Karen Shackleton, Resonance non-exec and independent investment adviser, discusses how Local Government Pension Schemes may view their options when social investment become mainstream allocations.

In September 2016, the Department for Communities and Local Government (DCLG) published long-awaited guidance on investments for Local Government Pension Schemes (LGPS). The guidance had been prepared to help administering authorities who now have to prepare an Investment Strategy Statement (ISS) – this, as its name suggests, outlines how the pension fund is invested. The deadline for local authorities publishing their first ISS is 1st April 2017. Importantly, the guidance indicates that there is going to be less central government prescription in respect of investment decisions. Instead, administering authorities are “expected to make their investment decisions within a prudential framework”.

One of the key policies, which an authority must outline clearly in the ISS, is how social, environmental and corporate governance considerations are taken into account within the fund’s investments. The guidance makes it clear that the administering authority must take proper advice and act prudently – not surprisingly, it isn’t just a case of being able to funnel money into pet projects. Importantly, however, the guidance explains that, although the financial risk-adjusted return from an investment must remain a priority, the authority may take into account non-financial considerations. The guidance goes further to clarify, specifically, the position on social investments, acknowledging that “some part of the financial return may be forgone in order to generate the social impact”. These investments can be considered “providing the administering authorities have good reason to think scheme members share the concern for social impact, and there is no risk of significant financial detriment to the fund”.

This helpful clarification is likely to lead to an increased interest in social investment from the LGPS. So what steps can a local authority take, when considering social investments as a potentially mainstream allocation, in a way that results in a successful whole fund investment strategy and, at the same time, generates meaningful social impact at the grass roots level?

Step 1: clearly define the types of social causes which the scheme is prepared to consider
This is an important point. There are many, well-deserving social enterprises throughout the UK who are all competing for funding. For the LGPS, it is likely to be social needs that typically come under the council’s normal remit – these are most likely to appeal to scheme members who may well work with those in need. Social causes might include, for example, homelessness, saving/developing community assets, diverting surplus food to those in need, and so on. Some engagement with the scheme members may be beneficial in this respect – an online questionnaire, for example, to identify preferred areas of social investment.

Step 2: decide what role these social investments will be playing in the investment strategy
According to Preqin, in 2014, 14% of investors in infrastructure felt their investment had fallen short of expectations, twice as many as when the survey was carried out in 2013. Part of the reason for this may well have been a lack of clarity as to what role infrastructure was playing in the overall investment strategy. Was it to access secure income? An inflation hedge? Growth? Diversification? The same is true for social investments. Different types of investment will result in different return streams. Resonance’s National Homelessness Fund, for example, gives the investor a stable rental yield and capital growth potential from the value of the underlying properties being purchased – this is, essentially, a residential property investment. Their Affordable Homes Rental Fund, on the other hand, is a secured asset backed loan. The two investments will have different risk/return profiles, and different social impact, as well.

Step 3: identify a suitable investment manager/fund
Finding a suitable manager requires thorough due diligence and a pension fund should be confident that their chosen firm has the necessary experience and skill in the area concerned. How well does the manager understand the issues being faced in the particular social sector in which they are investing? How established are their relationships with any charities, or other partners with whom they are working? Have they already got a strong track record in terms of delivering sound, risk-adjusted returns? How much capacity do they have for new investments? What headwinds are they likely to face?

Step 4: measurable impact
Whilst the return stream coming through to the pension fund will be relatively straightforward to identify and measure, what is often harder is how to gauge, objectively, the impact of a social investment. Yet managers should be able to evidence this with hard data, for example: the number of projects supported, the total amount invested, number of adults and children housed, locations where social investments were made, number of affordable houses completed, progression of tenants towards work, and so on. Pension funds may even wish to set some (realistic) milestones which they expect the fund to achieve, as an objective measure of success.

Step 5: communication with members
The guidelines from DCLG are quite clear that social investments are permitted “providing the administering authorities have good reason to think scheme members share the concern for social impact”. The AGM or annual report is an ideal way to communicate progress to scheme members. Many of the stories behind social investments are encouraging and uplifting to read and promote a level of interest, for members, not normally associated with regular bond and equity investments. These tangible outcomes can be used positively by the pension scheme, in its engagement with the beneficiaries of the fund.

Structured properly, there is no reason why social investments cannot become excellent mainstream allocations for local authority pension funds, over time. Many investments provide secure income streams that can be directly used to pay pensions. The fact that a number of these initiatives are tackling problems already being faced by many local authorities, means there is an alignment of interests. Pooling of LGPS assets is also likely to facilitate more significant investment in regional social investments, achieving this in a more diversified manner than can be managed at the individual fund level.

The future for social investment may just be beginning to look a little brighter…