Agenda item

Representatives from Aegon will be present to provide a presentation as part of this item. A copy of the presentation slides is attached.

The Committee considered a report of the Director of Corporate Resources which provided the Committee with background information on the Leicestershire Pension Fund (Fund) Investments held with Aegon asset management and the performance of bonds generally. A copy of the report marked ‘Agenda Item 6’ is filed with these minutes.

Mr Richard McGrail, Mr Rory Sandilands and Mr James Lynch of Aegon Asset Management were in attendance and supplemented the report with the presentation which was included with the report.

Arising from the presentation the following points arose:

      i.         There had been a modest drop in the client valuation of the Global Short Dated Climate Transition Fund since inception and the top up of £60million in March 2022. The Fund now valued £82.3m

     ii.         In terms of market review, 2022 had been a challenging year for bond markets in general, with a number of factors contributing, including the recent pandemic, persistence in inflation and the war in Ukraine which had exacerbated supply chain problems, and had contributed to central banks raising base rates over the course of the year to levels not seen in recent years.

    iii.         It was noted on the index linked bond portfolio there had been an almost 30% drop in returns over 2022. It was explained that index linked bonds were a long duration asset which meant they were very sensitive to movements in interest rates.

   iv.         In response to a question as to whether index linked bonds should be classed as a riskier investment rather than a protection asset as the Pension Fund currently classed them, it was noted that it was dependent on the assumption of risk or protection and what liabilities they were being held against. Over the past two to three years, the movements in index linked bond prices had become a more volatile asset class, and an increased risk with uncertainty in inflation and interest rates, and it was further believed that volatility would be experienced in future years.

     v.         It was noted that when looking at a longer-term view on inflation, taken into consideration was CPI or the RPI inflation as there was almost a 1% difference. It was explained that since 1997 up to the start of the Covid-19 pandemic, there had been a 2% average CPI inflation over that period. The assumption going forward was that there would be structurally higher inflation than the post financial crisis, but it was hard to predict over a 20-year average.

   vi.         Interest was paid on the nominal value of the bond multiplied by the RPI rate, for example, when it came to redemption, the figure was the RPI fixing in 20 years multiplied by the nominal value.

  vii.         In relation to inflation expectations it was asked that, as nations looked to reduce the amount of goods it was outsourcing abroad, if it would lead to inflation being higher structurally. In response it was acknowledged this change could be one of the reasons for rising inflation. It was noted that from the UK’s point of view it had been fortunate to have a ‘just in time’ economy, receiving quick imports from cheaper sources. Unfortunately, the fragility of supply chains had been seen through Covid, and there would be more onshoring of goods, not just in the UK but in other countries also. The fragilities in the global system and security of the supply chain of goods, whether food, energy security, and even defence security, would all lead to structurally higher inflation than previously experienced.

 viii.         It was noted it had been a very challenging year, but it was firmly believed that this asset class over the medium to long term did display characteristics of being very resilient in terms of yield and capital return.

   ix.         The Bank of England had been raising rates aggressively (as seen in the deposit rates) and shown in examples given in the presentation for short-rated gilts and short rated bonds assets in the portfolio. With the cost of living issue and slowdown in the mortgage market, it was thought the Bank of England would not push to further increase rates, and the next period should be more positive.

     x.         Reference was made to breakdown by credit rating, with the heavy weighting on the triple B percentage at over 45%. It was asked if, with the current economic crisis, companies were at risk of slipping beyond that figure. In response, it was reported that the portfolio had a limit of 70% triple B risk, and that the position reflected caution towards the current market. It was noted the last few years of very low interest rates had allowed a lot of investment grade companies to term out to longer maturity debt, which meant they did not have to face re-financing risk and had longer-term security. It was further noted that credit rating agencies had more companies on upgrade than downgrade risk through 2022 and it was only recently the position was beginning to shift, reflecting the fact the outlook was more challenging.

   xi.         It was reiterated that the Fund’s portfolio was short-dated, within the region of 25% of the bonds maturing every year, and therefore there was no immediate concern of default risk. Whilst there might be the one or two companies in the portfolio facing pressure over the next 12-18 months, there was capacity within the portfolio to hold onto such companies and confidence remained that all the securities in the portfolio would be paid.

  xii.         In response to a question regarding the Fund’s name, it was noted that it had changed earlier in 2022 to the Aegon Global Climate Transition Fund following a piece of work undertaken in order to factor in climate transition framework into the portfolio to reflect a new investment philosophy and provide relevance to investors. In practice the fund sought to direct its investors to those companies with robust and credible transition plans towards a net zero future.

 xiii.         Climate guidelines were there as a steer and over time the portfolio would be adjusted, with a focus on shift to better companies regarded as leaders, and those names that failed to improve their transition credentials would more likely be disinvested in, by not being reinvested in rather than sold. The output of that work meant there was an additional target within the portfolio of weighted average carbon intensity, a commonly used measure of carbon impact across portfolios.

xiv.         In response to a question as to what metrics or trigger points would lead to potential staged disinvestment, it was emphasised that this was not an exclusionary approach to transition, but an approach to invest in companies best positioned for the transition. One of the trigger points could be that one of the targets had not been met, for example, when looking at what interim targets those companies had set themselves to reduce their carbon footprint over the next ten to twenty years. The assessment of a company would be more holistic rather than focussing on one quantitative metric like carbon intensity or absolute emissions. It was suggested that the trigger for disinvestment could be identified when the portfolio had to be reviewed in 2024, but companies would continue to be monitored.

  xv.         The different levels of the weighted average carbon intensity (WACI) metric measure of carbon reduction were Laggard (bottom), Unprepared, Transitioning, Prepared and Leader (top). In response to a question, it was explained that Anglian Water were classed as ‘Unprepared’ based on their initial (base) assessment which would include what they had done to date, what their targets were over the medium term and the long term and how aligned their corporate strategy was with those targets. They then had a sector adjustment which placed them as one of the weaker companies compared to other water companies in the UK, in terms of ambitions, targets and the realism of those targets.

RESOLVED:

That the report and presentation be noted.