HERTFORDSHIRE COUNTY COUNCIL PENSION FUND

Transcription

1 HERTFORDSHIRE COUNTY COUNCIL PENSION FUND ANNUAL REPORT AND ACCOUNTS 2003/2004

2 CONTENTS Introduction Page Foreword 3 Financial Summary 3 How the Scheme Works 4 Administering Authority Report Management 6 Scheme Management and Advisers 7 Contact Points 8 Membership 9 Benefits 10 Actuarial Valuation 11 Financial Statements Statement of Responsibilities for the 13 Statement of Accounts Auditor s Report 14 Fund Account 15 Net Assets Statement 16 Notes to the Accounts 17 Investment Report Background 26 World Markets 28 Investment Performance 30 Investment Policy 32 Statement of Investment Principles 34 Appendices Certified 2001 Actuarial Valuation 47 Contribution Rates List of Employing Bodies 48 1

3 INTRODUCTION Foreword Financial Summary How the Scheme works 2

4 FOREWORD This report provides details for employing bodies and other interested parties on how the Hertfordshire Local Government Pension Fund has been managed during the year 1 st April 2003 to 31 st March There were 160 employing bodies and 26,871 contributing members of the Fund at 31 st March During the year the Fund increased by 293m to 1,362m and the overall investment return for the year was 19.2%. This report summarises the main features of the Fund. Firstly the Administering Authority report outlines the scope and management of the Fund. This is followed by the financial statements for the year 2003/04 with comparative information for the previous year. Finally the Investment report sets out the background against which investment took place, the Fund s investment policy and the level of performance achieved. FINANCIAL SUMMARY Below is a summary of the Pension Fund accounts for the year 2003/04 and a graph showing the movement of the value of the Fund over the last 5 years. 2002/03 000s 2003/04 000s Value of Fund at 1 April 1,300,342 1,069,890 Net additions/(withdrawals) from dealing with members 16,177 31,600 Net returns on Investments (246,629) 260,930 Increase/(Decrease) in Fund during the year (230,452) 292,530 Value of Fund at 31 March 1,069,890 1,362,420 Value of Fund ( m) 1,600 1,400 1,200 1,

5 HOW THE SCHEME WORKS Legal Framework The terms of the Local Government Pension Scheme are contained in the Local Government Pension Scheme Regulations 1997 (as amended) and apply to employees of local authorities other than teachers, fire-fighters and police. Other specified bodies providing public services are either included by statute or may apply for admission. Employing Bodies All employees of the County Council and the District Councils are entitled to join the scheme. Parish and Town Councils can join the scheme by passing a resolution and other bodies join through admission agreements. A list of the 160 employing bodies in the Fund is shown on pages Benefits The Scheme is a final-pay scheme, which guarantees to provide, on retirement, a lump sum and pension as a proportion of final salary according to the length of service. Each year pensions in payment and deferred benefits are increased in line with inflation. In addition lump sums, spouses and children s pensions are payable on death. Further details are provided on page 10. Funding The funding for the pensions and other benefits comes from several sources: Employees contributions these are fixed Employers contributions these are adjusted at each valuation to reflect any surplus or shortfall (see page 11 for details) Investment Income the cash, which is not immediately required to pay benefits is invested and provide an additional source of income for the fund. 4

6 ADMINISTERING AUTHORITY REPORT Management Scheme Management and Advisors Contact Points Membership Benefits Actuarial Valuation 5

7 MANAGEMENT The investment management of the Pension Fund is monitored by the Hertfordshire County Council Investment Committee. The Local Authority (Functions & Responsibilities) (England) Regulations 2000, state the functions relating to the Local Government Pension Scheme are the responsibility of the full Council. The County Council has delegated these functions to the Investment Committee. Its members can make decisions without reference to the full Council. The composition of the Committee remains the same i.e. eight County Council members and three District Council representatives. A staff representative nominated by UNISON is invited to attend meetings as an observer. Mercer Human Resource Consulting Limited, as Investment adviser to the Committee provided training for all committee members during the year. These actions brought the Fund in line with the Myners report recommendations. (See Statement of Investment Principles for further details) Members during 2003/04 (All members served throughout 2003/04 unless stated otherwise) County Council members N K Brook D W Clayton F Escott died October 2003 P V Goggins B N W Hammond M H T Janes I H Laidlaw Dickson R J Smith D B Lloyd (replaced F Escott) Substitute Members G F Wenham died April 2003 S Quilty E Singam (replaced G Wenham) District Council representatives H G S Banks East Herts DC N L Payne Hertsmere BC S Taylor Stevenage BC 6

8 Staff Representative (UNISON) S Thornley SCHEME MANAGEMENT AND ADVISORS Administering Authority Hertfordshire County Council Finance Director: Chris Sweeney CPFA Scheme Administrators ITNET Employee Benefits Fund Managers Baillie Gifford & Co Capital International Jupiter Asset Management Merrill Lynch Asset Management Schroder Investment Management Ltd. Permira TTP Ventures Harbour Vest Standard Life Investments Property Unit Trust Fund Handled internally Custodian ABN-Amro Mellon Global Securities Services Consulting Actuary Hymans Robertson Investment Consultant Mercer Human Resource Consulting Limited Corporate Governance Advisor RREV (Research Recommendations and Electronic Voting) provided by NAPF and Institutional Shareholder Services Performance Measurement Consultants The WM Company AVC Providers The Equitable Life Assurance Society Standard Life Assurance Company Auditor R Murray District Auditor, Stevenage Legal Advisor Andrew Laycock, County Secretary, Hertfordshire County Council 7

