Annual Report and Accounts 2004

Investment Report

Management of the Fund's assets is determined within the context of the Local Government Pension Scheme (Management and Investment of Funds) Regulations 1998 as amended. These require the Fund to have regard to both the diversification and suitability of its investments and to take proper advice in making investment decisions.

During 1994, the Management Panel decided to separate the assets of the Fund into two distinct parts - a Main Fund and a Designated Fund - in order to reflect a major difference between most of the employers in the Fund and that of a small number of employers in the Fund in their liability profiles. The Designated Fund is used for employers who have a very high proportion of  pensioner liabilities.

At 31 March 2004 the total Fund value was £6,593 million. Of this total, £6,195 million was held in the Main Fund and invested across a broad spread of assets whilst £398 million was held in the Designated Fund and invested almost wholly in UK index-linked with a small amount held in cash.

The UK index linked portfolios of the Designated Fund are passively managed in-house.

During the course of 2000/2001 an extensive review of the external management arrangements of the Main Fund was undertaken. This review culminated in the adoption of a Fund specific benchmark and the appointment of UBS Global Asset Management (UK) and Capital International as active managers and Legal & General Investment Management as passive manager. UBS and Capital manage the securities portfolios investing in equities, fixed interest and index linked on a multi-asset discretionary basis, whilst Legal & General manage a multi-asset indexed securities portfolio.

The chart on the facing page summarises the management arrangements for the Main Fund at the end of the year.

Custody of financial assets and banking

The Fund uses an independent custodian - currently the JP Morgan Chase Bank - to safeguard its financial assets and the rights attaching to those assets. The Custodian is responsible for the safe-keeping of the Fund's financial assets, the settlement of transactions, income collection, overseas tax reclamation and other administrative actions in relation to the investments.

The Fund's banker is Royal Bank of Scotland.

The remaining comments and results in this Investment Report relate solely to the Main Fund.

In December 2000 the Panel adopted a Fund specific benchmark, which defines the proportion of the Main Fund to be invested in each asset class.

Each year the Management Panel reviews the Main Fund's investment guidelines for the coming year. The 2003 benchmark is summarised in the following chart. Please click here to view the chart.

Each of the three managers has been given a specific benchmark reflecting their perceived skills and the relative efficiency of markets. The active managers are given ranges for each asset class allowing them to make tactical asset allocation decisions.

The Fund's strategic allocation to venture capital is 3% of Main Fund value, which is implemented by commitments to specialised funds of £40 million per year and a local venture capital fund of £20 million.

The Fund supports local investment predominantly through the Property Venture Fund (allocation range £100 to £120 million) and local venture capital (£20 million). Such local investment is restricted to 3% of Main Fund value.

The graph here shows the net effect of the total investment activity of the Main Fund during the year, based on the Panel's guidelines. As can be seen, during the year there has been a modest switch out of equities, particularly UK equities, and into Government Fixed Interest, Corporate Bonds and cash.

 Top 20 holdings

Performance

The graph here compares the return achieved by the Main Fund with the market/benchmark index return in each of the main investment categories during the year.

The year saw substantial market returns for both UK and overseas equities, with Emerging Market equities leading the way. Significant positive returns were also achieved by property investments. Of the other main investment categories, low negative returns were seen from all sub-categories of overseas bonds.

The Main Fund achieved an excellent return of 26.3% during the year and outperformed the benchmark index in all of the major asset classes except overseas index-linked and UK Government fixed interest. This overall outperformance was overwhelmingly due to a stellar outperformance in UK equities supported by a predominant pattern of slightly above average stock selection within other markets.

The Fund subscribes to the WM Pension Fund Performance Measurement Service in order to judge its performance relative to the rest of the pensions industry. Over the long term (10 and 15 years) the Main Fund's performance is just under 1% per year above average. The Main Fund is ranked in the top 10% of all pension funds over all standard timeframes in excess of 1 year. This excellent record is also borne out in comparison with the largest 50 UK pension funds.

In addition to comparing performance with the UK pensions industry as a whole, the Fund also subscribes to WM's Local Authority Pension Fund Service in order to assess its performance relative to all other funds which operate under the same regulations. The graph here looks at the Main Fund's performance as compared to the local authority average over various durations.

