Lothian Pension Fund (LPF), the pension fund for local government employees in the Edinburgh area, is backing equities to help reduce investment risk and protect assets over the next few years, according to its latest annual report.

The £4.1bn (€4.8bn) fund – which returned 13.9% over the year to 31 March and 8.1% per year for the three years to that date – said equities were more attractively priced than “safe” government bonds over the long term.

“High-quality, sustainable businesses with strong cash generation should be able to continue to prosper in the challenging environment envisaged,” it said.

Lothian – along with the £312m Lothian Buses Pension Fund and the £140m Scottish Homes Pension Fund – is managed by the City of Edinburgh Council.

The remarks came in the wake of a review of investment strategies following the 2011 actuarial review.

The review concluded there was scope to reduce the investment risk over the next few years and increase the focus on investment income to reduce returns volatility over the coming years.

In addition to a focus on equities, it suggested a number of other investment themes to reduce risk and protect assets.

The annual report said: “Financial institutions may be forced to discard sound assets at attractive prices as they rebuild balance sheets in deleveraging economies. Such opportunities could allow the [three] funds to enhance investment returns.”

The report also said the funds should reduce their reliance on benchmarks based on market capitalisation, which it said were sub-optimal, and ensure that the objectives and risk tolerances of individual portfolios within the fund are as closely aligned as possible with the fund’s overall objectives.

Finally, according to the report, capital preservation and growth is more important than following an index.

Lothian’s current benchmark is 64% equities, 30% alternatives and 5% index-linked Gilts.

Despite strong investment returns in excess of expectations, the actual funding level has fallen, from 96% at the time of the last actuarial valuation on 31 March 2011 to 87% at 31 March 2013.

This was largely a result of falling real Gilt yields, which caused an increase in the value of liabilities.