INVESTMENT PANEL REPORT

TEESSIDE PENSION FUNDAdministered by Middlesbrough Council

AGENDA ITEM 7

29 JUNE 2016

INTERIM CHIEF FINANCE OFFICER – MARK TAYLOR

PERFORMANCE REPORT

1 PURPOSE OF THE REPORT

1.1 To report on the performance of the Fund.

2 RECOMMENDATION

2.1 That Members note the report and agree to the Head of Investments carrying out a search for a replacement to the WM Company to provide performance monitoring reports in future.

3 FINANCIAL IMPLICATIONS

3.1 The performance of the Fund is one of the factors which the Fund Actuary takes into account when setting the Employer's contribution rate. Costs relating to investment management are charged directly to the Fund as a management expense.

4 BACKGROUND

4.1 The way in which the Fund's investments perform is measured by the WM Company, the leading provider of performance services to public and private sector pension schemes. These results are reported to the Investment Panel in accordance with the requirements of the Management Agreement.

4.2 Monitoring performance is one way in which Members can assess how well the Fund is being managed. Traditionally performance has been reported in two ways:

Firstly, the way in which the Fund has performed against other funds can be shown in a league table. This can be comprised of other Local Government Pension Scheme (LGPS) funds or funds of a similar size, or as has been traditionally the case for the Teesside Pension Fund, a universe of all funds, both public and private.

The other way of looking at performance is more tailor-made to an individual fund. To do this an assessment is made of the mix of

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investments which would produce the sort of returns which would, over the medium to long term, meet the liabilities of the Fund; in other words the pension benefits payable to scheme members. From this a benchmark can be created and the actual performance of the Fund measured against that benchmark. The benchmark is reassessed every three years as part of the Asset/Liability Study.

4.3 The WM Company is currently part of State Street, a US and multi-national bank and custodian, and has clients in both the public and private sector. State Street has decided to not continue to provide the performance monitoring service in the UK as from March 2016. This is a sudden and unexpected decision and leaves the Fund without a provider. Options are available, but members may need to compromise in future on the performance information received, e.g. percentile rankings against all Funds and the Local Authority Funds may not be available in future.

5. HEAD OF INVESTMENTS REPORT

5.1 2015 was another positive year for the Fund and most investors in general. Most of the major asset classes produced positive returns, particularly UK Property, which continued to benefit from attracting foreign investment into London in particular, and Private Equity, which for a second year producing a double digit return.

5.2 Bond performance was flat over the year, a contrast to the strong returns of 2014. Equities were mixed at year end, with most territories producing a modest return. Japan performed strongest out of the major markets as confidence grew with investors by signs of economic momentum. Emerging markets performed poorly.

5.3 The small positive rise in most markets at the end of 2015 hides a year of volatility, particularly in the summer and autumn months. As is often said in the Investment Panel meetings, investors hate uncertainty, and it is this uncertainty that causes volatility. Two areas of concern during 2015 were the slowing economic growth rate and currency devaluation in China, and the “will they, won’t they increase” story of US interest rates.

5.4 The asset allocation to “Alternative” investments for pension funds was again 9% of the average fund assets, and has remained at this level since 2011. This term covers a number of different strategies, the main ones being private equity, hedge funds, infrastructure, and commodities. The average funds allocation is still much greater than Teesside’s allocation.

5.5 Against this background the Teesside Pension Fund continued to build up its weightings in overseas equity and property, and took advantage of high bond prices making significant reductions in both overseas bonds and UK index linked bonds. In the year, a total of £23.7 million (net) was divested. Cash

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increased by £76 million to a year end amount of £150 million. The figures below show the detail:

Purchases Sales Net--------(£ millions)--------

UK Equities 119.7 118.1 1.6Overseas Equities 186.9 151.1 35.8Alternatives 8.4 18.2 -9.8Property 41.4 21.7 19.7UK Bonds 8.7 4.1 4.6Overseas Bonds 0 37.1 -37.1UK Index-linked 0 38.5 -38.5TOTAL 365.1 388.8 -23.7

5.6 In summary, as the outcomes set out in Section 6 show, Fund performance for 2015 was positive, but underperformed both the customised benchmark and our peers. The policy of being overweight in Equities, particularly in Asia Pacific ex-Japan, underweight in Property and Alternatives, particularly Private Equity, and holding a higher weighting in cash, negatively affected the Fund. The Fund has a mix of investments which differs vastly from the average fund and is highlighted in more detail in Section 6. Members are aware of this difference in asset allocation and have accepted that such a mix carries the risk of greater volatility and that the Fund’s performance can differ vastly from other funds.

5.7 One of the reasons performance measurement is important is that it enables the Investment Panel to assess the effectiveness of the fund management arrangements. The Fund has a regime of undertaking regular reviews of Fund Management Arrangements. These are carried out every 5 years by the Investment Advisors, in conjunction with the Head of Investments, with a report for approval to the Investment Panel. The last review was approved in March 2015.