As can be seen, the results of the Main Fund over all the time periods shown are significantly better than the average local authority fund and have ranked in the top 10% of local authority funds over each time period, including being top performing fund over the 5 year and 15 year periods.

The distribution of assets across the main investment categories within the Main Fund changes as a result of the investment strategy followed by the managers and the performance achieved within each investment category. These changes are shown in the graph alongside.

During the year, global economic recovery continued. However, concern remained about the sustainability of both global growth and low inflation. In the US, whilst the actions of the Administration in cutting interest rates and relaxing fiscal constraints allowed the economy to grow strongly, the robustness of growth rates remained questionable. In the UK, economic growth continued to be underpinned by a high level of household debt and the level of such debt remains the greatest risk to the UK economy.

Economic conditions in Europe improved during the year, but the strong Euro and subdued domestic demand meant that growth in Continental Europe continued to lag that of other regions. Over the same timeframe, the Japanese economy continued to improve, spurred by exports particularly to China. However, a sustained recovery in Japan will undoubtedly require further economic reforms.

Whilst Central Banks worked to control inflation and maintain low interest rates in order to promote economic growth, there were growing expectations that the levels of both inflation and interest rates would soon increase.

After two difficult years, 2003 saw the long-awaited upturn in the fortunes and prospects of private equity on both sides of the Atlantic. This fragile recovery, across all stages of private equity investment and evinced by increased investment activity, reflected cautious optimism.

Most experienced venture capital teams, having maintained their disciplined approach during difficult times, continued to preserve value within portfolio companies whilst awaiting exit opportunities. Whilst the new issues market in the US re-opened during 2003, it effectively remained closed in Europe. It was the flood of Secondary buy-outs that kept cash flowing back to investors, albeit at reduced rates to that previously seen.

More reliable performance figures are becoming available for private equity and these figures indicate that private equity performance over 1 year again achieved positive returns, albeit at low levels. Over 5 years the average return was 35% per year.

The Fund invests in private companies via two routes:

Direct local holdings: The Fund's direct local private equity vehicle, Ventures North West, is advised by Aberdeen Murray Johnstone Private Equity who, following a tender exercise, were reselected as preferred adviser to a further £20 million allocation. During the year Ventures North West made seven follow-on investments at a total cost of £0.7 million.

Ventures North West targets investment in the Greater Manchester and North West area. One of the further investments was the provision of additional expansion capital to the Knutsford based Swan Plant Services Ltd, which provides grounds maintenance equipment to Local Authorities and industry. Further investment was also made in Heathcotes Restaurants Ltd to finance the continued roll-out of the new 'Olive Press' restaurant concept.

Full and part realisations amounting to £3.8 million were made during the year. Of this figure, £2.2 million was received from the sale of one investment, representing over twice the amount invested.

Indirect holdings: The majority of the Fund's private equity investment is made via pooled funds raised by specialist management teams. Investments were made in a further 4 funds in the year, increasing the number of funds to 88. The portfolio is diversified by stage of investment (from early stage investments to very large management buyout investments) and geographic location across the UK, Europe and the US. The target rate of investments remained at £40 million per year.

Of the £290 million committed to these investments, some £181 million has been drawn down and invested by managers in a total of over 1,100 individual companies. In addition, £249 million has been received back through distributions of realisations and income.

The Fund's adviser on investment strategy for this portfolio is Westport Private Equity Ltd.

The value of assets currently invested in private equity is £6 million direct and £62 million indirect.

The 83 directly owned investment properties which comprise the Main Fund's property portfolio were valued at more that £457m at 31st December 2003. During the year one more indirect investment (Industrial Property Investment Fund) was added to our two existing holdings (Lend Lease Retail Partnership and Hercules Unit Trust) Once again this type of investment was chosen because it gave exposure to an asset class in which we wanted to increase our weighting and which would have been difficult to buy through direct acquisition.

The directly owned portfolio is diversified geographically and by sector. It contains standard shop units, shopping parades, shopping centres, retail warehouse parks, stand-alone retail warehouse units, city centre offices, campus office investments, multi-occupied industrial estates, single-let industrial units and one very large distribution warehouse.

We bought four investments during the year. These were: two prime shops in Leeds, an industrial estate in Hayes, and two mixed use retail/office investments in West London. Five properties were sold. They were: three shops, one office and one mixed-use investment.

