Annual Report and Accounts of the Orkney Islands Council Pension Fund

2023/2024

www.orkney.gov.uk

IMAGE: Cover page for the Annual Report and Accounts of the Orkney Islands Council Pension Fund 2023/2024. It shows the Orkney Islands Council crest and the Orkney Islands Council name above a coastal scene with a road crossing a causeway, rocky shoreline, water, and a rusted boat. The cover also displays the text “Annual Report and Accounts of the Orkney Islands Council Pension Fund 2023/2024” and “www.orkney.gov.uk”.

Contents

• Annual Report and Accounts of the Orkney Islands Council Pension Fund — 1

• 2023/2024 — 1

• Management Commentary — 1

• Statement of Responsibilities for the Annual Accounts — 15

• Remuneration Report — 17

• Annual Governance Statement — 18

• Governance Compliance Statement — 27

• Annual Accounts 2023/2024 — 31

• Pension Fund Account — 31

• Net Assets Statement as at 31 March 2024 — 32

• Notes to the Annual Accounts — 33

• Independent Auditor’s Report to the Members of Orkney Islands Council as administering authority for the Orkney Islands Council Pension Fund and the Accounts Commission — 58

• Annex 1 – Pension Fund Sub-committee, Pension Board, Scheduled and Admitted Bodies — 63

• Annex 2 – Actuarial Statement for 2023/2024 — 64

• Annex 3 - Glossary of Terms — 66

• Additional Information — 68

Management Commentary

Introduction

Welcome to the Annual Report and Accounts for the Orkney Islands Council Pension Fund for the year ended 31 March 2024.

The Local Government Pension Scheme (Scotland) Regulations 2018 require the Council, as administering authority for the Fund, to produce a separate statement of accounts for the Pension Fund and incorporate it into an Annual Report.

This Annual Report has been produced to provide Elected Members, employers, scheme members and other interested parties with information concerning the administration and performance of the fund for financial year 2023/2024 and we hope you find its content useful.

To assist in the understanding of the Annual Report and Accounts we would encourage you to make reference to the Management Commentary in the first instance.

We realise that pensions are a highly complicated subject. It is, however, important that fund members take the time to try and understand the scale of benefits that they will receive when they retire - whether this is from the Local Government Pension Scheme itself or through other pension arrangements, such as the State Pension.

Overview of Fund Business

Under the statutory provisions of the Local Government Pension Scheme, Orkney Islands Council is designated as an “Administering Authority” and is required to operate and maintain a pension fund – the Orkney Islands Council Pension Fund (“the Fund”).

The Fund is used to pay pensions, lump sum benefits and other entitlements to scheme members and their dependants. Contributions to the Fund are made by employee members and by participating employers. The Fund also receives income from its investments, which include equities and pooled investment vehicles.

The Fund operates under the terms of the Local Government Pension Scheme, which is a public sector pension arrangement. Scheme membership is made up of active, deferred and pensioner members. To be able to join the scheme, a person must be employed by a relevant employer and not eligible to join another public sector pension scheme. Teachers are not included as they have a separate national pension scheme.

Review of the Year

Key Facts and Figures

• Value of the Fund at 31 March 2024 was £535.8 million (£479.9m at 31 March 2023).

• An Operational and Investment Income Gain of £55.9 million was incurred on the activities of the fund (compared to a loss of £28.7m for the year ended 31 March 2023).

• The increase in fund value over the year was largely the result of an increase in the market value of investments of £43.7m. Outflows, including benefits payable (£11.2m) and management expenses (£3.4m) were offset by investment income of £11.9m and contributions receivable of £13.5m. Overall, this represents a year-on-year increase of 11.7% in the value of the fund.

• Performance of the Fund on a three-year rolling average basis has been 0.4% p.a., giving a relative return below benchmark of 5.9%.

• Fund membership increased by 186 to 4,661.

• Employers contributed £9.9 million to the Fund (£8.7m to 31 March 2023).

• Employees contributed £3.6 million (£3.1m to 31 March 2023).

• Pension and other benefits paid out were £11.2 million (£10.3m to 31 March 2023).

• Transfer values paid into the Fund because staff changed employers was £2.4 million (£1.1m to 31 March 2023).

