LGPS funding levels reach new high with rising Gilt yields

The latest release of Isio’s Low-Risk Funding Index reveals the aggregate funding level for the 87 funds participating in the Local Government Pension Scheme (LGPS) in England and Wales has improved from 106% at 31 March 2024 to 109% at 30 April 2024. This marks the highest reported month end funding position and includes a record high of 110% achieved during April.

The improvement is primarily due to increases to UK gilt yields, partially offset by small reductions in asset values. Of the 87 participating funds, 59 have funding levels of 100% or higher, with levels ranging from 68% to 163% funded.

At the previous actuarial valuation date, 31 March 2022, the aggregate low-risk funding position was 67% and none of the 87 funds had a funding level of 100% or higher on a low-risk basis. With only 11 months to go until the 31 March 2025 actuarial valuation, these results provide further evidence that ongoing funding levels for LGPS funds and their employers are expected to be higher than at 31 March 2022, meaning that surpluses will have increased further.

Equity markets have performed well recently, complemented by gilt yields rising during April, but there is a risk that equity markets and gilt yields fall over the next 11 months, negatively impacting funding, and causing some individual funds and their employers to move below a 100% funding level on a low-risk funding basis, which is a measure of self-sufficiency.

This creates an immediate challenge across the LGPS and funds could consider taking a shorter-term view to lock in some or all of the current equity market highs, or whether a long-term view should prevail.

Steve Simkins, Partner and public services leader at Isio, says: “The countdown to the 2025 valuation continues, with LGPS funds finding themselves in new territory, with the highest reported month-end low-risk funding level since launch and the Index exceeding 110% during April.

“Higher assets, combined with higher long-term yields, are a recipe for improved pension scheme funding. Whilst the LGPS takes a long-term perspective on funding, the evidence from the Index suggests that ongoing funding positions and surpluses have further improved since the 31 March 2022 valuation.

“This creates a tension between LGPS funds’ long-term funding strategies and short-term planning for the next valuation to secure the best outcomes for their employers, some of whom would welcome cost and investment risk reductions. Locking in some of the gains made from the current equity market highs presents an opportunity to achieve both. Higher gilt yields put the spotlight on the merits of an equity for gilts switch.”

Andrew Singh, Associate Director and Head of Public Sector Investment Advisory at Isio, says: “Current market conditions provide a somewhat unexpected opportunity for LGPS funds to review the risk levels associated with their investment strategies. However, despite the fall in gilt prices, reducing investment risk does not necessarily have to mean transitioning all the way from ‘growth’ equities to ‘protection’ bonds. It can instead involve modest reductions to expected returns in exchange for more contractual investment return profiles.

“Given the market movements we have seen it might be necessary for funds to re-balance assets back towards the strategic allocation, or go further and review the strategic allocation. Whilst investment strategies are built for the long-time, there are times when short-term considerations come into play and with the next actuarial valuation looming this might be one of those times.”

Isio’s Low-Risk Funding Index will undergo a recalibration using information available from the 2023 published annual reports when the data is available for all funds. Analysis of strategic asset allocations suggests that funds are starting to take small steps to ‘lock-in’ improved funding positions and reduce the risks associated with growth assets. However, closer inspection shows that, despite the shift on an aggregated basis, a number of funds actually increased their risk over the year to 31 March 2023.