Contact: Ian Howell, (01962) 847540; email: [email protected]

1 Summary

1.1 This report reviews the policy for managing the Hampshire Pension Fund's cash balance, for the Panel's approval.

2 Recommendation

That the County Treasurer be authorised to manage the Fund's cash balance in accordance with the policy set out in this report.

3 Background

3.1 The Panel considered a full report on the management of the Fund's cash balance at its meeting on 25 May 2007. It agreed a detailed policy for the County Treasurer to apply in managing the cash balance, including a requirement for the policy to be reviewed annually.

3.2 The Pension Fund's cash balance is held by the County Council and managed by the County Treasurer. It is placed on deposit as part of the management of the County Council's overall cash balance. Interest is paid to the Pension Fund by the County Council at the seven day market interest rate. On occasions when the available interest rates are advantageous, amounts are placed on specific longer-term deposits for the Pension Fund and the interest earned from those deposits is credited directly to the Fund. The County Council has rigorous procedures in place to ensure the security of all cash deposits, including criteria for the quality of counterparties and limits on the amount that can be placed with any one party. An Annual Investment Strategy is approved by Cabinet and County Council in February each year.

3.3 The Pension Fund requires a cash balance to be able to pay pensions and other benefits. The Fund receives cash each month from contributions by employees and employers, and from investment income. Dividends from shares and interest receipts from bonds are retained by the fund managers for reinvestment, but rent income from the Fund's direct property portfolio is credited to the Fund's cash balance held by the County Council. Distributions from the Fund's alternative investments will also be paid to the County Council.

3.4 The Fund currently generates a surplus of income over expenditure of around £67m per annum as the annual income from contributions and investments exceeds the annual outgoings on pensions and benefits. This surplus is expected to continue at this level or a little higher, at least for the medium term, in line with the actuary's assessment of the need for higher contributions to reduce the Fund's deficit. The surplus is invested to meet the Fund's future liabilities.

4 The current policy for managing the Fund's cash

4.1 The Panel agreed the following policy on 25 May 2007:

· a minimum cash balance of £20m should be held by the Fund for cash flow purposes

· the Fund's cash balance should be held as cash and not transferred to the equity and bond managers for longer-term investment until the two property portfolios are fully invested

· 65% of this temporary cash balance should be equitised using FTSE 100 Index futures to gain exposure to the UK stock market. (This policy is reviewed in section 5 of this report)

· the increase in the alternative investments portfolio to 10% of the Fund should be funded over the next three to four years from the Fund's positive cash flow

· the County Treasurer is authorised to transfer additional cash to the managers for long-term investment at regular intervals, using these transfers if necessary, to rebalance the Fund's strategic asset allocation

· the Fund's remaining cash balance should be placed on deposit by the County Treasurer in accordance with the County Council's Annual Investment Strategy

· interest will be paid to the Fund by the County Council on the cash balance on the basis of the seven-day market interest rate or, if specific deposits are made in respect of the Fund's cash balances, the interest actually earned by those deposits

· the County Treasurer will report to the Panel annually on the Fund's cash balance.

4.2 The report on 25 May 2007 included a forecast that the Fund's cash balance at 31 March 2008 would be £44m. In the event, the actual cash balance was higher at £162.5m. The main reason for the increase was that the Fund's UK property manager CB Richard Ellis made fewer purchases in 2007/08 than expected, because of the impact of the credit crisis on the property market. The rate of drawdown by the Fund's alternative investments was also a little slower than estimated.

4.3 The cash movements in 2007/08 are summarised below, together with a forecast of the cash balance for the next three years.

4.4 The cash balance will be kept under review during 2008/09. At some stage over the next two years, it will be necessary to transfer part of the cash balance to the fund's investment managers for longer term investment. Because of the uncertainty over the pace of investment in the property and alternative investments portfolios, it is suggested that no firm plans are drawn up now for this transfer. The position can be reviewed again in May 2009.

4.5 The County Treasurer will continue to monitor closely the impact of the credit crisis on the financial institutions used for depositing the Pension Fund's cash, including their credit ratings and the maximum sums that may be placed with each institution.

