Tailored advice to local authority pension schemes

We were approached by the investment adviser to the London Borough of Newham (LBN) Pension Scheme in early 2010 at a difficult period, not just for Newham, but for all local government pension schemes. In common with any open, defined-benefit scheme, Newham was exposed to interest rate risk. By early 2010, a long period of declining real rates of interest had raised scheme liabilities by more than it had raised scheme assets, leaving them with a material deficit. The investment adviser, already a client of Fathom, believed that Newham would benefit from a greater understanding of macroeconomic and financial market developments, and how these might affect the funding outlook. We met the then Chair of the scheme to discuss how we might help them. This resulted in Fathom being appointed macroeconomic advisers to the LBN Pension Scheme in May 2010.

Our brief was to support the scheme’s objectives by ensuring that its officers and its elected members were informed of macroeconomic and financial market developments that had the potential materially to affect scheme funding. To meet this objective, we provided a range of services, including regular briefing at face-to-face meetings of the scheme’s investment committee, periodic in-depth analysis of major events that might have a bearing on scheme funding, and member training. With committee members drawn from different backgrounds, it was important to translate complex ideas in a way that would be meaningful to the intelligent lay person. We also reviewed Newham’s strategic asset allocation several times.

An important part of our role was to be available, whether at the end of a phone line or more recently through Teams or Zoom, to provide advice to officers of the scheme when required. We had to be able to react, at short notice, to macroeconomic and financial market developments as they occurred.

The fan chart is derived from FIRM-DB and describes the outlook for a hypothetical local authority faced with a challenging macroeconomic and financial market backdrop. Each band represents 5% of the possible outcomes for scheme funding, with the whole chart covering 90% of possible outcomes.

One of our early recommendations was to reduce the allocation to UK equities, which reflected a third of the scheme’s equity holdings at the time Fathom was appointed, and increase the allocation to overseas equities, and to US equities in particular. Supported by the scheme’s investment adviser, this recommendation was accepted, and Newham’s overseas equity holdings began to rise. This gave the scheme a greater exposure to movements in the value of sterling, and the appropriate level of foreign currency hedging was a frequent topic of conversation. With the dollar tending to rise against sterling at times of economic stress, when equities were doing badly, our recommendation back then was that some US dollar exposure was desirable, and hedging of US dollar assets should generally be less than the hedging of other foreign currency assets. But as President Trump’s second term got under way the dollar’s attractiveness as a safe haven began to come under question, and hedging strategies started to be re-examined.

The ten years that followed the Global Financial Crisis of 2008/09, although a difficult one for the LGPS, was nevertheless one of relative economic stability. Inflation fluctuated around the 2% target, Bank Rate was stuck at or close to the zero lower bound, and long-term interest rates drifted steadily down year after year. Economic forecasting appeared straightforward. All of this changed with the COVID-19 pandemic, and the policy response to that, which saw the UK experience double-digit inflation for the first time in decades. A sound understanding, not just of macroeconomics in the round, but of monetary and fiscal policy in particular, was paramount. But as the 2020s progressed there was a growing focus on the outlook for interest rate, both short-term and long-term. This affected not just scheme assets and scheme liabilities, but with many of the officers also involved in treasury management, it was an important factor when thinking about the timing, and the duration of borrowing.

Fathom attended quarterly meetings of the investment committee, in person at the Town Hall before March 2020, virtually during the pandemic, and a mixture of the two from 2021 onwards. We would present our views, and where appropriate our recommendations, to the elected members, the officers, the investment adviser and other stakeholders, typically using a set of slides shared in advance. Meetings with officers were held on an ad hoc basis as required between the quarterly meetings of the investment committee.