• Transfer values out of the Fund because staff changed employers was £1.0 million (£3.2m to 31 March 2023).

Over the 2023/2024 financial year, the Fund returned 11.7% as the global investment markets gained momentum over the last 12 months.

The majority of the Fund’s mandates had positive returns this year in absolute terms, with the exception of fixed gilt and index-linked gilt holdings with LGIM.

Amongst the growth assets, the Baillie Gifford Global Alpha fund was the best performing mandate over the year, returning 17.6%, in absolute terms. Although the manager underperformed its benchmark by 3.0% over this period. Over the last 12 months global equities rebounded strongly as fears of a deep recession faded away. The underperformance of the manager was partially style driven, as higher yields led to lower valuation of the mandate’s high duration assets.

In a similar fashion, the Baillie Gifford UK equity fund returned 6.0% (in absolute terms) over the 12-month period but underperformed its benchmark by 4.9% (net of fees). The underperformance was largely driven by the manager’s sector positioning relative to its benchmark.

The Fund’s multi asset funds (Baillie Gifford Diversified Growth Fund and Multi-asset Fund), returned 3.3% and 2.1% over the last 12 months, underperforming the benchmark by 4.9% and 6.0% (net of fees), respectively. Both mandates were subsequently terminated in Q2 of 2024.

The Fund’s protection assets with LGIM, (gilts and index-linked gilts) detracted from the overall performance, returning -3.2% combined. Fixed income assets continued to suffer throughout the year as high inflation and rising interest rate expectations resulted in the rise of yields and the fall in prices (bond prices fall as their yields rise). UK bonds in particular dropped in value as rates rose throughout the year as the Bank of England attempted to tame inflation.

Within the Fund’s income assets, Barings Global Private Loan Fund (GPLF) 3 and 4 posted positive returns over the 12-month period, outperforming their benchmark, by 3.0% and 1.4%, respectively.

Similarly, IFM Infrastructure had a positive return over a 12-month period in absolute terms, returning 5.1%, albeit falling behind the benchmark by 4.4%. We note it is too early to meaningfully evaluate the manager’s performance, given this is a relatively newly appointed manager.

The overall benchmark return of 13.7% generally reflects variable market conditions for investors over the 12 months to 31 March 2024.

The table shown within the investment strategy section, page 6, details the allocation of the fund within asset class or pooled investment vehicle.

The value of the fund increased by £55.9m or 11.7% in the financial year and totalled £535.8m at 31 March 2024.

The change in value of the fund over any given period is a combination of the net money flows into or out of the Fund and any gain or loss on the capital value of its investments.

During the year, a gain on member contributions receivable and transfers in over pension payments and management expenses of £0.4m (2023: £3.3m loss) was increased by income from dividends and interest of £11.9m (2023: £9.6m). The Fund was further increased by a net capital gain of £43.7m (2023: £34.8m loss).

The Accounts are based on the market value of investments at 31 March 2024. This means that they include the profit or loss that has been made, due to the change in the value of investments, over the period from the date of their purchase to 31 March 2024 even though no actual sale has taken place. This notional value is defined as "unrealised” profit or loss. By contrast “realised” profits and losses are those that have arisen from actual sales throughout the year. Of the net capital gain of £43.7m in the year, £31.8m was an unrealised gain (2023: £30.6m loss) and £11.8m realised gain (2023: £4.2m realised loss).

After allowing for projected liabilities on the fund, the funding level has increased to 174% at 31 March 2024 from its value of 164% last financial year end, calculated on an ongoing funding basis. This improved investment outlook has been partially offset by an increase to future inflation expectations.

We are pleased to report that the Fund maintains a position above its 100% funding target, being in surplus by £221m at the financial year end (2022/2023: £188m) according to the actuary’s most recent funding update.

Economic and Market Background

Global growth has been stronger than expected over the past 12 months, particularly in the US, and, given ongoing improvements in activity survey data, global growth forecasts for 2024 have also been revised up, and now suggest only a marginal slowdown in 2024 versus 2023.

Year-on-year headline CPI fell to 3.2%, 3.5% and 2.4%, in the UK, US and eurozone, respectively, in March 2024, from 10.1%, 5.0% and 6.9% a year earlier. Core inflation, which excludes volatile energy and food prices, fell less but still declined materially, to 4.2%, 3.8% and 2.9% in the UK, US and eurozone.

