Agenda item

This paper reports on the performance of the Brunel and legacy portfolios and seeks to update the Panel on routine aspects of the Fund’s investments. The report contains performance statistics for periods ending 31 December 2021.

The Investments Manager introduced this report to the Panel and highlighted the following points.

·  No concerns to flag with any of the Brunel portfolios this quarter.

·  The Global Sustainable Equity portfolio again posted strong performance, achieving a 6.8% absolute return over the quarter, which was 0.5% ahead of its benchmark due to positive sector allocation.

·  The High Alpha portfolio returned 6.3% in absolute terms, underperforming the index by 1.1% and the underperformance is understood.

·  The quarter saw a number of portfolio changes in line with recommendations from the Equity Review. October saw a £575m sale from Brunel’s Low Carbon Passive portfolio into their new Paris Aligned Benchmark (PAB) Fund, while in December the Emerging Markets portfolio was sold (c£275m) with proceeds being fully re-invested in Global High Alpha.

Josh Caughey, Mercer addressed the Panel and highlighted points from within Appendix 2 – Performance Report.

Market background: The fourth quarter of 2021 came with a number of challenges. Global supply chains remained stretched and the new Covid-19 variant was discovered mid-quarter. Soaring inflation also forced some major central banks to accelerate their exit strategies from ultra-loose monetary policies.

In spite of these headwinds, risk assets fared reasonably well with a few exceptions. Inflation expectations increased and gilt yields generally declined slightly over the quarter.

Funding level and risk: The funding level is estimated to have improved over Q4 to c.102% as asset growth outweighed the rise in the value of the liabilities. It is estimated to have increased by 7% over the year to 31^st December 2021.

The Value-at-Risk rose over the quarter to £1,233m, mainly due to the increased allocation to equities under the new strategic asset allocation. Risk as a proportion of liabilities is lower compared to last year thanks to the decision to move to the dynamic equity option strategy.

Performance: Most assets delivered positive returns over the quarter, particularly the global equity portfolios. Property and infrastructure also generally fared well.

Relative performance was mixed at the mandate level, though the Hedge Fund and Core Infrastructure mandates have continued to stand out in outperforming their benchmarks. The Secured Income mandate has also done well over the year.

Asset allocation and strategy: The Fund terminated its holdings in Emerging Markets Equity, for which the strategic allocation was distributed between the High Alpha and Sustainable Equity mandates (which still contain emerging markets exposure).

From a strategic perspective, the allocation to Diversified Returns was also reduced, and the global equity mandates correspondingly increased in order to maintain the overall expected return of the portfolio in light of the reduction in emerging markets equities.

Total Fund performance attribution: Equities continue to be the biggest driver of returns and contributed over 70% of returns in the fourth quarter. The only detracting asset from class absolute returns over the period was Equity Protection (due to the rising underlying markets).

Performance vs. expected strategic returns: Returns have been above expectations for all global equity mandates, given the strength of equity markets since 2019.

Shirley Marsh-Hughes asked if a potential war in Europe would have a significant impact on the Value-at-Risk levels in terms of a 1-in-20 downside event.

Joshua Caughey replied that Covid-19 would also be put in the same scenario and that this highlighted the need for a scenario of differing portfolios as some asset classes might not suffer as much. He added that he felt that the Fund was in a strong funding position to do what it needed to going forward.

Steve Turner added that the dynamic protection would evolve with market levels, but said that sanctions imposed on Russia could damage economic growth.

The Panel, having been satisfied that the public interest would be better served by not disclosing relevant information, RESOLVED, in accordance with the provisions of the Section 100(A)(4) of the Local Government Act 1972 that the public should be excluded from the meeting for this item of business, because of the likely disclosure of exempt information as defined in paragraph 3 of Part I of Schedule 12A of the Act as amended.

Steve Turner highlighted points within Appendix 5 for the Panel.

We have seen increased global coordination in the fight against climate change, with the US, China, India, Australia and Saudi Arabia all now also committing to net zero targets; and significant degrees of innovation and resulting disruption across a number of sectors, most notably healthcare and finance.

To translate these and other developments into relevant themes for investors, we have identified three overarching themes which we believe will impact investment decisions in 2022 and beyond.

Changing of the guard: Understanding the effects of the changing fortunes of economic players and ways of thinking that have held sway for a long time, including the evolving responsibilities of monetary policies; the prospect of an “Asian century”; the dramatic re-morphing of how finance is provided.

Position for transition: How investors should plan for the changes required to put us on a most sustainable path; the role of impact investing; the management of resources to facilitate the green transition; and the power that can be exercised through engagement.

Modern diversification: How portfolios should be reinvented to hit target returns while maintaining protection; the use of dynamic allocation between strategies and themes; and how to gain access to emergent innovators.

Shirley Marsh-Hughes asked how in the reporting process can we capture more of the good work that we are doing with regard to climate change.

Steve Turner replied that the most likely way that they would be able to do this would be as part of the TCFD (Task Force on Climate-related Financial Disclosures) reporting process. He added data most readily available on equities and that they were working with Brunel to expand coverage where available and where the data is sensible.

He added that he felt it was unlikely that they would see quick progress in receiving accurate data in areas such as Private Markets. He said that there were developments and initiatives taking place within property and some multi-asset credit managers that could improve their data.

The Group Manager for Funding, Investment & Risk commented on the need for consistency in the data being received. She agreed that property and multi-asset credit were two likely areas to begin to receive accurate data. She added that this work would also require appropriate resourcing and conversations were being had with Brunel on this issue.

The Chairman asked if having currently withdrawn from emerging markets was presenting any particular difficulties given the prominence of Asian economies.

Steve Turner replied that not all themes and opportunities would be relevant to all clients. He said that there were reasons to be positive about China / Asia in the long term return perspective, but investors with net zero targets would find it challenging. He stated that they were trying to find the balance between achieving the expected returns whilst still achieving the net zero transition.

He said that having come out of emerging markets had allowed the Fund to invest further in sustainable equities. He added that should the position change significantly then there could be a case for re-engagement.

The Chairman asked what the advantages / disadvantages would be with regard to re-engagement with emerging markets, either as a whole or with the exclusion of China.

Steve Turner replied that if targeted exposure could be achieved and was easily implementable with Brunel, then we would have to judge whether it would be additive to returns, help to enhance returns, add genuine diversification and be consistent with your overall climate goals.

The Panel were minded to note the information as set out in the reports.