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Budget 2024: public debt switch likely to increase LGPS scrutiny and focus investment time horizons

Simon Bentley
Simon Bentley
Managing Director, Head of UK Solutions Client Portfolio Management

Key takeaways

  • Chancellor confirms switch to the use of Public Sector Net Financial Liabilities (PSNFL) to measure public debt
  • This includes the LGPS, which currently has a positive funding ratio – but any deterioration in this will now have a direct and immediate knock-on effect on the country’s finances
  • Falling interest rates would see rising liability values and worsening funding ratios, regardless of the success of growth-oriented strategies or Pooling-driven cost efficiencies and governance gains. However, a liability hedging strategy could directly address the issue

During yesterday’s Budget announcement the Chancellor, Rachel Reeves, confirmed expectations that she will switch to measuring public debt using Public Sector Net Financial Liabilities (PSNFL).

Unlike the currently used Public Sector Net Debt (PSND) approach – which largely compares cash receipts (mostly taxes) and cash outlays (mostly day-to-day public service spending), netting off only very liquid assets such as cash and FX reserves – PSNFL includes some additional longer-term assets and liabilities.

One of the more significant additions is funded public sector pensions (ie, the Local Government Pension Scheme), which at the time of writing is in a strong position, around 120% funded1. This excess of assets versus liabilities means that PSNFL reduces the UK’s debt level relative to PSND (or PSND ex Bank of England, ie adjusted for quantitative easing and related programmes).

This change of approach creates more headroom for the government, increasing scope for spending and/or reducing the pressure to raise taxes. As this move was well communicated before the Budget it did not come as a surprise to investment markets. Overall, it frees up about £50 billion of headroom, although it is not expected that this will all be used immediately. It will, however, support future investment spending to drive economic growth. The announcement was accompanied by a promise to have PSNFL falling over the Parliamentary term.

What does this mean for LGPS?

  • Firstly, there is likely to be more scrutiny on LGPS funding ratios within central government, as a deterioration in the funding ratio (even if they remain in excess of 100%) will worsen the PSNFL metric and have direct and immediate knock-on consequences for the country’s finances.
  • The change introduces an additional milestone for assessing LGPS funding ratios, to coincide with the five-year electoral cycle. Whereas the LGPS have always been able to take a long-term approach to deficit recovery and smoothing of contribution rates, this change forces a periodic check-in with a finite time horizon.
  • Linked to this point, the March 2028 tri-annual valuation cycle 2 will increase in importance as it will occur the year before the end of the current parliament.
  • With PSNFL considering both sides of the LGPS balance sheet, there is likely to be central government support for continuing to take investment risk to further improve the funding position. This is consistent with the government’s aspiration to use pension scheme assets to support UK growth through investment in UK productive assets.

Interest rates are broadly considered to be at the peak of the current cycle, with material scope for falling further or faster than is currently priced in. Falling interest rates would result in rising liability values and worsening funding ratios, irrespective of the good work being done on growth investments and Pooling cost and governance efficiency gains. Increases to inflation expectations would have the same impact, albeit more modest.

A liability hedging strategy would address the issue directly by immunising the funding ratio from changes in interest rates and inflation expectations. It would mean that any excess returns delivered by growth assets would feed directly through to the bottom line to improve funding ratios, and not be eroded by falling interest rates.

Liability hedging is a flexible, robust and highly tailorable investment tool, so is something that can reflect the unique valuation approach, time-horizon, liability profile and capital availability of each Fund within the Scheme, and potentially be implemented at either Fund or Pool level. We would be delighted to discuss how a hedging strategy might work for you. 

If you would like further details or would like to discuss why we think these points are of interest, then please do get in touch. 

Moira Gorman

Client Relationship and Sales Director

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Budget 2024: public debt switch likely to increase LGPS scrutiny and focus investment time horizons

1 Gov.uk, Local government pension scheme funds for England and Wales: 2023 to 2024, 24 October 2024

2 March 2029 in Scotland

Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients) This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry, or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either.Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients) This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry, or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either.Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

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