Local Government Pension Scheme (LGPS) funds and their employers could see their contribution costs increase if they unnecessarily de-risk their investment strategies, Local Pensions Partnership Investments (LPPI) has warned.

It noted that, as the LGPS’s next triennial valuation approaches, many funds are expected to have healthy funding positions, even on a low-risk basis.

As funds move into greater surplus, LPPI said that it had been traditionally assumed that funds would de-risk by shifting their strategic asset allocation to lower-risk assets.

However, analysis from LPPI estimated that shifting just 10 per cent of asset allocations from publicly traded stocks to fixed income assets would increase contributions by up to 3 per cent a year.

LPPI therefore posed the idea of a funding ‘risk appetite smile', whereby better funding would permit more risk taking and more investment in economically and socially productive assets.

“Some advisers to the LGPS need to fundamentally rethink their client fund’s relationship with risk,” commented LPPI head of investment strategy, Max Townshend.

“Decisions too often focus on the next valuation cycle and ignore the long-term impact of expected returns on contribution costs borne by employers.

“Yes, there are times when bonds can play a valuable role in asset allocation, and the recent back-up in gilt yields is an example of where someone might like the tactical opportunity.

“But strategically de-risking drives up the ultimate cost of employer contributions at a time when budgets are already stretched.

“Being mindful of risk but embracing the power of returns to deliver attractive benefits at affordable costs should be at the heart of an open and long-term defined benefit pension system like the LGPS.”

Townshend argued that there was an opportunity for the investment mentality to shift and, instead of using surpluses to play it safe, many employers could benefit by funds and their consultants considering how they could make the most of this ‘headroom’ and maintain their investment in higher-reward strategies aimed at long-term cost reductions.

“These investments can often be more productive for the employers’ wider regions, and for the nation,” Townshend concluded.

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