9 CONTACT POINTS Administering Authority Scheme Administrator - Investments - Benefits, Administration Nicola Webb Sharon Strath Corporate Finance ITNET Pensions Hertfordshire County Council County Hall County Hall Pegs Lane Pegs Lane Hertford Hertford SG13 8TN SG13 8DQ (01992) (01992) nicola.webb@hertscc.gov.uk hccpensions@itnetplc.com 8

10 MEMBERSHIP The graph below shows the changes in membership over the last 5 years. There has been an increase in the number of active contributors and a slight fall in the number of deferred beneficiaries. The largest increase is in the number of pensioners. Membership of Fund over 5 years at 31 March 30,000 25,000 20,000 15,000 10,000 5,000 Contributors Pensioners Deferred Beneficiaries The table below details the changes in membership during the year. 31 March March 2004 Contributors 26,553 26,871 Pensioners 15,290 15,895 Deferred Benefits (Former Contributors) 12,779 12,570 Changes in the Year * Admissions 2,767 2,176 Retirements Transfer payments made Transfer payments received Refunds of contributions 1, *The movement in membership is not fully explained by the details above due to the timing of transfer payments. 9

11 BENEFITS The Scheme is a "final-pay" scheme which guarantees to provide benefits which are a specified fraction of the scheme members "final-pay". The benefits are not affected by variations in investment performance. Below are indications of the benefits payable under the Local Government Pension Scheme. These are broad guidelines only and members should apply to ITNET, the Scheme Administrators, for individual estimates of benefits payable. Annual Pension The annual pension is based upon Final Pensionable Pay multiplied by 1/80 th for each year of scheme membership. The Final Pensionable Pay is the wage or salary on which contributions were paid over the last 12 months of service. The annual pension increases in line with the Retail Price Index every year once in payment. Retirement Lump Sum When a member retires, in addition to their annual pension, they are also entitled to a tax free lump sum. In general, this is equal to 3 times the annual pension. Ill Health Retirement Benefits are calculated in the same way as for normal retirements, except where members have 5 or more years of membership, in which case membership is increased to compensate for premature retirement. Death in Service A lump sum of 2 years final pensionable pay is payable to the estate. Pensions are also payable to surviving spouses and dependant children. Death after Retirement Spouse s and dependant children s pensions are payable based on the former employee s final pensionable pay or pension. A more detailed outline of the scheme is available on request from the Scheme Administrator, ITNET Employee Benefits. 10

12 ACTUARIAL VALUATION As stated on page 4, the Scheme is financed by contributions from both employer and employee, plus investment income earned on accumulated funds not immediately required for the payment of benefits. The Consulting Actuary reports periodically to the Council on the Fund's viability and employers contributions are determined in the light of the report. VALUATION AS AT 31 MARCH 2001 An actuarial valuation of the Fund was undertaken as at 31 March 2001 to determine employers contribution rates for the financial years 2002/03 to 2004/05. This valuation showed that the required level of contributions to be paid to the Fund by the County Council with effect from 1 April 2002 was 295% of members' contributions. The rates payable by participating City, District and Borough Councils with effect from the same date, are set out on page 47. These rates of contribution are the rates which, in addition to the contributions paid by the members, are sufficient to meet: 100% of the liabilities arising in respect of service after the valuation date plus an adjustment over a period of 12 years (the expected average future service working lifetime of the membership) to reflect the shortfall of the value of each participating employer's notional share of the Fund's assets compared with 100% of its accrued liabilities, allowing, in the case of members in service, for future pay increases. The increases in employers contribution rates found to be necessary are being phased in over three years. The market value of the Fund's assets at the valuation date of 31 March 2001 was 1,295.1 million and the actuarial value of 1,369.9 million represented 90% of the Fund's accrued liabilities, allowing for future pay increases. The contribution rates have been calculated using the projected unit actuarial method and the main actuarial assumptions were as follows: Rate of return on investments: Equities Bonds Rate of general pay increases: Rate of Price Inflation: 6.75% per annum 5.75% per annum 4.3% per annum 2.8% per annum The next actuarial valuation will take place during in 2004 using information as at 31 st March 2004, the results will be available early

13 FINANCIAL STATEMENTS Statement of Responsibilities for the Statement of Accounts Auditors Report Fund Account Net Assets Statement Notes to the Accounts 12

14 STATEMENT OF RESPONSIBILITIES FOR THE STATEMENT OF ACCOUNTS Hertfordshire County Council s Responsibilities The authority is required: to make arrangements for the proper administration of its financial affairs and to secure that one of its officers has the responsibility for the administration of those affairs. In this authority that officer is the Finance Director; to manage its affairs to secure economic, efficient and effective use of resources and safeguard its assets. The Finance Director s Responsibilities The Finance Director is responsible for the preparation of the Fund s statement of accounts which, in terms of the CIPFA/LASAAC Code of Practice on Local Authority Accounting in the United Kingdom ( the Code ), is required to present fairly the financial position of the Fund at the accounting date and its income and expenditure for the year ended (31 March 2004). In preparing this statement of accounts, the Finance Director has: selected suitable accounting policies and then applied them consistently; made judgements and estimates that were reasonable and prudent; complied with the Code. The Finance Director has also: kept proper accounting records which were up to date; taken reasonable steps for the prevention and detection of fraud and other irregularities. 13

