t cover from here because we don’t have the people, the knowledge or the systems”, says Huotari.
The mandates are specialised for reasons of control. There is an in-house group looking after equities that also monitors the performance of the outsourced equities mandates, and there is a similar set-up on the fixed income side.
Until 1995 all management was in house. The first outsourced mandate was in European equities. “There were in-house restrictions on investing abroad and because of our need to diversify we had to find external managers to make our board believe that it is a good idea,” says Huotari.
He adds: “If I was starting the operation now I would outsource almost everything and just hire a couple of people to look after outsourced investors.” He agrees that while this will be more expensive it will be wise in the long-term because of the specialist input.