At 7.6% the income return continues to be markedly higher than the benchmark. Investment returns for the portfolio bettered our target of median performance over 1 year, 3 year and 5 year periods. In addition the directly owned portfolio continues to have a low level of empty properties and a well diversified tenant base.

GMPVF invests in Greater Manchester locations. Acting through fund manager Dunlop Heywood Lorenz it creates property investments by a process of site acquisition and direct property development generating state-of-the-art office, retail, leisure, industrial/workshop accommodation and mixed-use premises. At the end of 2003 the financial allocation to GMPVF was increased from £45 million to £120 million.

Whilst achieving a commercial rate of return on its investments, GMPVF also aims to undertake regeneration projects and to create employment facilities within Greater Manchester embracing a policy of sustainable development.

Throughout the year GMPVF has taken advantage of the buoyant property market and disposed of investments at:

• Patricroft, Eccles, Salford
• Quattro Park, Bredbury, Stockport

Since completion of the mixed use development at the Deva Centre Salford GMPVF has completed 25 leases to individual companies all of whom now trade from the Centre. The Scheme was built speculatively and currently has only one unit available to let.

At 44 Peter Street, Manchester the extensive refurbishment works are completed and the property is now being marketed in order to attract either tenants or an owner/occupier.

In Wigan over the last 12 months, GMPVF has been undertaking the development of two office buildings at Westwood Park. Completion of the project is due in July/August 2004 following which both buildings will be occupied by staff of Wigan MBC. This Phase I scheme has had the effect of acting as a catalyst to further development in the area and GMPVF is currently appraising a potential Phase II office development also at Westwood Park.

In October 2003 GMPVF completed the purchase of its most significant development opportunity to date namely Elisabeth House a 1960s mixed use office/retail building located in St. Peter's Square, Manchester. GMPVF proposes to comprehensively redevelop the site in order to create a larger building of a style and quality commensurate with its location in one of Manchester's finest public squares. The new building will provide office and retail space and consideration will be given to incorporating residential units in the scheme.

In March 2001, Paul Myners published Review of Institutional Investment. It was a wide ranging report on how some of the main players - trustees, actuaries, investment consultants and fund managers - carry out their roles. The Government supported the report's conclusions, and in October 2001, it issued a revised set of 10 investment principles.

This section summarises the current Fund position on these 10 best practice principles.

1. Effective decision making: Key strategic investment decisions are taken by the Pension Fund Management Panel, for example asset allocation and investment management arrangements. In taking such decisions, the Panel receives advice from three external advisors and in house staff. Implementation decisions are delegated to the Director of Pensions and external managers.

2. Clear objectives: The Fund's investment objective is to help deliver low and stable employer contribution rates. This equates to a long term real rate of return of approximately 4.5%. An asset liability study undertaken during 2000 culminated in the adoption of a Fund specific benchmark, which is described on page 5.

3. Focus on Asset Allocation: The Panel gives in depth consideration to asset allocation issues in June each year. Material market movements would result in further consideration at other times. The Fund's benchmark is well diversified and periodically the merits of other asset classes are reviewed.

4. Expert advice: The Fund receives investment advice from its Actuary, other external advisors and in house staff. It also buys in specialist advice where appropriate, for example on private equity and corporate governance issues. The Director of Pensions provides the link between the Fund and its Managers and Advisors

5. Explicit mandates: Each manager has a specific benchmark and explicit risk parameters for both tactical asset allocation and stock selection

6. Activism: The Fund is developing its approach to activism through its Ethics & Audit Working Group and the instructions it gives to its managers, including its voting guidelines. Managers are required to report to this Group on their governance activities. The Fund is also working with other Local Authority Pension Funds where there is a common interest to influence companies for the benefits of shareholders

7. Appropriate benchmarks: The Fund's active managers have sufficient flexibility in both asset allocation and stock selection to deliver the target 1% outperformance of their benchmark. The benchmarks set for each manager aim to take account of their perceived strengths and the relative efficiency of markets.

8. Performance Measurement: Performance of managers is monitored on a quarterly basis (annually for property).

9. Transparency: A revised Statement of Investment Principles was published in October 2002. A Funding Strategy Statement will be published in early 2005.

10. Regular Reporting: The Fund communicates at least annually with all its members. Pensioners are also invited to an Annual Forum. The Annual Report and Statement of Investment Principles are available to all members, and are published on our website.

Back