The US Federal Reserve raised rates 0.5% pa, to 5.5% pa, in the 12 months to end-March 2024, while the Bank of England and European Central Bank both raised rates by 1.0% pa, to 5.25% pa and 4% pa, respectively. However, amid progress on inflation, the major western central banks have left rates unchanged since the summer of 2023 and markets were expecting them to deliver between 2 and 3 interest rate cuts in 2024 at the end of Q1. In March, the Bank of Japan raised rates for the first time in 17 years, exiting negative interest rates.

Trade-weighted US dollar, sterling and euro rose 2.3%, 4.6%, and 3.6%, respectively. The equivalent measures for Japanese yen declined 9.1%, as investors continue to bet on a wide interest rate differential between Japan and its global peers. Gold prices rose 12.0% on the back of lingering inflation concerns and strong central bank reserve demand, and oil prices rose 11.7% amid supply cuts and conflict in the Middle East.

Sovereign bond yields rose sharply in March amid expectations that rates might be cut less than previously anticipated. Over the past 12 months, UK and US 10-year bond yields rose 0.4% pa and 0.7% pa to 3.9% pa and 4.2% pa, respectively, while equivalent German yields remained broadly unchanged at 2.3% pa. Equivalent Japanese yields rose 0.4% pa, to 0.7% pa, as the Bank of Japan loosened its yield curve control policy and raised interest rates.

Global credit spreads fell, reflecting both the improved outlook and yield-driven demand from institutional investors. Global investment-grade credit spreads declined 0.5% pa, to 1.0% pa, over the past 12 months while global speculative credit spreads fell by 1.6% pa, to 3.4% pa. Despite a rise in underlying sovereign bond yields UK investment-grade and US high yield returned 7.4% and 11.0%, respectively.

The FTSE All World Total Return Index rose 25.0% in local-currency terms amid improving economic activity, declining inflation, and enthusiasm for all things AI. Japan strongly outperformed as yen weakness lent support to the export-heavy index and optimism around corporate governance reforms gained momentum. North American equities also modestly outperformed, given their large exposure to the outperforming technology sector. Emerging markets and Asia Pacific ex-Japan notably underperformed as investors remained concerned about China’s growth prospects amid ongoing property market weakness and disappointment with policy stimulus unveiled so far. The UK also underperformed, given little exposure to technology and above-average exposure to underperforming energy and basic materials.

Global growth momentum improved as the beginning of 2024, and there are tentative signs of a recovery in manufacturing activity, following the global industrial recession of the past 18 months. As a result, global growth is now expected to slow only modestly in 2024, and recession fears have rapidly receded. However, better activity data have been accompanied by a resurfacing of inflation fears, with markets now expecting two to three interest-rate cuts from the major central banks in 2024, down from six to seven at the start of the year.

The fundamental outlook for risk assets has improved, but our concerns are shifting towards valuations, which have baked in a lot of good news. Razor-thin credit spreads are supported by strong demand, but we think attractive yields are mostly a reflection of underlying sovereign bond yields, and credit risk premia look exceptionally low, particularly in fixed-rate bond markets. We do not suggest an imminent reversal of fortunes is likely, but global equity valuations point to a more subdued medium term return outlook. There are also hints of stabilisation in the UK commercial property market. Valuations are no longer demanding, given the steep declines in capital values over the last couple of years. However, the technical backdrop is still challenging.

While short-term sovereign bond yields, at best, fairly reflect the likely extent of near-term rate cuts, and underlying inflation pressures suggest central banks might cut even less than expected, we still think longer-term bond yields are attractive. A more modest pace of interest-rate cuts would also extend the shelf life of cash, which offers a positive real yield to sit on the sidelines.

Investment Strategy

The investment strategy of the Fund is to invest monies in a prudent and diversified manner, in accordance with the Scheme regulations and in recognition of the inherent risks that accompany any investment in the respective asset classes. The strategy is set out in the Statement of Investment Principles which can be viewed on request.

