Annual Report and Accounts 2006

Investment report

Statement of Investment Principles

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

Click here for the Statement of Investment Principles (159 KB)

The Statement of Investment Principles is available in hardcopy form upon request.

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 2006 the total Fund value was £8,944 million. Of this total, £8,552 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.

The chart 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.

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 2005 benchmark is summarised in the charts on the right.

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 4% of Main Fund value, which is implemented by commitments to specialised funds of £60 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 million to £120 million) and local venture capital (£20 million) and the ‘New Initiatives’ allocation. Such local investment is restricted to 3% of Main Fund value (currently 0.5%).

This graph 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 substantial switch out of Overseas Equities, and into Cash/other, Overseas Government Fixed Interest, UK Equities, UK Government Fixed Interest and Overseas Corporate Bonds.

Top 20 investment - Unilever: Unilever's mission is to add vitality to life, meeting everyday needs for nutrition, hygiene and personal care with brands that help people feel good, look good and get more out of life. Unilever is one of the world's leading suppliers of fast moving consumer goods with strong local roots in more than 100 countries across the globe. Its portfolio includes some of the world's best known and most loved brands including twelve €1 billion brands and global leadership in many categories in which the company operates. The portfolio features brand icons such as Hellmann's, Flora, Dove, Domestos, Wall's and Marmite. Unilever generated sales of €40 billion in 2005. For more information about Unilever and its brands, please visit www.unilever.com.

Performance

This graph 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 Overseas and UK Equities and for property investments. Significant positive returns were also achieved by Overseas and UK Index Linked investments and UK Corporate Bonds together with positive returns from all the other main investment categories.

The Main Fund achieved an excellent return of 22.7% during the year and outperformed the benchmark index in all of the major asset classes except UK Equities and UK Government Fixed Interest.

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, 15 and 20 years) the Main Fund’s performance is around 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. This graph 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, beyond 1 year, are better than the average local authority fund and have ranked in the top 5% of local authority funds over each time period, including being top performing fund over the long term, 20 year period.

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. There were no material changes in the year as illustrated in this graph.

Economic background

Despite the acceleration in economic growth rates during the second half of 2005, global growth moderated by early 2006, expanding at or just above its long term trend. Inflation remains low in the developed world, notwithstanding the pressures resulting from the continuing high levels of oil prices.

In the US, customer spending continues to be robust and corporate profits continue to grow strongly over the short term, although it is expected that this pace may slow to more modest levels.

In the UK, the growth rate of consumer borrowing moderated and no longer provided a stimulus to the economy during 2005, but both consumer spending and the housing market showed signs of improvement in the first quarter of 2006, providing some evidence that the economy had stabilised.

Growth in continental Europe during the year remained weak as a result of slow growth in personal incomes. However, it is encouraging to note that, in recent months, the major European economies have experienced a reacceleration in economic activity.

The Japanese economy, having rebounded as IT spending recovered and the Chinese economy maintained its rapid growth, remained strong during the year although there was uncertainty as to how it would respond to the likely increase in interest rates.

Private equity

The year saw a significant increase in private equity/venture capital activity in Europe, benefiting from continued low interest rates and reflected in the record level of debt multiples (and therefore, pricing), which is probably not sustainable. Fund raising, particularly in the large buy-out sector, was at record levels and the positive environment also benefited the venture segment. Fundraising in the US also returned to record levels, particularly for buy-out funds and venture funds.

Most experienced private equity/venture capital managers continued to build value within portfolio companies, whilst using recapitalisations and secondary buyouts to achieve exits and return cash to investors. The IPO (initial public offering) market in the US continued to slow and is not expected to improve substantially in 2006. During 2005, IPO activity in Europe remained weak except in the UK where the Alternative Investment Market (AIM) saw more flotations than NASDAQ but few opportunities for private equity managers to achieve exits for cash.

More reliable performance figures are becoming available for private equity and these indicate that the Fund’s private equity performance over one year again achieved substantial positive returns (31.3%). Over five years, the average return was 2.5% per year, whilst the ten year return is 29.6% per year. Since inception in 1981, the average annual return has been 18.5%.

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 Asset Managers Limited who, following a tender exercise, were reselected as preferred adviser to a further £20 million allocation (styled VNW3) which commenced investing in early 2004. As a result of a number of management changes within the advisers during the year, the VNW3 agreement was terminated and, as a consequence, Ventures North West made no new investments from the VNW3 allocation during the period under review.