15 AUDITOR S REPORT The Auditor s report for the Pension Fund can be found in the Financial Report and Accounts for Hertfordshire County Council 2003/04. A copy is available on request. 14

16 FUND ACCOUNT FOR YEAR ENDED 31 MARCH 2004 Note 2002/ / Contributions and Benefits Contributions receivable 2 Members 21,561 23,119 Employers 56,191 70,155 Transfers in from other funds 14,562 14,528 Other Contributory Income 11 2,446 4,763 94, ,565 Benefits payable Pensions and pensions increase (55,676) (56,644) Retirement grants (5,342) (7,194) Death and ill health grants (820) (1,269) Other benefit payments (8) (6) Leavers Transfers to other funds (14,316) (13,323) Refunds of contributions (309) (319) Other Payments Contributions Equivalent Premium (265) (313) Administrative Expenses 3 (1,847) (1,862) Bad Debts 0 (35) (78,583) (80,965) Net Additions (withdrawals) from dealing with Members 16,177 31,600 Returns on Investments Investment Income 4 37,461 39,400 Change in market value of investments 7 (282,244) 223,849 Investment Management Expenses 8 (1,846) (2,319) Net Returns on investments (246,629) 260,930 Net increase (reduction) in fund during the year (230,452) 292,530 Net assets of the scheme At 1 April 1,300,342 1,069,890 At 31 March 1,069,890 1,362,420 Pension Fund Income Pension Fund Expenditure m /03 03/04 m /03 03/04 Members' Contribs Employers' Contribs Transfers In Investment Income 15 Pensions Lump Sums Transfers Out InvestMngt Expenses Admin Expenses

17 NET ASSETS STATEMENT Note 2002/ / Investments 6 Fixed Interest Securities Public Sector 73,448 64,299 Other 60,450 72,208 Equities UK 395, ,621 Overseas 271, ,863 Index-linked Securities Public Sector 35,182 41,749 Managed and Unitised Funds UK 94, ,406 Overseas 36,525 58,064 Cash Deposits 86,060 78,308 AVC Investments 10 5,378 6,221 1,058,260 1,347,739 Current assets and liabilities 9 11,630 14,681 Net Assets of the scheme at 31 March 1,069,890 1,362,420 Chris Sweeney Finance Director 16

18 NOTES TO THE ACCOUNTS 1. Accounting Policies The accounts summarise the transactions and net assets of the Pension Fund and comply in material respects with the recommended form - SORP: Financial Reports of Pension Schemes - issued by the Accounting Standards Board, with reference to the Code of Practice on Local Authority Accounting in the United Kingdom. 2. Contributions a) The contribution made by most employees is 6% of their remuneration. Manual workers who joined the scheme prior to 1 st April 1998 contribute 5%. b) The employer's contribution is formally reviewed every three years on the basis of the actuarial valuation and varies for each employer. The County Council's contribution for 2003/04 was 2.85 times the employee's contribution (17.1% of officers remuneration and 14.25% of manual workers remuneration). c) From 1 April 1984, pensions increases and compensatory pensions in relation to the major employing authorities have been charged through the Pension Fund and financed by increased levels of employers contributions. The level of such contributions is assessed by the Fund's Actuary. In the case of payments made in respect of other employers these are recovered directly from those bodies. d) Contributions Receivable 2002/ / Employers Normal 55,006 62,344 Special (lump-sum contributions) 1,185 7,811 56,191 70,155 Employees Normal 20,596 22,228 Special Additional Voluntary Contributions ,561 23,119 Total 77,752 93,274 e) Contributions Receivable - Employing Bodies / /04 Administering Authority 35,764 41,631 Admitted Bodies 4,546 4,522 Scheduled & Resolution Bodies 36,821 46,614 Additional Voluntary Contributions Total 77,752 93,274

19 3. Administrative Expenses a) Since 1 April 1986, it has been possible to charge pensions administration expenses direct to the Fund and the County Council elected to follow this course. The expenses listed below include a charge made for the work carried out on investments by the County Council s Corporate Finance Department. Expenses incurred by the Fund s investment managers are listed in Note 8 below. The Fund is generally exempt from VAT and is therefore able to recover such deductions. b) Administrative Expenses 2002/ / Administration and processing 1,766 1,758 Actuarial Fees Audit Fee Legal and other Professional Fees Total 1,847 1, Investment Income a) Investment income in the form of both interest on fixed interest stocks and announced dividends on equity securities is accrued as at the financial year end. b) Investment Income 2002/ / Income from fixed interest securities UK 5,411 5,788 Overseas 2, Dividends from Equities UK 17,480 18,812 Overseas 5,561 7,784 Income from index-linked securities Income from managed or unitised funds 3,963 4,670 Interest on Cash Deposits 3,971 2,727 Securities Lending Commission Recapture Underwriting Commissions ,589 41,752 Irrecoverable Taxation (2,128) (2,352) Net Investment Income 37,461 39,400 c) In his Budget on 2 July 1997 the Chancellor of the Exchequer removed the tax concession that allowed authorised Pension Funds to recover tax credits at a rate of 20% on dividends on UK equities paid after this date. 18

