Archived decisions

HAMPSHIRE COUNTY COUNCIL

Decision Report

1. Executive Summary

1.1. This report provides an annual review of the policy for managing the Hampshire Pension Fund's cash balance.

2. Background

2.1. The Panel last considered a report on the management of the Fund's cash balance at its meeting on 23 May 2008. 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.

2.2. The Pension Fund's cash balance is held by the County Council and managed by the County Treasurer as part of the County Council's overall cash balance. Unless specific deposits are made on behalf of the Pension Fund, interest is paid to the Pension Fund by the County Council at the seven-day notice market interest rate. This rate is specified as the minimum interest payable in statutory regulations governing the Local Government Pension Scheme.

2.3. On occasions when the available interest rates are advantageous, amounts are placed on specific longer-term deposits for the Pension Fund. 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 counterparty. An Annual Investment Strategy is approved by Cabinet and County Council in February each year (attached as Appendix 1). The County Council did not invest in Icelandic banks and has not suffered any loss of deposits in the recent financial crisis.

2.4. 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 and indirect property funds are also paid to the Fund's balance.

2.5. The Fund currently generates a surplus of income over expenditure of around £70m per annum as the income from contributions and investments exceeds the 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 projected long-term deficit. The surplus is invested to meet the Fund's future liabilities.

3. The Fund's cash balance

3.1. The report on 23 May 2008 included a forecast that the Fund's cash balance at 31 March 2009 would be £101m. In the event, the actual cash balance was higher at £136m. The main reason for the increase was that the Fund's UK property manager CB Richard Ellis made fewer purchases in 2008/09 than expected, because of the impact of the global financial crisis on the property market. The cash incurred on the Fund's alternative investments portfolio was a little higher than originally forecast as a result of the decision in September 2008 to begin investing in hedge funds.

3.2. The cash movements in 2008/09 are summarised below, together with a forecast of the cash balance for the next three years.

3.3. The County Treasurer will continue to monitor closely the impact of the financial 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.

4. Interest earned by the Pension Fund

4.1. Interest on the cash balance is credited to the Pension 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.

4.2. During 2008/09, the Fund earned an average of 4.95% on its specific external cash deposits which were for periods of between two and twelve months. On an annualised basis, the average amount on deposit was £71.5m. Around £100m was on deposit at the start of 2008/09 but this was reduced during the year, particularly autumn 2008 when concerns were raised about the viability of bank counterparties. As most of the deposits were in the earlier part of the year, before interest rates fell, the average return is relatively high at 4.95%.

4.3. The weighted average seven-day interest rate paid to the Pension Fund in 2008/09 on internally managed cash was 3.48%. Here, the pattern was reversed. Because of the concerns about counterparties in the latter half of the year and the emphasis on preserving capital, the amount managed internally was higher at the end of the year when interest rates were lower.

4.4. In practice, the County Council co-mingles the remainder of the Pension Fund's cash with its own cash balances that are not held in specific external deposits. It places these co-mingled amounts with money market funds and call accounts and, occasionally in 2008/09 with the Government's Debt Management Office or on short-term deposit. The average interest rate earned by the County Council in 2008/09 on the Pension Fund's co-mingled cash was 4.20%.

4.5. Recent press reports have drawn attention nationally to the differential between the statutory minimum seven-day interest rate paid to pension funds (3.48% in Hampshire's case for 2008/09) and the interest actually earned by administering authorities on those cash balances (4.20% in Hampshire). The press have suggested that administering authorities were taking advantage of pension funds to the benefit of their council taxpayers. In interest terms, the differential for Hampshire was worth £380,000 in 2008/09.

4.6. This does not, however, taken into account who bears the risk of counterparty default. In the case of the co-mingled deposits, the County Council is taking the full risk of default and it is appropriate that the Hampshire Pension Fund receives a lower interest rate alongside the guarantee of the full return of its cash.

4.7. As reported to the Panel on 3 March 2009, the Government is considering requiring administering authorities to establish separate bank accounts for pension funds and to end the practice of co-mingling cash balances. A further report will be made to the Panel if the Government decides to proceed with that proposal.

4.8. Overall, the Pension Fund earned an average of 4.3% on its cash balances in 2008/09. This compares favourably with the return on equities and bonds in 2008/09.

4.9. As indicated in paragraph 3.1, the Pension Fund's cash balance at 31 March 2009 was higher than forecast a year ago, at £136m (5.7% of the total Fund). With equities falling significantly during 2008/09, holding a higher than expected balance in cash has worked to the Fund's advantage.

5. Transferring part of the cash balance to the managers for investment

5.1. Most of the cash balance is required to meet existing commitments to invest in property and to fund drawdowns by the private equity funds, as well as covering day-to-day cashflow. The cash balance will be kept under review during 2009/10. In the future, as cash continues to flow into the Fund from the annual surplus of contributions over benefits, it will be necessary to consider whether to place part of the balance with the equity or bond 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 at the Panel's meeting in May 2010.

