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United Kingdom, Institutional
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Key points
- We estimate that the Local Government Pension Scheme (LGPS) will become cash-flow negative within the next five years, with an ageing membership leading to an increasing cash-flow mismatch as contributions decline and benefit payments increase.
- To counteract the impact of this cash-flow mismatch, schemes within the LGPS are considering ways to secure higher levels of investment income within their portfolios.
- We believe LGPS schemes will face three challenges to securing this investment income: 1) a lack of dynamism and diversification, 2) inconsistency of income and 3) their liquidity profile.
- Wellington has designed a multi-asset income solution that aims to address these three challenges and provide secure regular income for LGPS schemes: the Wellington Dynamic Diversified Income Fund (the DDI Fund).
- The DDI Fund is a dynamic portfolio that seeks to deliver regular income sourced from highly liquid investments and aims to pay out of the portfolio’s natural yield.1
An evolution of the LGPS
Since Wellington started managing assets for local authority pension schemes in 1999, the number of members who are active employees has fallen significantly. This evolution in membership has led to a cash-flow mismatch, with fewer employees providing regular contributions and more former employees requiring benefit payments to be made.
We compared the contributions (inflows) with the benefits paid (outflows) for each of the 86 schemes in England and Wales (Figure 1). Each dot on these charts represents an LGPS scheme. Schemes with a cash shortfall (which we define as the excess of the benefits paid over the contributions) are represented by the dark-blue dots, and those with no cash shortfall are represented by the light-blue dots. We have observed a clear trend to the left of the diagonal line between 2012 and 2020, as expenditure has stayed relatively constant and contributions have declined. For ease of comparison, both metrics are shown relative to the market value of the scheme.
Figure 1
The implications: how are LGPS schemes managing this cash shortfall?
To manage this cash shortfall and pay their pensioners without needing to redeem any holdings, LGPS schemes are turning to one primary solution: investment income. As the need for income has increased with the fall in contributions, LGPS schemes are increasingly…
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Key topics and themes
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1INCOME MAY FLUCTUATE IN ACCORDANCE WITH MARKET CONDITIONS, IS NOT GUARANTEED AND MAY BE PAID FROM CAPITAL. Natural yield is defined as any income produced that does not eat into the capital value of the investment. | INVESTORS SHOULD CONSIDER THE RISKS THAT MAY IMPACT THEIR CAPITAL, BEFORE INVESTING. THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE FROM THE TIME OF THE ORIGINAL INVESTMENT.