20 d) The Fund suffers with-holding tax on most overseas investment income. The Fund has been granted exemption from US taxation and in some instances partial recovery of other with-holding tax is possible. Provision is made for the estimated sums to be recovered and income grossed up accordingly. 5. Investment Valuations a) Investments, including foreign currencies, are shown at market values, based where available on mid-market prices at the close of business on the Balance Sheet date or the nearest preceding business day. Property unit trust prices are as quoted by the trusts on an offer basis on the nearest issue date to 31 March. Unquoted securities are valued having regard to the latest dealings, professional valuations, the advice of directors, asset values and other appropriate financial information. b) All investments are shown in sterling. The market value of overseas securities and cash is shown in sterling based on exchange rates applicable at 31 March c) Rights issues are processed on ex-date. If the value of the rights on ex-date is 15% or more of the value of the underlying security, cost is allocated from the parent to the rights. If the value is less than 15%, the rights are allocated at zero cost. 19

21 6. a) Analysis of investments at market value 2002/ / Fixed Interest Securities UK Public sector 45,174 42,532 UK quoted and unit trusts 45,412 50,286 Overseas public sector 28,274 21,767 International unit trusts 15,038 21, , ,507 Equities UK quoted 395, ,364 UK unquoted Overseas quoted 270, ,758 Overseas unquoted 1, , ,484 Index linked securities UK public sector 35,182 41,749 Managed and unitised funds UK Property 69,571 80,422 Other 24,449 34,984 Overseas Property 0 0 Other 36,525 58, , ,470 Cash Deposits Sterling 86,060 78,308 Foreign Currency ,060 78,308 AVC Investments 5,378 6,221 Total 1,058,260 1,347,739 b) Analysis by Fund Manager Manager Market Value % of Fund 2004 Baillie Gifford 18.7% Jupiter Asset Management 27.4% Schroder Investment Management 22.8% Capital International 11.9% Jupiter Asset Management - UK 3.9% Merrill Lynch 6.0% In -House Property Trust Fund 7.7% Private Equity TTP Ventures 0.1% Standard Life Investments 0.4% Harbour Vest 0.4% Permira 0.7% 20

22 7. Analysis of changes in market value of investments Value at 1/4/03 Purchases at cost Sales Proceeds Change in Market value Value at 31/3/ Fixed Interest Public sector 73,449 57,352 (67,878) 1,376 64,299 Other 60,449 32,973 (6,674) (14,540) 72,208 Equities UK 395, ,076 (171,258) 115, ,621 Overseas 271, ,100 (152,103) 91, ,863 Index-linked 35,182 33,288 (28,063) 1,342 41,749 Mng & Unit Funds UK 94,020 14,138 (5,543) 12, ,406 Overseas 36,525 12,419 (6,908) 16,028 58,064 Cash Deposits 86,060 20,908 (28,427) (233) 78,308 AVC Investments 5, (522) 613 6,221 Total 1,058, ,006 (467,376) 223,849 1,347,739 8 Investment Management Expenses a) The Fund s Balanced Managers are remunerated on the basis of fees calculated as a percentage of total assets under management. The Specialist Managers have a performance related fee structure. b) The Fund subscribes to the measurement service of The WM Company. Some of the statistics they provide are shown in the Investment Performance section on page c) Acquisition costs are included in the cost of purchases. d) Investment Management Expenses 2002/ / Administration, management and custody 1,821 2,293 Performance Measurement Services Total 1,846 2,319 21

23 9. Current Assets and Liabilities a) Debtors and creditors are accrued for refunds of employees contributions, tax and contributions due from admitted and scheduled bodies. b) From 1 April 2002 all transfer values from other pension schemes are treated on a cash basis. c) The tax items are in respect of tax deducted from payments to beneficiaries that are due to be passed to the Inland Revenue. As from 1 st April 2002 the investment income due figure includes tax to be recovered. The cash figure shown is net of any outstanding investment purchases or sales. 2002/ / Current Assets -Debtors Sums due from Admitted Authorities 4,376 4,650 Investment Income due 7,257 9,426 Miscellaneous 773 1,427 12,406 15,503 Current Liabilities - Creditors Commissioners of the Inland Revenue Miscellaneous Provision for bad debts Net current assets 11,630 14,681 22

24 10. Additional Voluntary Contributions Scheme members have the option to make additional voluntary contributions to enhance their pension benefits. These contributions are invested separately from the Pension Fund, with either the Standard Life Assurance Company or the Equitable Life Assurance Company. 2002/03 Standard Life 2002/03 Equitable Life 2002/03 Total AVCs 2003/04 Standard Life 2003/04 Equitable Life 2003/04 Total AVCs Value at 6 April ,624 5,230 1,882 3,496 5,378 Income Contributions received Transfer Values received Expenditure , , , , Retirement Benefits (7) (275) (282) (96) (359) (455) Transfer Values paid (4) (945) (949) (50) (16) (66) Refunds of Contributions Change in market value Value at 31 March (24) (24) (1) 0 (1) (11) (1,244) (1,255) (147) (375) (522) (301) (31) (332) ,882 3,496 5,378 2,819 3,402 6, Early Retirement Funding a) During 2003/04 a total of 4,762,356 was paid into the Fund by employing bodies towards the cost of the early retirements from their organisations during 1999/00, 2000/01,2001/02,2002/03 and 2003/04. This is included in Other Contributory Income in the Fund Account. 23