A revised investment strategy was approved in February 2019. The process of transitioning to the revised strategy started during 2019 with the selection, appointment, and onboarding of new fund managers. The process of diversification commenced in financial year 2019/20 and was still ongoing during financial year 2023/2024. Significant steps have been taken towards the Fund’s interim-target allocation during the year. The revised asset allocation and range guidelines were applied with effect from December 2019 and have been regularly reviewed with the most recent review in February 2024. The agreed interim and long-term target allocations are shown in the Asset Allocation table below together with the actual asset allocation at 31 March 2024.

In time the strategy will transition towards the relevant target allocations. As at 31 March 2024 the equities asset allocation was overweight when compared to the target range, however, was within the overall range for total growth. The Fund has acted to reduce its holdings in growth–seeking assets in favour of funding a new allocation to income generating assets as part of a strategy to further diversify the Fund’s investments. Nevertheless, holdings in equities still account for 57.3%, with indirect holdings in Diversified Growth and Multi-Asset Growth pooled funds accounting for a further 16.7% of the Fund’s portfolio as at 31 March 2024. The remaining 26.0% is held in Infrastructure Credit, Private Debt, Bonds and Cash at 8.3%, 9.8%, 6.0% and 1.9% respectively.

Along with new allocations to global infrastructure credit and private debt, other changes included an increase in the bonds allocation which is now managed on a passive basis. In 2022 it was agreed to increase the Fund’s infrastructure allocation through a commitment to a net zero infrastructure fund. The most recent review in 2024 agreed a full disinvestment from the multi-asset mandates and subsequent investment of those proceeds into protection assets. These changes are intended to reduce the risk profile of the fund and will be matched by a proportionate reduction in growth assets.

As a result of its exposure to equities, the relative performance of the Fund against its benchmark can be volatile over the short term. However, the Fund continues to have a strong funding position together with a net contribution from its dealings with members which allows it to take a long-term view across successive investment cycles.

Responsible Investment Policy

A Responsible Investment Policy was approved in February 2024 which sets out the underlying objectives and beliefs of the Sub-committee on behalf of the Fund and what the Sub-committee expects to achieve from having this policy in place. It details the actions that the Sub-committee will take to achieve those actions and the means by which the actions will be assessed in order to judge whether the expected outcomes have or have not been achieved.

The top 10 direct equity holdings within the Fund at 31 March 2024 were:

Investment Performance

The performance of the Pension Fund managed investments has been measured against a bespoke or fund specific benchmark since the 1 April 2018, following the closure of the previous peer group benchmark, and reflects the weighting or concentration of individual asset classes within the approved investment strategy. The benchmark is maintained by Hymans Robertson.

The revised investment strategy approved in February 2019 included principally new allocations to infrastructure equity and private debt, funded by a further reduction in the Fund’s exposure to equities. The weightings of the fund specific benchmark were subsequently amended in December 2019 to reflect the revised investment strategy and signalled the start of the process to transition the Fund’s investments to the new strategy.

The Fund’s performance target for this accounting period is to outperform the fund specific benchmark measured over a rolling 5-year period. The average performance over the last 5 years of 6.1% is behind the benchmark of 7.9%.

IMAGE: A bar chart titled “Annualised Performance 2019-2020 to 2023-2024”. It compares Actual and Benchmark annualised performance over 1-year, 3-year and 5-year periods. The chart shows approximately 10.7% actual versus 13.7% benchmark for 1 year, 0.4% actual versus 6.8% benchmark for 3 years, and 6.1% actual versus 7.9% benchmark for 5 years.

Structure of Administration

Staffing

Administration of the Fund is carried out in-house and undertaken by the Payroll and Pensions section within Orkney Islands Council’s Enterprise & Sustainable Regeneration Service.

The Pensions team within the Payroll and Pensions section has 3.7 full time equivalents, consisting of a Service Manager, one full time Team Manager, two part time Senior Assistants and an Administrative Assistant. In addition to maintaining Fund members’ records using data supplied by all Fund employers, the Pensions team also provides frontline services to scheme members. As well as answering telephone calls and responding to electronic and written correspondence, meetings are provided where requested.

The staff resources detailed above are supplemented by shared staff resources within the Enterprise & Sustainable Regeneration Service, providing additional governance, payments, investment, and accounting expertise. In addition, the Human Resources and Organisational Development section, within Orkney Islands Council’s Strategy, Performance & Business Solutions Service also supports the work of the Pension section by arranging pre-retirement workshops for scheme members who are within two years of retirement.

