Oil wealth fund managers beat the market but council outspends growth

The fund managers entrusted with taking care of Shetland Islands Council’s oil wealth achieved a well-above average stock market return of £23 million last year, yet the local authority still needed to withdraw £8 million over and above that to complement its spending on public services and capital projects.

Council investments on the world’s money markets were valued at £231 million at the start of 2010/11 but, despite investors providing better than normal returns of 10 per cent, the total value of the reserves dropped to £223 million by the end of March. In addition to the latter sum, more than £30 million is held locally.

The latest figures could serve to intensify a growing sense that the local authority will have to abandon its policy of maintaining the oil reserves at or above £250 million. Steep reductions in public spending mean councillors will have to strike an ever more careful balance between using the reserves to cushion the damage caused by cuts and the risk of seriously depleting the funds left for future generations of Shetlanders.

The minimum floor policy was agreed in the middle of the last decade to help safeguard the community’s Sullom Voe-funded nest egg, though if inflation were taken account the reserves’ actual value has declined considerably since then.

Councillors today heard presentations from the five fund managers responsible for investing £650 million of community funds: the council’s oil reserves, Shetland Charitable Trust’s £179 million pot and the SIC’s pension fund, which ended last year valued at £251 million.

The pension fund is now in robust health having risen by £29 million over the course of 2010/11. That was thanks to a £15 million return on stock market investments and a £14 million increase caused chiefly by payments to pensioners being comfortably outweighed by pension contributions from the council and its existing staff.

SIC accountant Colin Bain said the pension fund was growing so strongly that if every council employee were to retire tomorrow, they could expect to get 88p in every pound of their pension entitlement – a much higher ratio than most pension funds can boast.

It is welcome news given that, over the past five years, the pension fund had been the worst-performing of all UK local authority funds. Former manager Capital was sacked for its dismal performance two years ago and the SIC’s independent adviser, State Street’s Karen Thrumble, said things had definitely moved “in the right direction” since.

More than nine tenths of the pension fund is now invested by Black Rock, which aims to match the performance of the market as a whole. It also invests just over 60 per cent of the charitable trust’s funds.

Ms Thrumble said Black Rock was doing “exactly what you’d expect” at a relatively low cost in fees. “For a pension fund, boring can be a very, very good thing,” she said.

The remainder of the pension fund is invested in property markets by Schroders, though their return in 2010/11 was well below the benchmark it was set. Its representatives remain confident that returns will be “more consistent” and healthy in the long run.

Councillors agreed to record “dissatisfaction” at Schroders’ performance, though Ms Thrumble urged members not to “get too worked up” about one-year figures, which were “almost meaningless” as investing in property is a long-term game.

A fluctuating number of councillors, varying from six to 11, were present for the 165-minute meeting in Lerwick Town Hall. They heard of differing fortunes for the trio of firms which manage the council’s precious oil reserves.

The undoubted success story was Baillie Gifford, which invests more than a third of the reserves and in 2010/11 outperformed its benchmark by some seven per cent. Mr Bain’s report described its equity dealings as “excellent”.

The company attributed the lucrative outcome partly to shrewd investments in blossoming internet commerce operations, including fashion retailer ASOS, property website rightmove.co.uk and Chinese search engine Baidu.

Baillie Gifford also made money-spinning investments in new technologies and Chinese healthcare manufacturers, while avoiding BP stocks meant it did not lose out when the oil giant’s share value halved as a result of the Deepwater Horizon disaster in the Gulf of Mexico last year.

Councillor Jonathan Wills was “very pleased” with the results, though he felt “very guilty” about exploiting cheap labour in China. Dr Wills has long been a proponent of investing ethically and he was “very re-assured” to learn that Baillie Gifford was actively lobbying oil and mining companies on health and safety matters.

Its representative Anthony Tait explained that behaving more ethically was in firms’ interest because if they were found to be using child labour or conducting activities which damaged, say, the Amazon rainforest, it would be extremely destructive to their corporate reputation.

Less impressive was the performance of GMO, whose good returns on UK shares were offset by a disappointing performance in overseas markets.

It takes a “contrarian” approach to investing because of a belief that many investors get carried away and reach unwarranted “bold conclusions” about the future. Examples given included the mistaken belief back in 1998 that there was too much oil sloshing around, or the lethal assumption that US house prices could not plummet prior to the global financial crisis three years ago.

GMO representative Ian Thompson acknowledged the company’s approach meant returns were “lumpy”. Sometimes it was “difficult to get the timing absolutely right” when buying undervalued stocks, he conceded, but he maintained it was a valid strategy. Councillors agreed to register “dissatisfaction” at GMO’s performance.

The third and final fund manager, Insight, has now been working for the SIC for a decade. Ms Thrumble said their performance was broadly in line with the norm for the bonds market in which they operate. Though they had not quite matched their benchmark target, Insight’s work was deemed satisfactory.