25 b) The Administering Authority of the Fund has the right to invoice employing bodies for the cost of early retirements under the Local Government Pension Scheme Regulations 1997 Augmentation over a selected period of time. The expected income from this in future years is as follows: Deferred Income Related to Early Retirement Costs / / / / / Related Parties Hertfordshire County Council The majority of the pension fund s cash is invested with the fund managers, however a small amount is invested with Hertfordshire County Council in order to manage the payment of pensions and collection of contributions. Hertfordshire County Council paid the pension fund 663,321 in interest during 2003/ Securities Lending The fund has an arrangement with its custodian (ABN- Amro Mellon) to lend securities from within its portfolio of stocks to third parties in return for collateral. Lending is limited to a maximum of 20% of the total Fund value. Collateralised lending generated income of 55,853 for 2003/04 ( 38,721 for 2002/03). This is included within investment income in the Pension Fund Account. At 31 March m worth of stock (2% of the Fund) was on loan, for which the Fund was in receipt of 33.1m worth of collateral. 14. Liabilities after year end The Fund s financial statements do not take account of the liabilities to pay pensions and other benefits after 31 st March These liabilities are valued as part of the triennial valuation process described on page

26 INVESTMENT REPORT Background World Markets Investment Performance Investment Policy Statement of Investment Principles 25

27 BACKGROUND Responsibility for investing the Fund The responsibility for the management of the Fund's investments has been delegated to the Finance Director of Hertfordshire County Council. The Finance Director, in consultation with the Investment Committee, uses the services of external investment managers who have substantial discretionary powers regarding their individual portfolios. The split of the Fund between these managers is shown below. The Committee meets quarterly and receives reports from the managers on their activities and outlook for the markets. It thus has the opportunity to influence broad strategy, but the detailed daily management, stock selection and timing is left to the professional Fund Managers. The Finance Director maintains a regular contact with the Fund Managers. The Committee also monitors the performance of the Fund, details of which are provided on pages Manager % of Fund Baillie Gifford 18.7 Capital International 11.9 Jupiter Asset Management Balanced Portfolio 27.4 Jupiter Asset Management UK Equities Specialist Portfolio 3.9 Merrill Lynch Asset Management 6.0 Schroder Investment Management 22.8 In House Property Fund 7.7 Private Equity 1.6 Total 100% Powers of Investment The Local Government Pension Scheme (Management and Investment of Funds) Regulations 1998 as amended, require that an administering authority must invest any fund money that is not needed immediately to make payments from the Fund. Investment may be made in: any security on any recognised stock exchange (no single investment to exceed 10% of the value of all investments - excepting Government Securities) in unlisted securities (subject to a maximum of 10% of the total value of investments) in Unit Trusts and other Managed Funds (subject to a maximum of 25% of the total value of investments with any one manager) by deposit with any bank (subject to a maximum of 10% of the value of all investments to any one bank - excepting National Savings Bank) or Local Authority (the total of such deposits not to exceed 10% of the total value of all investments). 26

28 The Regulations do require that the administering authority shall have regard to the need for: diversification the suitability of any proposed investment proper advice from suitably qualified persons or person. Apart from these legal restraints, the Local Authority may elect to impose its own restrictions. A number of restrictions have been introduced as part of the Statement of Investment Principles (SIP). These cover Private Equity investment, overseas investments and the size of holdings in individual companies. More detail is provided on pages 34 to

29 WORLD MARKETS Review of the World Markets during 2003/04 (courtesy of Baillie Gifford) Overview of global equity and bond markets In contrast to last year, the 12 months to March 2004 was an excellent period for equity investors, with all major markets recording significant gains. In sterling terms, the FTSE World Index rose by 39%. At the start of the period, market sentiment improved markedly on the back of further interest rate cuts in the UK, Europe and the US and looser fiscal policy in the US and UK. With increasing signs of economic recovery, improving corporate profitability and reasonable share price valuations, investor optimism returned. All equity markets benefited and one of the best performers was Japan. Here the receding prospect of deflation, evidence of corporate reform and improving growth prospects contributed to particularly strong returns. Despite the buoyant economic environment, bonds performed better over the year than might have been expected. The continued absence of inflation and the repeated statements by the US Federal Reserve that rates would remain low for as long as it took supported bond valuations. Corporate bonds performed best as, after the excesses of the late 1990s, companies focused on repairing their balance sheets. In the UK, yields on both corporate and government bonds were further supported by strong demand from pension funds and life assurance companies. Across all markets it was the riskier assets that were in the most demand. In fixed income this meant the best returns were found in high yield bonds and in equity markets the most economically sensitive, in particular cyclical stocks and Emerging Markets, were amongst the strongest. Detailed Review of Equity Markets United States: The economy continued to strengthen throughout the year. Tax cuts and mortgage refinancing boosted consumer spending, and rising corporate profits funded capital spending. In terms of sectors, technology was particularly strong whilst pharmaceuticals failed to build on their good start to the year and ended the 12 months down over 8%. Over the year, the weak dollar meant the US market lagged the other major markets but still gained a respectable 16% in sterling terms. Europe: European stocks rose strongly, up 37% over the year. The European economy deserves very little credit for this as the global recovery was barely perceptible in continental data. Some of the responsibility for this state of affairs lies with the appreciation of the Euro but it has been disappointing that economies such as France, which had previously been fairly buoyant, have succumbed to the widespread stagnation and that even Ireland has shown only moderate growth. The strength of European markets was instead a reflection of the intense sensitivity of many continental companies to the progress of the global rather than regional economy. The software and computer services sector was remarkably strong, rising by just over 70% in the year. As elsewhere, defensive sectors did not fare so well, though generally they ended the year in positive territory. United Kingdom: In early 2003 the UK equity market yielded more than government bonds for the first time in over forty years. However, the market bounced back from this oversold position, rising 31% in the 12 months to March 04. Throughout 2003, 28

