George Graham, director of the South Yorkshire Pensions Authority, talks to portfolio institutional about hitting carbon targets, alternatives, investing locally, the benefits of working with other schemes and inflation.
What changes have you implemented since joining South Yorkshire Pensions Authority as fund director in 2018?
Quite a number. Some of them were going to happen anyway, such as pooling. More than two-thirds of the fund is pooled, and by the end of the year property will be the only asset that is not. That will happen in 2022.
And then there are the legacy alternatives, which are running-off. The re-investment will be in the pooled products, which was always going to be the case. We will have 95% of the fund pooled by the end of 2023.
That has resulted in changes to what we do around investment, moving from directly running money to an organisation that oversees people running money. So there has been a change in mindset. We transferred six of our staff to the pool, which for an organisation with around 100 people is a significant change.
The other changes have been around managing the organisation. We have restructured the corporate functions and the pension administration function to make it more customer focused – that is to make it easier for scheme members to contact us. This also helps us to focus on employers better and support them. And that has paid off during the pandemic.
What about on the investment side?
One of the strengths of South Yorkshire as a fund is the consistent approach that has been taken over time. We do not make big changes in the investment strategy. And we are not big risk takers. We are active investors, but our equity mandates, for example, target the benchmark plus 1% and we consistently achieve that.
So, we do not see the stunning returns that some mandates do, but we see good, consistent returns, which has eroded the deficit of the fund. The estimate, as of March 2021, was 108% – so an 8% surplus. March 2020 was difficult, with markets falling off the edge as a result of the pandemic. That means we have been able to capitalise on the strong performance that followed.
We had an equity protection policy that protected us, rolling off from April to June last year. So, rolling off at just the right time, meaning that we were able to capture much of the equity upside. The end of June valuation saw the fund at a record level.
We are also rebalancing into alternatives. We have put more money into some credit portfolios, which later this year will transition into a multi-asset credit fund. There is better value there than in gilts, for example.
The fund has committed to being carbon neutral by 2030, which you wanted pushed back to 2050. How optimistic are you of fulfilling that commitment?
If we take the March 2020 position as the baseline on all the portfolios we measure, the reduction in the year to March 2021 has been at a pace ahead of a straight-line reduction to 2030.
Getting to net zero by 2030 is going to be tough, there is absolutely no doubt about it. Certain elements of the portfolio give us levers that some of our colleagues do not have: our large exposure to agriculture, for example, as well as to renewables and clean energy. So those are things that help.
By around 2025 we will be faced with making decisions about the balance of our equity portfolio and how we deploy cash there. The key challenge is that equities are on a downward path. We need to understand our starting point in a way that gives us a much better understanding of how far we have to travel.
The 2025 schedule gives us time to work on building our exposure to climate opportunities. We are making progress, but it is going to be tough. We are trying to move at a faster rate than the market, but this is the most systemic risk to our pension fund.
What will the carbon neutral commitment mean for your investments?
One of the challenges for the industry is to think about net zero in a positive sense, and we want to reframe the debate in that way. Some of that reflects our investment approach, where we favour engagement over divestment.
We already have a clean energy and renewables focus in the alternatives portfolio and have been building that up for some time. We are beginning to see a focus on a wider range of climate opportunities. Things like alternative power sources like hydrogen, alternative proteins – those sorts of things. So, going beyond solar power and wind turbines. It is looking at other things that will help us make the transition to a low carbon economy.
It is about a low carbon economy, rather than just an energy transition. Ultimately, we are here to make money to pay people’s pensions. So, we need to ensure as changes happen that we are not fundamentally changing the risk balance in the portfolio.
A report noted that the South Yorkshire Pension Fund has a long-standing commitment to “investing locally to generate commercial returns and positive local impacts”. Why is investing locally, and with impact, important to the fund?
On the local part, the clue is in the name South Yorkshire. Our board is made up of councilors who are connected to the local area, which is different to a big corporate scheme. We have the real connection to a place. What we are trying to do is take a different approach to making returns. What we do is find a niche where others are not playing, so we can make more money.
With the loans to support local property development that we are making, we are playing in a space where the banks have ceased to operate, certainly locally. This gives us an opportunity to make returns that more than meet our return hurdle, with an appropriate level of risk. And some of this would not happen if we did not get involved, but it will only ever be a small part of the fund.
What future impact investments do you have in the pipeline?
There are a number of local development loans that we are examining. We expect to fully allocate that halfway through the next calendar year, so becoming a revolving fund of loans. We will be looking at a range of impact funds that managers are raising money for. When we do the next strategy review at the back end of the next calendar year, we will be looking explicitly at a more impact allocation.
Real estate has been a focus for the fund: what are the benefits to the fund?
Real estate is 10% of the fund. It is partly in there as inflation protection and because it generates a steady income stream. The past 18 months have been interesting in terms of the income stream, but our portfolio is fairly skewed to logis- tics and industrials – they have not suffered in the same way as retail.
How important is a wider commitment to ESG to the fund, and what impact does this have on your investments?
We are reviewing our focus around responsible investment and ESG issues. They have always been important – part of our organisational DNA. It therefore continues to be an important area of focus, but not at the expense of returns.
We have a set of organisational values and want to invest in line with them. The evidence is that we have been successful in doing that over a long period of time. ESG also influences how we steward our investments, our approach to stewardship and that focus.
In terms of where we are making specific choices, if we had to choose between two alternative funds targeting the same returns, the one that had better ESG characteristics would win.
ESG is fundamental to what we do. Ultimately, it is not separate to our thinking, but part of all our decisions.
Have you made savings as part of the LGPS pooling regime?
We have seen some reductions in cost. There were quite a lot of collective vehicles in the equity portfolios, many have been unwound, which has reduced costs. But we will not see overall savings for some years. We started from a low-cost base because we were running the money ourselves.
How has the whole pooling experience been for the fund?
It has been an incredible amount of work. We are essentially buying the same product as we had before, but it is now being run through a more sustainable business model, there are significant additional resources being deployed in support to help us achieve our objectives – particularly concerning resources around responsible investment. That ability to work with other people to deliver a good product, in the right way, has been a real positive. So, from that point of view, the pooling process has delivered and been successful.
What major challenges have you faced as director?
Suddenly telling all our staff they have to work at home. Having to adapt to that situation almost instantly was a great challenge. We continued though and every- thing achieved through that period is down to our staff. It was extremely challenging as a manager, not being able to interact with your staff the way you would normally do, particularly as at the beginning we did not have TEAMS.
On an investment level, there was a challenge around the pooling process. We had to change our mindset from being a direct investor and manager of money to an overseer of investment managers. Achieving the more strategic focus that we need to have in terms of our investments, has been a challenge.
How do you view the uncertainty around the inflationary environment?
Inflation picking up is a concern, as it is a key driver of our liabilities. We have some inflation hedges within the portfolio, but it is a clear risk. It is one we keep looking at and reflecting on. It is some- thing we must keep an eye on, because of the potential impact on the funding level.
What objectives do you have for the fund?
On the investment side, it is to maintain the funding level. We want to maintain the stable contributions for employers. It is always a challenge, but we need to keep this level of funding.
If future returns are going to come down, which all the actuaries and others are saying, then that will be challenging in terms of employer contributions. Actuaries often say this, but, and I loath to say it – this time they may be right.