Having had a good year in 2010 when its portfolio returned 14.7% net of fees, Fred Green, Head of Investment & Treasury management of the £2.4bn Middlesbrough Borough Council Pension Scheme, admits that 2011 performance will not be as good.  The extraordinary volatility experienced  in equity markets in 2011 and the uncertainty surrounding local authority contributions rates has caused the fund to delay its triennial ALM process until the first half of 2012. Green says: “We would like to see the outcome of the negotiations with the Government before doing anything. There has been a lot of talk about opt out rates, with figures bandied about ranging from 1% by the Government to 50% by the GMB union. There has also been a suggestion that contribution increases be deferred until the major review of the Local Government Pension Scheme in 2015. I expect fewer opt outs if contribution increases are delayed.”

At the time of writing, local government employers and unions had agreed a framework that could postpone contribution increases for two years to 2014, by bundling all the issues in a package of changes from 2014. Whatever the final form of the agreement, Green believes that if the opt out rate exceeds 25% of membership, the scheme would be obliged to adopt a new, more risk averse approach, investing more in bonds, whereas if opt outs were to settle at 5% or under, no change in investment strategy would be necessary. That said, given that the council is witnessing a significant cut in the workforce due to redundancies and early retirements in order to achieve £900m in savings, a 5% opt out rate looks distinctly optimistic.

As for 2012, Green says he still favours equities, particularly global equities over bonds, despite the widespread economic uncertainty and geopolitical risks clouding the horizon. “There is a very good case for not having any bonds at all,” he insists. With 38% of the fund invested in UK equities and 39% in overseas equities, the fund is certainly bucking the trend for UK pension schemes to shed equities in favour of bonds and fixed interest. The National Association of Pension Funds’  recently published 2011 Annual Survey shows that UK local government and private sector final salary schemes had an average total allocation to equities of 42% in 2011, down from 60% in its 2006 survey.

The rest of Middlesbrough’s portfolio is allocated 9% to bonds, 6% property, 4% cash and 3% -4% to alternatives, with the latter split 60% commodity funds and 40% infrastructure funds. Green says: “We believe in active management and don’t use passive funds at all. The main reason for using passive is low cost, but we’re cheap anyway as we are a team of local government officers managing the fund.” Although the fund is predominantly managed in-house, it employs some pooled funds and property unit trusts. The CIO is pleased with the fund’s exposure to infrastructure through primary and secondary Innisfree PFI funds, which invest in schools and transport facilities, and a worldwide infrastructure fund run by Goldman Sachs. He says the fund might do more infrastructure investment in future if the UK government’s recently announced initiative to encourage greater infrastructure investment by pension funds is properly structured. “If something is put together by the government and it ticks all the boxes and provides a rate of return with a government guarantee, then we may be willing to accept a lower rate of return of around 7-9%,“ he says.

The fund also uses an external manager for the management of its direct property portfolio. The latter was managed until the end of December 2011 by LV= Asset Management. The mandate is currently out to tender, due to LV= Asset Management having been acquired by Threadneedle, rather than performance issues. Green is not a great fan of hedge funds and says he does not invest in them as a matter of policy. “We don’t need that sort of uncertainty and volatility and these funds are unable to guarantee the type of returns we need. The same applies to private equity. We’ve got a lot of equity risk in the portfolio already,” he says. In any event, he shuns complex products such as bank loans, CLOs and structured products. “We have looked at them and they’re not for us,” he says.

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