30 corporate and economic news flow continued to be healthy. As elsewhere, cyclical companies, including technology and capital goods stocks, responded well to the improved outlook. In addition, stocks sensitive to the equity market, such as insurance companies and companies with large pension scheme deficits, also benefited from rising share prices. Japan: The Japanese market s 48% rise over the year was one of the best amongst developed equity markets. The relatively modest economic expansion that began in 2002 continued throughout the period. Industrial production rose further, helped by export demand and rising private capital spending. Unemployment fell, although private consumption has been steady rather than buoyant. Recent trends in some property and consumer prices suggest that downward pricing pressure has eased, although it is too early to confidently project a sustained period of rising prices. As bad debt problems began to be addressed, financial stocks performed strongly, some rising by over 100%. Asia Pacific: Two economies dominated market behaviour in Asia over the last year - the United States and China. A weak dollar, low US interest rates and a strong US economy proved an ideal combination for the Asian markets. In China, the economy grew so strongly that some severe inflationary bottlenecks began to emerge and remedial action was eventually required to prevent over-heating; however, the strong economy helped Asian exporters. Resource and mining stocks were some of the best performers. Emerging Markets rose 56% and the developed Asian markets increased 34%. 29

31 INVESTMENT PERFORMANCE In order to monitor the performance of the fund managers, the Fund participates in the measurement service of The WM Company. To enable comparison between the Hertfordshire Fund and others, The WM Company produces one set of figures relating to Local Authority Pension Funds solely and one set covering a larger number of Pension Funds, primarily from the industrial and commercial fields. As stated in the Statement of Investment Principles, the Fund has a specialist benchmark against which it compares its performance. Comparison with other Local Authorities The graph below shows the performance of the Hertfordshire Fund over the last ten financial years relative to the median (or middle) fund in the local authority list. The graph shows that the Hertfordshire fund has been in the top fifty percent of local authority funds in 6 of the last 10 financial years. Hertfordshire Fund Performance over 10 years relative to Local Authority Median Fund 2.00 Relative Percentage Return / / / / / / / / / / Year Cumulative Returns 94/95-03/04 Hertfordshire Fund Comparative Information 7.0% 6.7% Local Authorities average 2.6% Retail Price Index 30th Percentile 4.3% Average Earnings This table shows that over the last 10 financial years, the Hertfordshire Fund s performance has been 0.3% over the average local authority fund, placing it in the 30th Percentile of funds. This performance was also well in excess of inflation (measured by the Retail Price Index) and average earnings which drives the cost of pensions. 30

32 Comparison with the Fund s Benchmark The graph below shows the performance of the Hertfordshire fund relative to the Fund Benchmark. During the period , the benchmark was the WM All Funds weighted average. The graph shows that the Hertfordshire fund has been above average in 5 of the last 10 calendar years Hertfordshire Fund Performance over 10 years relative to WM All Funds weighted average, Benchmark as from 2002 Relative Percentage Return Year Cumlative Returns Calendar years Hertfordshire Fund 6.3% Benchmark 6.4% Comparative Information 2.6% Retail Price Index 4.1% Average Earnings This figures above show that over the last 10 calendar years, the Hertfordshire Fund has performed just below the Benchmark by -0.1%. The Fund achieved a return of 3.7% in excess of inflation and 2.2% in excess of average earnings. 31

33 INVESTMENT POLICY Distribution of Fund Now ( ) Distribution of Fund One Year Ago ( ) 8% 6% 6% 38% UK Equities Overseas Equities 8% 7% 8% 37% 13% UK Fixed Interest Overseas Bonds Property Unit Trusts Cash 14% 29% 26% The above graphs demonstrate the largest movement during the year was into UK and overseas equities and out of UK gilts and cash. This was in the main due to the rising value in equity markets, as discussed in the World Markets review on pages Distribution of Overseas Equity Holdings (including UK Based Unit Trusts) Total Value 443m 8% 18% 34% North America Pacific Basin Europe International 40% 32