Systems

Fund members’ records are maintained on Aquila Heywood’s pensions administration system known as Altair. Every current and former employee of Fund employers, including Orkney Islands Council, who has a pension entitlement in the Fund is included in the Altair system.

The Council’s ResourceLink Payroll system is used to pay pensioner benefits. The Pensions team is restricted to read only access of the payroll system, with amendments being made to pensioner records via a formal request process to the Payroll team.

Administration Performance

Orkney Islands Council as administering authority is committed to providing a high-quality pension service to both members and employers and ensuring members receive their correct pension benefits entitlement.

Administration performance figures are monitored by the Pension Fund for financial year 2023/2024, against the key service standards set by the Pension Fund Sub-committee, as follows:

Scheme Arrangements

Career Average Revalued Earnings Scheme (CARE) – LGPS 2015

A number of important changes have been made to the LGPS from 1 April 2015. The changes, which have been agreed between the Trade Unions, COSLA and the Scottish Government, ensure that the scheme complies with the terms of the Public Pensions Act 2013.

From 1 April 2015 the pension scheme moved away from a final salary to a career average revalued earnings scheme (CARE).

The main changes of this scheme were:

• A move towards benefits being worked out using career average revalued earnings (CARE) rather than final salary.

• Pensions being built up at a rate of 1/49th of annual pensionable pay.

• Member’s normal retirement age being linked to their own State Pension Age. Members may still be able to retire from age 60 but a reduction for early payment may apply.

• Protection of benefits for members aged 55 and over at 1 April 2012 who will be guaranteed that their benefits will not be less than they would have been if the 2015 scheme had never been introduced, and

• Benefits built up before April 2015 will continue to be calculated using actual final pensionable pay at date of leaving.

Fund Update

Membership details are shown below along with a short description for each membership status:

Employer Bodies

The Fund invested and administered pensions on behalf of 4 current and former employers during financial year 2023/2024. These include scheduled bodies, brought into the Fund by legislation, and admitted bodies, which chose to join the Fund. The detailed listing of employers and their membership numbers is contained in Note 1 of the Annual Report and Accounts for the Fund.

Pension Increases

Pensions which are in payment and deferment are increased each April in accordance with the Pension (Increase) Act 1971. Since April 2011, this increase has been linked to the Consumer Price Index (CPI) rather than the Retail Price Index (RPI).

Actuarial Valuation

Annex 2 contains the formal Actuarial Statement for financial year 2023/2024 which is prepared in line with International Accounting Standard (IAS) 26 and supports the preparation of the Accounts for the Pension Fund.

The last triennial valuation, as at the 31 March 2023, calculated that the Fund’s assets were valued at £480m, and were sufficient to meet 164.0% of the liabilities (i.e., the present value of promised retirement benefits) accrued up to that date. This compared with 118% at the previous March 2020 valuation. The resulting surplus at the 2023 valuation was £188m.

For the purpose of reporting a funding level and an associated surplus/deficit for the 2023 valuation a prudent future investment return of 5.2% p.a with a 75% likelihood of success has been used, this compared to 2.9% p.a for the 2020 valuation.

The liabilities were assessed using an accrued benefits method which takes into account pensionable membership up to the valuation date and makes an allowance for expected future salary growth and inflation to retirement or expected earlier date of leaving pensionable membership.

Since the previous valuation, various events have taken place which affect the value placed on the liabilities, including:

• Decrease due to future investment returns being anticipated to be higher than at 2020.

• Increase due to the significant increase in short-term future inflation expectations.

• Decrease due to a slight reduction in life expectancy (not allowing for Covid-related excess deaths).

• Decrease due to updated model of future improvements to the most recent model available, including allowance for some recent mortality experience related to the excess deaths from the Covid 19 pandemic.

This overall decrease in liabilities has been offset by an increase in the Fund’s assets resulting from a positive investment return and a net cash inflow over the period since the last full valuation at 31 March 2023.

As recommended by the Fund’s Actuary (Hymans Robertson) the employers contribution rate has been reduced to 15.0% for the period 1 April 2024 to 31 March 2027 with reference to the future costs and also taking account of the current funding position, which is based on past service benefits.

