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Real estate boosts UK local authority investment returns

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UK public sector pension schemes posted an average 4.5% investment return in the 12 months to the end of March, aided by double-digit property gains.

Data collated by Pensions & Investment Research Consultants (PIRC) showed that property investments for funds in the Local Government Pension Scheme (LGPS) returned an average 10% for the 2017-18 financial year.

Equities added 4%, while fixed income gained 1%, the consultancy reported.

Longer-term returns were “excellent”, PIRC said, with LGPS funds posting gains in 25 out of the last 30 years. Over those three decades, PIRC’s sample of 61 funds returned 9% a year.

LGPS funds with the strongest returns were boosted chiefly by active global equity managers, PIRC found, which outperformed their benchmarks by 2% on average during the period. The company highlighted Baillie Gifford as a particular contributor: the asset manager runs more active equity mandates for LGPS funds than any other group.

In addition, PIRC recorded a year-on-year reduction in the level of passive investment – the first time it had observed this.

However, it warned that the LGPS’ move to asset pooling could erode the positive effects of active management as funds move to different methods of allocation and seek to reduce investment costs.

% a year3 years5 years10 years20 years30 years
Equity9.610.18.86.69.4
Bonds4.54.96.76.57.8
Cash0.71.11.63.25.1
Alternatives10.19.36.19.0n/a
Property8.810.64.77.87.9

LGPS asset class returns over the long term to end-March 2018. Source: PIRC

Equity holdings fall

Despite equity outperformance, LGPS funds continued to take equity risk out of their portfolios, shifting towards multi-asset products such as diversified growth and absolute return funds. The year-on-year decline in average equity exposure – from 62% to 55% – was the biggest PIRC had ever recorded.

“Such a strategy will inevitably bring with it lower long term returns,” the consultancy said. “However, as the key actuarial discount rate assumptions have fallen to relatively modest levels, some funds may now feel comfortable accepting more modest returns and this may be making the decision straightforward.”

However, the consultancy also highlighted that, over the course of its 30-year dataset, “the equity ‘shocks’ that investors are so concerned about mitigating have been infrequent and the reward for holding equities substantial”.

In the past 10 years, PIRC reported, the best performing funds held a “relatively high” allocation to equities and a lower exposure to alternatives.

“The general move to reduce volatility, while necessary as funds mature, will inevitably reduce the overall level of returns,” PIRC said.

PIRC’s local authority data covers 61 of the 88 LGPS funds in England and Wales, covering £177bn (€196bn) of the system’s £274.5bn in total assets.

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