34 Ten Largest Equity Holdings at Market Value m % of Total Investments Vodafone BP PLC HSBC Holdings Glaxosmithkline Royal Bank of Scotland Barclays Astrazeneca Shell Transport and Trading BG Group HBOS Ten Largest Equity Holdings at (for comparison) Market Value m % of Total Investments Vodafone BP PLC Glaxosmithkline HSBC Holdings Royal Bank of Scotland Shell Transport and Trading Astrazeneca Barclays HBOS Diageo

35 STATEMENT OF INVESTMENT PRINCIPLES Introduction The County Council ( the Council ) is responsible for the administration of the Hertfordshire Local Government Pension Scheme (LGPS). The Council has a statutory duty to ensure that any Local Government Pension Scheme funds, not immediately required to pay pension benefits, are suitably invested. As required by statute the Council has approved a statement of investment principles which are applied to the management of the LGPS investments ( the Fund ). In accordance with Government guidelines, the extent to which the Hertfordshire scheme complies with the 10 Principles set out in the Myners review of Institutional Investment in the U.K. is set out at Appendix A to this statement. Who makes the investment decisions? The Investment Committee of the County Council ( the Committee ), advised by the Finance Director, is responsible for setting the overall investment strategy, monitoring investment performance and then implementing relevant policies. The Committee consists of 8 County Council members; 3 (non-voting) district council members elected by the Hertfordshire Local Government Association and a nonvoting Unison representative. Day to day operational decisions are delegated to the County Council s Finance Director. All investments, with the exception of property unit trusts ( PUTs ), are managed by external investment management organisations ( the managers ). From 1 July 2002, in-house staff in Corporate Finance, reporting to the Finance Director, have been responsible for the management of PUTs. What are the investment objectives of the Fund? a) To comply with the Local Government Pension Scheme (Management and Investment of Funds) Regulations 1998, specifically to ensure that all:- - funds are suitably invested, - investments are diversified, - relevant investment limits are not exceeded, - investments and investment arrangements are regularly monitored and reviewed. b) To ensure that the Fund has sufficient assets to pay scheme benefits. 34

36 c) To achieve a long term rate of return on the invested funds (both capital gains and income) which assists in controlling the level of employer s contributions to the Fund and also the cost of the pensions to the local tax payers where appropriate by; i) as a minimum matching the actuary s rate of return assumptions made when assessing the Fund s level of funding, and ii) exceeding the fund benchmark by 1% measured over three year rolling periods. Achieving the investment objectives The Council, having taken appropriate professional advice, has made the arrangements set out below to reduce the risk that one or more of the investment objectives for the Fund are not achieved over the long term. a) Suitable Investments The Committee considers that the following types of investments, within specific limits, are suitable for the purposes of a pension scheme: cash, bank deposits and other short term money market investments; quoted fixed interest securities; individual securities and pooled investment vehicles; quoted equity investments; individual securities and pooled investment vehicles; property unit trusts; derivative instruments, but not to be used for speculative purposes; unquoted equity investments and private equity pooled vehicles. b) Fund benchmark and asset allocation From 1 July 2002 the Fund has adopted a specific benchmark which has been approved by the Committee, following appropriate professional advice from the investment consultant, fund managers and the performance measurement consultant. The composition of the Fund benchmark is set out at Appendix B to this Statement. The weightings of the various asset classes within the benchmark form the basis for asset allocation within the Fund. The asset allocation set out in the benchmark is designed to spread the risk and minimise the impact of poor performance in a particular asset class. It seeks to achieve a spread of investments across both the main asset classes (quoted equities, bonds, private equity and property) and geographic regions within each class. 35

37 c) Management of Investments The main choices when selecting a fund management style are: Active or passive making independent decisions when buying or selling investments (active) or buying stocks to replicate a specific index (passive); Balanced or specialist investing across a broad range of asset classes (balanced) or in a narrow, specific asset class (specialist). The Fund uses a mixture of active, balanced and active, specialist managers. The number of managers and the share of the Fund by type as at 31 March 2004 is shown in table 1 below, along with the comparitive figures for March Table 1 No. of managers Share of total Fund at 31 March March 2004 External, active, balanced % 68.9% External, active, specialist % 21.8% Private equity 4 0.8% 1.6% In-house, active, specialist (property unit trusts) 10.1% 7.7% Full details of the managers, their mandates and fee basis are shown at Appendix C. All the managers need the approval of the Finance Director to acquire shares in any securities that are not listed on a recognised stock exchange. d) Social, environmental and ethical considerations The Council retains external investment management organisations to select, monitor and realise the Fund s investments. The investment managers are expected to apply their professional expertise to maintain suitably diversified portfolios for a Local Government Pension Scheme. When making investment decisions the managers are expected to take account of what they reasonably believe are all relevant considerations. 36