6. PERFORMANCE

6.1 The total Fund return for calendar year 2015 was 2.2%, against a benchmark return of 4.1% and the average fund return of 2.9%, placing the Fund in the 62nd percentile of funds in the WM All Funds Universe, a universe made up of public and private sector funds. (Note that 1st percentile ranking is highest, 50th percentile is median and 100th percentile is lowest ranking of performance. This is the return for the calendar year, as is standard practice for this report, not the financial year. The financial year’s performance result are published in the Annual Report and Accounts.)

6.2 The most important measure of pension fund performance is over the long term. Pension Fund investment is a long-term business. The way the Fund is

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managed looks to take the long-term view while being open for opportunities to exploit short-term market opportunities.

6.3 The Fund’s performance over both 3 and 10 years is positive, 6.1% pa and 6.0% pa respectively. Over 3 years the Fund underperformed its benchmark by 2.8% pa and its peers by 2.2% pa (91st percentile ranking), and over the longer period of 10 years, the Fund has also underperformed its benchmark by 0.2% and its peers by 0.1% pa (58th percentile ranking).

6.4 The tables and charts below show the Fund’s returns over the last 10 years compared to the benchmark returns and the average fund returns.

Relative Performance v. Benchmark:

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 yr 10 yrFund 11.8 10.3 -17.3 21.8 14.7 -4.2 10.2 12.5 3.8 2.2 6.1 6.0B’mark 10.2 6.2 -16.7 16.9 14.0 -.03 9.6 16.4 7.4 4.1 9.1 6.3Rel Pfmce 1.5 3.9 -0.7 4.1 0.6 -3.9 0.6 -3.3 -3.4 -1.8 -2.8 -0.2

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 yr 10 yr

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Relative Performance v. Benchmark

Year

Relative Performance v. WM All Funds:

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 yr 10 yrFund 11.8 10.3 -17.3 21.8 14.7 -4.2 10.2 12.5 3.8 2.2 6.1 6.0WM 10.5 7.0 -17.2 15.1 12.7 3.6 8.4 11.0 11.7 2.9 8.5 6.2Rel Pfmce 1.2 3.0 -0.1 5.8 1.8 -7.6 1.7 1.4 -7.1 -0.7 -2.2 -0.1% Rnkg (21) (4) (46) (12) (15) (95) (38) (53) (97) (62) (91) (58)

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 yr 10 yr

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

Relative Performance v. WM All Funds

6.5 Analysing the performance further, the graph below shows the divergence in performance between the Teesside Fund and the Average Fund. This shows underperformance over all three time measures.

1yr 3yr 10yr0

1

2

3

4

5

6

7

8

9

Annualised Rate of Return

Av FundTPF

6.6 In December 2014, the Asset/Liability Study (ALS) was reported to the Investment Panel. The Panel were informed at that time of the differences in asset allocation between the Teesside Fund and other Pension Funds. This is illustrated with the asset allocation of the Fund compared to the average fund and to the customised benchmark agreed as part of the ALS.

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Av Fund 2006

Av Fund 2012

Av Fund 2015

TPF 2006 TPF 2012 TPF 2015 Cust B'mark0

20

40

60

80

100

120

Asset Allocation

Equities Alternatives Property Pooled Multi Bonds Cash

6.7 The table below emphasises the difference between the average fund and the Teesside Fund’s actual allocation and the customised benchmark as at December 2015:

Asset AllocationAv Fund % TPF B’Mark

%Diff. % Actual TPF

%Diff. %

Equity 45 70 +25 83 +38Alternatives 9 5 -4 2 -7Property 8 10 +2 7 -1Pooled Multi 1 0 -1 0 -1Bonds 36 13 -23 3 -33Cash 1 2 +1 5 +4

6.8 Over the past 10 years the average fund has increased allocation to bonds and alternatives considerably at the expense of equities. In contrast, the Teesside Fund has shifted its allocation in the opposite direction, increasing the allocation in equities by 14% over the past 10 years at the expense of bonds and cash which have reduced by 11% over the same period.

6.9 For 2015, the difference in performance returns between the average fund (2.9%) and the Teesside Fund (2.2%) was 0.7%. Explaining how this difference occurred, the graph below shows performance for each asset class in 2015:

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Equity Alternatives Property Bonds Cash

-10

-5

0

5

10

15

Performance Return %

Av Fund Return % TPF Return %

6.10 From an asset allocation view, it can be clearly seen that the Fund is underweight its customised benchmark and its peers in the best performing asset groups (Property & Alternatives) and overweight in Equities which performed much poorer. The above graph also shows the difference in returns between the average fund and Teesside Fund. As well as asset allocation decisions, stock selection decisions have impacted performance negatively with underperformance in Equities, where the Fund is overweight, and Alternatives. This is better illustrated in the following chart and graphs which shows the impact on relative performance of both asset allocation and stock selection when comparing the Fund to the average fund.