5 Equitisation of the cash balance

5.1 Holding a large balance in cash can involve risks for the Fund from not being invested in equity and bond markets should they rise. With this in mind, part of the cash balance was `equitised' in mid February 2007 with the assistance of Aberdeen Asset Management in order to gain exposure to the movements of the stock market. Initially £150m (around 65%) of the cash balance was equitised using FTSE 100 Index futures. The 65% represented the proportion of the Fund's strategic asset allocation invested in equities. The £150m was reduced to £100m in April 2007 and to £65m in July 2007 as the cash was required for longer-term investment.

5.2 With the prospects for stock markets looking increasingly volatile, the County Treasurer terminated the equitisation on 12 December 2007. Since then, the FTSE 100 Index fell 17.5% by mid March 2008 but has recovered a little to be 5.3% lower by 13 May 2008. With prospects for UK equities still difficult to predict, there are no strong grounds for re-equitising the cash balance. The interest rates available on cash deposits remain attractive and it seems sensible to hold cash during this period of volatility and uncertainty.

5.3 The equitisation of cash between February and December 2007 generated an additional £0.75m for the Fund compared with simply placing the cash on deposit. This gain reflects the small rise of 1.6% in the FTSE 100 Index over the period.

6 Re-balancing the Fund's strategic asset allocation

6.1 The cash management policy agreed in May 2007 recognised that it might be necessary to use part of the cash balance to adjust the Fund's actual asset allocation between equities, bonds and property if changes in market values have moved the asset allocation outside the range of tolerances around the central strategic asset allocation agreed by the Panel.

6.2 As reported to the Panel's last meeting, the Fund remains within these tolerances and no action is currently necessary to re-balance the asset allocation.

7 Interest earned by the Fund

7.1 Interest is credited to the Fund in two ways:

· as the actual interest earned on specific external deposits of Pension Fund cash, and

· at the seven-day interest rate on cash held internally by the County Council.

7.2 During 2007/08, the Fund earned an average of 5.79% on its specific external cash deposits which were mainly for periods of three, six, nine or twelve months. The average seven-day rate used for the remaining balances was 5.65%.

7.3 This return on cash in 2007/08 was better than the return on equities but lower than global bonds and UK index linked bonds.

Global equities	MSCI World Index	-4.0%
UK equities	FTSE All Share Index	-7.7%
Global bonds	Lehman Bros Index	+7.0%
UK index linked bonds	FTA over 5 years Index	+13.5%

8 Future cash management policy

8.1 No changes are proposed to the existing policy set out in paragraph 4.1 with the exception that the consideration will only be given to re-equitising part of the temporary cash balance if prospects for UK equities are thought to have improved.

8.2 The proposed policy for 2008/09 is summarised in Appendix 1.

Section 100D - Local Government Act 1972 - background documents

The following documents discuss facts or matters on which this report, or an important part of it, is based and have been relied upon to a material extent in the preparation of this report.

NB: The list excludes:

None.

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Appendix 1

Policy for managing the Fund's cash

A minimum cash balance of £20m should be held by the Fund for cash flow purposes.

The Fund's cash balance should be held as cash and not transferred to the equity and bond managers for longer-term investment until the two property portfolios are fully invested.

Consideration may be given to equitising part of the temporary cash balance using FTSE 100 Index futures to gain exposure to the UK stock market if prospects for the market improve.

The increase in the alternative investments portfolio to 10% of the Fund should be funded over the next two to three years from the Fund's positive cash flow.

The County Treasurer is authorised to transfer additional cash to the managers for long-term investment at regular intervals, using these transfers if necessary, to rebalance the Fund's strategic asset allocation.

The Fund's remaining cash balance should be placed on deposit by the County Treasurer in accordance with the County Council's Annual Investment Strategy.

Interest will be paid to the Fund by the County Council on the cash balance on the basis of the seven-day market interest rate or, if specific deposits are made in respect of the Fund's cash balances, the interest actually earned by those deposits.

The County Treasurer will report to the Panel annually on the Fund's cash balance.