38 e) Investment Restrictions The following investment restrictions apply to the funds under management: i) all limits determined under the LGPS (Investment and Management of Funds) Regulations 1998, (as amended) ii) additional limits which have been determined by the Council: Venture Capital - total investments are not to exceed 5 per cent of the value of the Fund. Options, futures & contracts for differences Individual equity holdings - Maximum 25% of UK equity portfolio. Only to be used to protect against possible adverse fluctuations in the values of other investments or cash in the portfolio. - the total holding in a single company is not to exceed 5% of the issued share capital. There are no other restrictions placed on the managers investment decision making. f) Investment Performance Measurement The investment performance of the Fund s managers is measured by an independent organisation, the WM Company, which reports quarterly to the Finance Director and at least annually to the Committee. g) Monitoring of Investment Managers The Committee meets quarterly to consider reports from each investment manager. Each manager makes a presentation in person to the Committee on at least an annual basis and to the Finance Director (or his representative) on a more regular basis. h) Actuarial Valuation The LGPS is subject to triennial valuations by an independent actuary. Employers contributions are determined by the actuary to ensure that in the long term the fund s assets will match its liabilities. i) Voting of Shares The Fund routinely votes on all matters raised by the largest 350 listed UK companies where it owns shares. The Fund s voting policy is to vote in accordance with the current principles of corporate governance best practice, as advised by the RREV (Research Recommendations and Electronic Voting) Service, provided by NAPF and LSS, except when the advice of the Fund s managers indicates such action would not be in the best financial interests of the Fund. 37

39 j) Custody Arrangements The Fund s assets are held in custody by an independent custodian, where reasonable controls have been certified by an appropriate auditor. This Statement of Investment Principles will be approved by the Investment Committee of Hertfordshire County Council on 9 th September Copies are available on request for participating scheme employers, scheme members, pensioners and deferred beneficiaries. The statement will be reviewed on an annual basis by the Council s Investment Committee. k) Future Strategy At the time of going to print, the Investment Committee are implementing changes to the investment Strategy of the fund. This will result in a move to a more specialist management structure. This document will be updated to reflect these changes as soon as they are complete, and the updated Statement of Investment Principles will be included in the 2004/05 Annual Report and Accounts 38

40 Compliance with 10 Myners Principles Appendix A Principle 1 Effective Decision Making Principle 2 Clear objectives Decisions should be taken only by persons or organisations with the skills, information and resources necessary to take them effectively. Where trustees elect to take investment decisions, they must have sufficient expertise and appropriate training to be able to evaluate critically any advice they take. Trustees should ensure that they have sufficient in-house staff to support them in their investment responsibilities. Trustees should also be paid, unless there are specific reasons to the contrary. It is good practice for trustee boards to have an investment subcommittee to provide the appropriate focus. Trustees should assess whether they have the right set of skills, both individually and collectively, and the right structure and processes to carry out their role effectively. They should draw up a forward-looking business plan. Trustees should set out an overall objective for the Fund that: Represents their best judgement of what is necessary to meet the Fund s liabilities given their understanding of the contributions likely to be received from employers and employees; and Current position Day to day operational decisions are delegated to the County Council s Finance Director who, with relevant members of his staff, regularly attends seminars and briefing sessions to maintain a high level of skill and knowledge in investment matters. Members of the Investment Committee act in the role of trustees for the Fund. They attend training sessions organised by the County Council. They receive no specific payments in relation to this work. Both members and officers involved with making investment decisions take advice from appropriately qualified professionals where appropriate. Development area The Investment Committee will draw up a business plan setting out the future investment strategy for the Fund. Current position The Fund s main investment objective as set out in this SIP is to have sufficient assets to meet the liabilities by achieving a long term rate of return on the investments at least equal to the rate used by the actuary when setting the contribution rate every three years. 39

41 Principle 3 Focus on asset allocation Takes account of their attitude to risk, especially their willingness to accept underperformance due to market conditions. Objectives for the overall Fund should not be expressed in terms, which have no relationship to the Fund s liabilities, such as performance relative to other pension funds, or to market index. Strategic asset allocation decisions should receive a level of attention (and where relevant, advisory or management fees) that fully reflect the contribution they can make towards achieving the fund s investment objective. Decision-makers should consider a full range of investment opportunities, not excluding from consideration any major asset class, including private equity. Asset allocation should reflect the fund s own characteristics, not the average allocation of other funds. Development area To define acceptable risk levels for the Fund as a whole and for individual managers. Current position The use of a scheme specific benchmark from 1 July 2002 requires Committee members, with professional advice, to make high-level, asset allocation decisions. The Fund will no longer use a peer-group benchmark, which resulted in asset allocation based on the average for a group of other funds. The new benchmark gives more substantial weighting to alternative investment opportunities in private equity and property, alongside the other major asset classes of equities and bonds. 40

42 Principle 4 Expert advice Principle 5 Explicit mandates Contracts for actuarial services and investment advice should be opened to separate competition. The fund should be prepared to pay sufficient fees for each service to attract a broad range of kinds of potential providers. Trustees should agree with both internal and external, investment managers an explicit written mandate covering agreement between trustees and managers on: an objective, benchmark(s) and risk parameters that together with all the other mandates are coherent with the fund s aggregate objective and risk tolerances; the manager s approach in attempting to achieve the objective; and clear timescale(s) of measurement and evaluation, such that the mandate will not be terminated before the expiry of the evaluation timescale for underperformance alone. The mandate and trust deed and rules should not exclude the use of any set of financial instruments, without clear justification in the light of the specific circumstances of the fund. Current position From September 2002 there are separate contracts for actuarial advice and investment consultancy. Current position Formal, written agreements are in place with each manager which set out the investment objective, the benchmark, any limits on investments and the period over which performance is to be measured. An annual report is presented to the Committee detailing all the costs involved in managing the Fund s investments, including direct and indirect costs. Only 1 of the Fund s external managers still uses soft commissions. 41