5.2. In the meantime, one option for gaining exposure to the UK stock market would be to resume the `equitisation' of part of the Fund's cash balance. This technique was successfully employed in 2007/08 using FTSE 100 Index futures. It would provide exposure to the movements in the Index whilst still leaving the cash available for investment in property or to meet draw downs as they arise. However, although there are some signs of a possible recovery in equity markets, it is probably too risky to implement equitisation in the short term.

6. Policy for managing the Pension Fund's cash

6.1. The following policy could be adopted for managing the Pension Fund's cash. It is based on the policy agreed by the Panel in 23 May 2008:

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

· the Pension 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

· once the property portfolios are fully invested, 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 Pension Fund's strategic asset allocation

· consideration 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 cash flow requirements for the alternative investments portfolio should continue to be funded from the Pension Fund's positive cash flow from employer and employee contributions less benefits etc

· the Pension 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 Pension 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 Pension Fund's cash balances, the interest actually earned by those deposits

· the risk of default on Pension Fund cash deposits that are co-mingled with the County Council's cash deposits remains wholly with the County Council not the Pension Fund

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

6.2. This policy will be reviewed if the Government implements proposals to require administering authorities to maintain separate bank accounts for pension funds.

7. Recommendation

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

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CORPORATE OR LEGAL INFORMATION:

Links to the Corporate Strategy

Other Significant Links

IMPACT ASSESSMENTS:

1. Equalities Impact Assessment:

1.1. Equality objectives are not considered to be adversely affected by the proposals in this report.

2. Impact on Crime and Disorder:

2.1. The proposals in this report are not considered to have any direct impact on the prevention of crime.

3. Climate Change:

a) How does what is being proposed impact on our carbon footprint / energy consumption?

No specific impact.

b) How does what is being proposed consider the need to adapt to climate change, and be resilient to its longer term impacts?

No specific impact.

County Council's Annual Investment Strategy 2009/10

The Annual Investment Strategy was agreed by the County Council in February 2009.

The `lending list' section is under constant review by the County Treasurer and the version of the Strategy below reflects the current position

1. This Annual Investment Strategy has been prepared in accordance with guidance issued under section 15(1)(a) of the Local Government Act 2003.

2. When investing its surplus funds, the Council's investment priority is to continue to maintain the security of capital and maintain policy flexibility through liquidity of its investments. The Council will aim to achieve the optimum return on its investments commensurate with the proper levels of security and liquidity.

3. Accordingly, only `specified investments' will be used in 2009/10. These categories of investment are defined in the Government's guidance as offering both high security and liquidity.

4. The Council's surplus funds will either be invested in:-

· fixed-term deposits for periods of up to 364 days with local authorities, the Government's Debt Management Office, or banks and building societies rated at least A2 by Moody's (a Government-recognised credit rating agency) that are included on the Council's lending list;

· call deposits with NatWest Bank (rated Aa3); and

· call deposits with four managed Aaa-rated money market funds included on the Council's lending list, which are given as follows:

- Standard Life Sterling Fund

- Fidelity Institutional Sterling Cash Fund

- RBS Global Treasury Sterling Fund

- JP Morgan Sterling Liquidity Fund.

5. The `call deposits' may be recalled by the Council at any time. The Council's cash flow position will be monitored on a daily basis and adjustments made as necessary to the funds placed on call.

6. Lending is restricted to certain of the UK clearing banks and the larger UK building societies, with the Council's current lending list given as follows:

Counterpart Moody's long-term

rating

Lloyds TSB / BoS Aa3

HSBC Aa2

Barclays Aa3

Royal Bank of Scotland (NatWest) Aa3

Abbey Aa3

Northern Rock A2

Nationwide Building Society Aa2

Britannia Building Society A2

Leeds Building Society A2

Hierarchy of Moody's long-term ratings:

Aaa Obligations rated Aaa are judged to be of the highest quality, with the "smallest degree of risk".

Aa1, Aa2, Aa3 Obligations rated Aa are judged to be of high quality and are subject to very low credit risk, but "their susceptibility to long-term risks appears somewhat greater".

A1, A2, A3 Obligations rated A are considered upper-medium grade and are subject to low credit risk, but that have elements "present that suggest a susceptibility to impairment over the long term".

7. The lending list is closely monitored and reviewed by the County Treasurer, taking into account each institution's credit ratings, asset base, market capitalisation, press reports, etc. Institutions will be removed immediately from the list if any doubt is cast on their credit worthiness. Changes in the lending list will be reported in the quarterly review of the financial health indicators.

8. Limits are placed on levels of total deposits made with individual institutions, based on their relative strength as a counterparty. Whilst the Treasury Management and Investment Strategy sets a maximum lending term of 364 days, this will be shortened in respect of those institutions with a relatively lower credit rating.

9. The County Treasurer will continue to manage cash balances on a cautious basis with the emphasis on capital preservation at the expense, where necessary to avoid unjustifiable risks, of additional interest returns.

10. For information, the County Council has never placed deposits with Icelandic banks and has not used any overseas institutions in the last 18 months.

11. Other, or `non-specified', investments will not be used.

12. Treasury management staff operate within detailed parameters set out in an internal code of practice, which takes account of CIPFA's Treasury Management in the Public Services: Code of Practice and other guidance issued by the Chartered Institute of Public Finance and Accountancy.