The LGPS regulations state that a Primary Contribution Rate should also be set, which is the cost of active members accruing benefits in the scheme. The overall contribution rate, expressed as a percentage of pay, has reduced due to both an improvement in the past service funding position and higher assumed future investment returns at 2023 compared to 2020.

The most recent funding update produced at 31 March 2024 indicates that the funding surplus has increased from 164% to 174% since 31 March 2023. The improvement has been driven by strong investment performance since 31 March 2023 and the changes to the economic outlook. A summary of these results is shown below:

The assessed Primary contribution rate for 1 April 2024 – 31 March 2027 at March 2023 was 22.1%. On applying a Secondary contribution rate of -7.1% to give a required minimum contribution, against the background of increased uncertainty over the future impacting on actuarial assumptions the employer contribution rate will be reduced to 15.0% for the three-year period 2024 to 2027.

Main Risks and Uncertainties facing the Fund

Awareness of risk and risk mitigation is a key facet of the Fund’s strategic and operational activities. Whilst it is not possible to eliminate risk entirely, the Fund has taken steps to evaluate risk and put strategies and controls in place to minimise its adverse effects. The Fund has its own risk register, which details some 24 risks faced by the Fund and can be viewed at the related downloads section here. The risk register is reviewed annually by the Pension Fund Sub-committee and Pension Board.

Principal risks, and the way in which they are managed, are as follows:

Financial Mismatch, the risk that the Fund’s assets fail to grow in line with the cost of meeting its liabilities. The Pension Fund Sub-committee measures and manages financial mismatch in several ways. It has set a strategic asset allocation benchmark for the Fund and assesses risk relative to that benchmark by monitoring the Fund’s asset allocation and investment returns. It also assesses risk relative to liabilities by monitoring benchmark returns relative to liabilities. The Pension Fund Sub-committee keeps under review demographic assumptions which could impact on the cost of benefits. These assumptions are considered formally in the triennial valuation and reviewed annually within funding update reports (Navigator) produced by the Fund’s Actuary, Hymans Robertson.

Systemic Risk, the risk of an interlinked and simultaneous failure of several asset classes and/or investment managers. The Pension Fund Sub-committee seeks to manage systemic risk by the appointment of investment managers. The Pension Fund Sub-committee regularly reviews total asset values within asset class.

Liquidity Risk, the risk that the Fund cannot meet its immediate liabilities because it has insufficient liquid assets. This is controlled by the regular estimation of cash flow to ensure that sufficient cash balances are available. By holding the majority of its assets in liquid assets such as equities and bonds, unexpected cash flow requirements can be met by the realisation of assets. Liquidity risk is also moderated by the Fund continuing to have a surplus of contributions receivable over pensions payable.

Custody Risk, the risk of losing rights to Fund assets when they are held in custody or being traded. The Pensions Sub-committee manages custody risk by the monitoring of custodian activities. The Fund has appointed Bank of New York Mellon’s London branch as its Custodian.

Transition Risk, the risk of incurring unexpected costs or losses when assets are transferred between asset classes. When carrying out significant transitions the Pensions Sub-committee will take professional advice and consider the appointment of specialist transition managers.

Pension Fund Sub-Committee and Pensions Board

In line with scheme regulations, and the respective terms of reference for the Pension Fund Sub-committee and Pensions Board, the group met concurrently on four occasions during 2023/2024.

Training activity for the members of the Pension Fund Sub-committee and Pension Board was undertaken during the financial year 2023/2024, in accordance with the agreed training plan, to enable Councillors charged with the governance of the Fund to execute their role as quasi-trustees effectively. In recognition of the complex and ever-changing environment of Local Government Pension Scheme finance, and specifically to address the governance requirements, the Chartered Institute of Public Finance and Accountancy Code of Practice on Public Sector Pensions Finance Knowledge and Skills has been adopted.

Acknowledgement

We would like to take this opportunity to thank our colleagues in the Enterprise & Sustainable Regeneration Service and the members of the Pension Fund Sub-committee and the Pensions Board for their help and co-operation in managing the financial affairs of the Pension Fund.

Gareth Waterson, BAcc, CA
Section 95 Officer
30 September 2024

Councillor Heather Woodbridge
Leader
30 September 2024

Oliver D Reid
Chief Executive
30 September 2024