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3yrs 10yrsFund 11.8 10.3 -17.3 21.8 14.7 -4.2 10.2 12.5 3.8 2.2 6.1 6.0All Funds 10.5 7.0 -17.2 15.1 12.7 3.6 8.4 11.0 11.7 2.9 8.5 6.2Rel Pfmce 1.2 3.0 -0.1 5.8 1.8 -7.6 1.7 1.4 -7.1 -0.7 -1.4 -0.1P’cile Rnk (21) (4) (46) (12) (15) (95) (38) (53) (97) (62) (91) (58)Asset All. 1.6 0.0 -2.2 3.7 1.7 -6.4 1.9 5.5 -3.3 0.9 0.9 0.3Stock Sel. -.04 3.0 2.2 2.1 0.1 -1.2 -0.2 -3.8 -3.9 -1.6 -3.1 -0.4

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 yr 10 yr

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

Asset Allocation Impact

Asset Allocation Impact

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 yr 10 yr

-5.0-4.0-3.0-2.0-1.00.01.02.03.04.0

Stock Selection

Stock Selection Impact

6.11 Carrying out the same comparison of the Fund’s relative performance to the customised benchmark and showing the impacts from asset allocation and stock selection performance give the following result:

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3yrs 10yrsFund 11.8 10.3 -17.3 21.8 14.7 -4.2 10.2 12.5 3.8 2.2 6.1 6.0B’mark 10.2 6.2 -16.7 16.9 14.0 -0.3 9.6 16.4 7.4 4.1 9.1 6.3Rel Pfmce 1.5 3.9 -0.7 4.1 0.6 -3.9 0.6 -3.3 -3.4 -1.8 -2.8 -0.2Asset All. 0.2 -0.4 1.3 -0.1 0.0 -3.2 -0.1 -1.1 -2.3 -1.0 -1.4 -0.7Stock Sel. 1.3 4.1 -1.9 4.0 0.7 -0.1 0.7 -2.2 -1.1 -0.8 -1.4 0.4

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 yr 10 yr

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

Asset Allocation

Asset Allocation Impact

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 yr 10 yr

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Stock Selection

Stock Selection Impact

6.12 Confusingly in 2015, the asset allocation strategy was not suitable to achieve higher performance returns compared to the Fund’s customised benchmark, but outperformed other Funds by 0.8%.

6.13 With so much of the Fund invested in Equities (83%), it is always this asset class that determines how well the whole Fund performs. There were regional disparities in performance during 2015. Approximately half of the whole Fund is invested in UK and Asia Pacific Ex-Japan Equities. The returns from these markets for 2014 were -0.6% and -3.5%. The returns from US and European markets were 8.5% and 6.4% respectively. Only Japan (6% of the whole Fund at the year-end) performed very well last year with a double-digit return of 17.4%.

6.14 From Equities, the worst performing territory from stock selection was UK Equities (-0.6%). It was reported in last year’s Performance Report that falling iron ore and oil prices negatively impacted in 2014 as the Fund holds a larger than average proportion investment in companies related to these

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commodities. These commodities and the companies whose business is related to them have benefitted greatly in the past from Asian, and particularly Chinese, demand and growth.

6.15 The Fund continues to support the position that demand and growth in Asia remains robust over the longer term; hence the continued overweight asset allocation to Asia Pacific ex-Japan. This comfort contributed to a continued overweight position in commodities and oil, however these assets performed poorly again during 2015. Some recovery has been seen in Q1 2016.

6.16 In other asset classes, the Fund has very little invested in its Alternatives, but our Alternatives portfolio consists of Commodities, Infrastructure and Absolute Return Funds. In this asset class the best returns were from Private Equity (11%) and Hedge Funds (5%) – investments disliked by the Teesside Fund.

6.17 The Fund's strategy in Alternatives is to retain a limited portfolio of Infrastructure and Commodity assets. The benchmark is based on an absolute return, but the portfolio is not structured to be controlled to this in the short term. Commodity prices suffered heavily in 2015, which reflected negatively in the stock selection return (-0.3%).

6.18 In Bonds, previous evidence that other Funds are increasing their risk in comparison to the Fund, investing in Emerging Market Debt and higher yielding Structured Finance and other types of Credit did not follow through with higher returns. However, in Cash other funds reported an average return of 1.9% compared to base rates (0.5%) and our return (0.5%). Given Bonds and Cash are the Fund’s protection assets and the size of the amount invested in growth assets, it is not appropriate at this time for the Teesside Fund to follow other funds and invest with greater risk in these asset classes.

CONTACT OFFICER: Paul CampbellHead of Investments & Treasury Management

TEL. NO.: (01642) 729024

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