UK - The Lothian Pension Fund should take advantage of bank deleveraging to acquire “sound assets at attractive prices”, the local authority scheme’s head of corporate governance has said.

According to a report by Alastair Maclean, the £3.6bn (€4.3bn) fund administered by the City of Edinburgh council should also refocus its investment targets toward capital preservation, taking note of its income requirements, and do away with existing benchmark outperformance targets.

As part of the fund’s investment strategy review, Maclean recommended that it reduce investment risk in the long term - shifting private equity from the alternatives portfolio to the equity portfolio and reducing long-term stock holdings from 71.5% to 65%.

The report said: “The investment outlook will remain exceptionally challenging for years to come. The world’s major central banks are set to maintain, if not increase, their use of excess monetary stimulus, almost regardless of the latent inflation potential accompanying those strategies. This argues for maintaining meaningful exposure to real investments.”

As part of the proposed shift in strategy, Lothian would increase index-linked Gilt holdings by 2 percentage points to 7%, with a modest revision of its long-term alternatives holdings to 28%, targeting assets sold due to bank deleveraging.

“Many financial institutions will be forced to discard sound assets at attractive prices as they rebuild balance sheets in deleveraging economies,” Maclean said in the report. “Such opportunities could allow the fund to enhance investment returns.”

Pension funds in the Netherlands were recently called upon to buy part of €650bn in domestic loan portfolios as the institutions deleveraged. 

A number of the country’s larger pension funds, however, quickly dismissed the suggestion for being “at odds” with responsible investing.

Lothian’s director of corporate governance also made the case for a shift away from benchmark outperformance within its portfolio and branded market-cap-weighted benchmarks “suboptimal”.

He recommended that other benchmarks more in line with individual portfolio’s risk tolerances be employed.

“Capital preservation and growth is more important than tracking error,” he said, later adding that a focus on such areas would be likely to result in the fund performing well in times of market downturns, but less well during rallies.

As part of the changes, Maclean would be granted powers to change asset allocation within the pre-determined ranges “in the event of extreme investment market fluctuations”, as long as the changes were implemented in consultation with the chair of the council’s pension committee.

Lothian most recently reviewed its investment strategy in 2009, at the time halving bond investments to the current 5% and reducing equity allocations to 60%.