Annual Report and Accounts 2005

Investment Report

Statement of Investment Principles

The Fund is required to maintain and publish a Statement of Investment Principles detailing its investment arrangements.

The Statement is published on the Fund’s website and is available in hardcopy form upon request.

Statement of Investment Principles

(159 KB)

Investment management

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 2005 the total Fund value was £7,361 million. Of this total, £6,969 million was held in the Main Fund and invested across a broad spread of assets whilst £392 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.

A chart summarising 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.

Investment strategy

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 2004 benchmark is summarised in the charts here.

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.

Portfolio distribution

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 here.

Economic background

Following a series of interest rate rises, global growth has slowed towards the trend (circa 3%) from the higher levels of early 2004. Inflation remains low in the developed world, though there are potential oil price induced pressures.

In the US, consumer spending continues to be robust and corporate profits are expected to grow over the medium term, but at a slower pace than seen during the second half of 2004.

In the UK, consumer borrowing has fallen and is no longer providing a stimulus to the economy. As a consequence, retail sales growth has declined. A slowdown in consumption remains a key risk to the UK economy over the medium term.

Growth in Continental Europe has been relatively slow, although there are indications of a small upturn in consumer spending and investment demand.

The Japanese economy continues to send out mixed signals, but overall has enjoyed good growth as exports to China have offset a weaker domestic picture.

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.

TOP 20 HOLDINGS 2005

Private equity

The upturn in the fortunes and prospects of private equity on both sides of the Atlantic which began in 2003, continued during 2004. This recovery, although fragile across all stages of private equity investment and revealed by increased investment activity, reflected cautious optimism and a return to more usual levels of fundraising.

Most experienced venture capital teams continued to preserve value within portfolio companies whilst seeing limited exit opportunities. Recapitalisations and secondary buyouts continued to dominate exit routes and kept cash flowing back to investors. Whilst the new issues market in the US rose sharply during 2004, it effectively remained closed in Europe.

More reliable performance figures are becoming available for private equity and these figures indicate that private equity performance over 1 year again achieved substantial positive returns (31.1%). Over 5 years the average return was 1.9% per year, whilst the 10 year return is 29.2% per year. Since inception of the portfolio in 1981, the average annual return has been 18.4%.

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 2 new investments and 4 follow on investments at a total cost of £2.1 million.

Ventures North West targets investment in the Greater Manchester and North West area. One of the new investments was the provision of additional expansion capital to the Altrincham based Styles & Wood Ltd which is the leading independent provider of store fit out and refurbishment programmes to the UK retail sector. The other new investment was the provision of capital to Brookhouse Holdings plc. Further investments were made in 4 portfolio companies including Power Gems Ltd and Swan Plant Services Ltd.

There were no full realisations during the year but 5 minor part realisations amounting to £0.1 million were made.

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 3 funds in the year, increasing the number of funds to 91. 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 £318 million committed to these investments, some £206 million has been drawn down and invested by managers in a total of over 1,100 individual companies. In addition, £278 million has been received back through distributions of realisations and income.

The Fund’s adviser on investment strategy for this portfolio is Capital Dynamics Ltd, formerly Westport Private Equity Ltd.

The value of assets currently invested in private equity is £8 million direct and £75 million indirect.

Property

At year end the Main Fund’s property portfolio was valued at more than £462 million. It comprised 75 properties. During the year two more indirect investments were added. These were holdings in the Henderson Central Office Fund, and the Henderson UK Shopping Centre Fund, and they raised the number of such specialist investments to five (with a total value of more than £85 million). These indirect investments were bought to give the Fund exposure to sectors that are difficult or impossible to gain exposure to through direct ownership.

The Fund also holds general pooled property vehicles with a value of £95 million.

The directly owned portfolio is well diversified both in sector and in geographical spread. The Fund own standard shop units, shopping parades, small shopping centres, retail warehouse parks, stand alone retail warehouse units, city centre offices, offices on business parks, multi let industrial estates and single let industrial units. The indirect holdings diversify the portfolio still further, into large retail warehouse parks, central London offices and large shopping centres with regional catchments.

An active sales programme saw the disposal of a large distribution warehouse in Warrington, several high street shops, an industrial unit in Leeds and a small office investment in Esher. By reducing the number of investments, the average lot size has been increased so that attention can be focused on fewer more active holdings with the prospects of more “added value”.

Greater Manchester Property Venture Fund

When originally established the GMPVF remit was to invest in Greater Manchester locations. However last year the decision was taken to extend the geographic boundaries to include the North West of England. Acting through fund manager Dunlop Haywards, GMPVF 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 the North West embracing a policy of sustainable development.

During last year GMPVF sold investments at Lynstock Way, Bolton and Martland Park, Wigan. Several other investments are being considered for sale where the developments are completed in order to take advantage of the buoyant property market.

At the Globe Park Business Estate Rochdale leases of four units have been completed.

Three further sites have been acquired as part of the Stalybridge West redevelopment project.

In August 2004 GMPVF completed the development of two 25,000 square feet office buildings at Westwood Park Wigan. Both of these buildings are now occupied by staff employed by Wigan MBC. GMPVF has an option to acquire/develop a further site at Westwood Park and this is currently under consideration.

Several potential development opportunities are currently being progressed. The Stalybridge West Scheme is currently at the land assembly stage and a range of development options for the site are under consideration.

GMPVF is engaged in detailed negotiation with Oldham MBC in relation to a potential Oldham town centre office development project.

Also under review is a development site located in Wigan town centre. The site provides a range of development options which are currently being appraised.

Myners principles

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.

In December 2004, HM Treasury published a consultation document reviewing progress made with the recommendations in the Myners Report. GMPF officers had participated in the review and the Fund considers the consultation document to be positive in terms of the Local Authority ‘model’ of appointing lay councillors working with Fund officers giving expert advice.

The National Association of Pension Funds (NAPF), of which GMPF is a member, was also generally supportive of the review’s findings and the revisions proposed to the current principles. In submitting its detailed and extensive response to the consultation document, the NAPF suggested specific amendments to proposed revisions to principles 1, 4, 6 and 10. The results of the consultation exercise, when published, will be considered in relation to GMPF’s Statement of Investment Principles (159 KB)

This section summarises the current Fund position on the 10 best practice principles. Further comment is incorporated in the Statement of Investment 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 at the top of this page.

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 benefit 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% out-performance 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 (159 KB) was published in October 2002. A Funding Strategy Statement (241 KB) was published in March 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, Statement of Investment Principles and Funding Strategy Statement are available to all members, and are published on our website.

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