Ventures North West targets investment in the Greater Manchester and North West area. During the year further investments were made into four existing portfolio companies at a cost of £0.7 million. These portfolio companies included Altrincham based Styles & Wood Holdings Ltd, which is the leading independent provider of store fit-out and refurbishment programmes to the UK retail sector, Heathcotes Restaurants Ltd and Synexus plc.

There was one full realisation and six part realisations achieved during the year, amounting to £2 million.

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 six funds in the year, increasing the number of active funds to 70. 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 was increased with effect from 1 January 2006 to £60 million per year.

Of the £371 million committed to these investments, some £247 million has been drawn down and invested by managers in a total of over 1,250 individual companies. In addition, £312 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.

The value of assets currently invested in private equity is £6 million direct and £102 million indirect.

Private equity investment - Provexis: Provexis is a Manchester based AIM listed company, which is part of the RisingStars Growth Fund. The company specialises in the development of scientifically proven novel bioactive food and drink products such as Sirco®, a heart health fruit juice drink. The active ingredient in Sirco is Fruitflow®, also a Provexis innovation, a patented tomato extract which is proven to help the blood flow smoothly to maintain a healthy heart and circulation. Sirco is already on sale in Tesco, Waitrose and Holland & Barratt, and Provexis has just secured a new distribution arrangement with Morrisons.

During the year the indirect holdings were bolstered by units in a new fund, the Standard Life Investments UK Retail Park Trust, and more units in Henderson’s Central London Office Fund. The first raised the Fund’s retail warehouse weighting above that of the benchmark, and the second stiffened its Central London Office weighting substantially.

No properties were bought for the directly owned portfolio during the year.

Three properties were sold in accordance with the policy of shedding small single let properties, and reducing the number of directly-owned investments, to increase the average size of those that remain. This allows the Fund to concentrate its efforts more productively on its properties, manage them better and enhance their investment returns.

The best performing property in the portfolio was the neighbourhood shopping centre in Bearwood, a suburb of Birmingham, where the Fund concluded new lettings of unit shops and a supermarket, in so doing improving the quality and length of its income stream and also revitalising the town centre.

The directly owned portfolio is well diversified by sector and geography, and contains high street shops, small shopping centres, retail warehouses, town centre offices, business park offices and industrial properties. It has no out of town fashion parks, nor has it any large regional shopping centres, because these are generally held by a small number of specialist investors and are much too large for a Fund of this size to own without exposing the portfolio to a big specific risk. Until now the holding in Central London offices has been low, too. The growing portfolio of indirect holdings has addressed these imbalances and brought the property investment portfolio as a whole much closer to the benchmark than hitherto.

The Fund also gains exposure to property through investments in generalist pooled property vehicles. These investments are held for asset allocation reasons and they are valued at £124 million.

Greater Manchester Property Venture Fund (“GMPVF”)

The GMPVF with a financial allocation in excess of £100 million creates property investments by a process of:

• site acquisition
• building design
• direct property development
• property letting/management

in order to generate state of the art office, retail, leisure, industrial/workshop accommodation. The current value of investments is £35 million

Since its establishment in 1990 GMPVF has developed more than 1 million square feet of commercial buildings within the Greater Manchester area.

Whilst aiming to achieve a commercial rate of return on all its property investments GMPVF also aims to develop commercial buildings in order to create/preserve jobs and to boost the North West local economy. In addition GMPVF seeks to make an environmental impact through regeneration. The Deva Centre in Salford is a good example of the regenerative impact of the Fund’s investment where a derelict brewery has been converted into high quality accommodation that is fully let.

At present the target area for GMPVF property investments is the North West of England, with a particular focus on Greater Manchester.

During the year GMPVF has sold two sites at Martland Park, Wigan and a car sales/showroom facility will be constructed on each of the sites.

At Globe Park, Rochdale, several new leases have been completed and out of a total of 17 units developed by GMPVF only two units are currently unoccupied.

GMPVF has an option to develop a further site at Westwood Park, Wigan which is currently under consideration following the construction by Wigan MBC of a new roadbridge over the canal and highway network to provide improved access to the Park.

Negotiations are ongoing with Oldham MBC regarding the construction of a 30,000 square feet office building in Oldham town centre and several other potential development projects in Oldham are also under consideration.

During the year a new GMPVF marketing brochure has been prepared and a new marketing campaign will be undertaken in 2007 including presentations of GMPVF to all the Greater Manchester local authorities and others within the North West in order to identify new investment opportunities.

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 one, four, six and ten. The results of the consultation exercise are still under review within HM Treasury but, when published, will be considered in relation to GMPF’s Statement of Investment Principles.

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.

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% 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 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 here.

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