Bruno Bamberger: LGPS funds cannot afford to neglect their investments
It is a truly pivotal time for the Local Government Pension Scheme (LGPS). Surpluses skyrocketed throughout 2024, with the aggregate funding level having recently hit 112%, and a record high surplus of £45bn being reported on a low-risk basis.
At the same time, cooling inflation brings with it hope that cashflow pressures will soon begin easing for LGPS funds, while the government's Fit for the Future consultation has set out game-changing proposals for the LGPS with regards to pooling, local investment and governance.
With the government expecting 100% of LGPS funds to have been pooled by March 2026, pooling will undoubtedly consume the lion's share of funds' governance budgets in 2025. But LGPS funds cannot afford to neglect their investments and must remain laser focussed on allocating in a way that will boost financial outcomes while supporting their strategic objectives.
There are three major investment themes for LGPS funds to keep front of mind for 2025.
Supporting UK economic growth
Pressure has been building for LGPS funds to increase their allocation to UK assets, with the government's proposals to set a target allocation for local investment being the latest in a series of moves to catalyse investment in the sector.
While it would seem the government is now pushing Funds to put emphasis on the area within which they are based, with the ultimate aim being to boost UK investment overall, Funds should not be overlooking potential easier wins to increase exposure, such as opportunities in UK equities, or sterling credit.
On the whole, UK companies are currently reporting robust underlying earnings, forecasts are prudently set, and valuations remain attractive in the context of history and relative to global equity markets. For larger LGPS funds in particular, mid-cap UK stocks may offer both growth potential and increased capacity.
Is de-risking a good idea?
Many LGPS funds will use the current environment as an opportunity to de-risk, helping to lock in the surplus by reducing the chances of it being lost by adverse market moves.
Re-allocating funds to fixed income – such as global high yield, alternative assets like asset-backed securities, or emerging market debt – is one of the most common ways to do this, while not significantly reducing the expected return versus equities. This is thanks to the new era of higher yields across liquid fixed income strategies providing better opportunities for long-term investors than they have in over a decade.
If LGPS funds wish to de-risk further, high quality buy and maintain strategies can be a terrific way to obtain cost-efficient access to the investment grade credit market. Further, they can also be designed to provide a regular cashflow stream to match member payments, as required.
Elsewhere an allocation to short duration bonds is worth considering for those looking to de-risk, with short duration strategies being less volatile and dependent on day-to-day movements in interest rates versus longer-maturity fixed income assets, as well as being attractive due to the current flat yield and credit spread curves.
The path to sustainability
Net zero commitments and broader sustainability goals have been a core consideration for the LGPS in recent years but, with the focus quickly shifting from target-setting to implementation, there are some key points to keep in mind.
Most important of all is taking a holistic approach. With the evidence showing that, in the medium to long-term, businesses which are climate-focussed, socially aware and displaying the best governance practices to be most likely to outperform, or at least not underperform their peers. More than ever implementation of ESG and sustainability objectives should not be confined to one or two asset classes, but integrated across the entire portfolio, from UK equities and fixed income, to alternative investments.
In the context of net zero objectives, the road to implementation will be challenging and there is no single path or answer to navigating it. However, there are plenty of ready-made strategies out there which can help LGPS funds gain strategic advantage depending on which ‘shade of green' they are looking to capture from an integration point of view. From carbon transition and green bond funds, to those themed around people and planet, these are strategies that can support a Fund's sustainability objectives without, crucially, sacrificing returns.
In particular, it is worth exploring solutions investing in biodiversity and social impact too. With these themes set to gain prominence in the coming years, we see these asset classes as genuine diversifiers to portfolios and expect to see increasing interest from the LGPS as they look to drive forward their net zero journeys.
But primarily, LGPS funds need to have certainty that sustainable strategies such as net zero do not compromise long-term returns. This is a key consideration for further increases in exposure to such strategies, with biodiversity being a very good example.
Where now – and how?
The financial health of LGPS funds remains top priority, so any shift in investment approach must first be carefully considered in the context of their long-term objectives and risk profile.
Whether an LGPS fund is at the point of directly pre-pooling or working with respective pools to invest into, in an ever-changing landscape, keeping these three themes – supporting UK growth, de-risking and sustainability – front of mind will enable them to put their best foot forward and effectively navigate the opportunities and challenges that lie ahead.
Bruno Bamberger is co-head of fixed income investment specialists at AXA Investment Managers
