The London Pension Funds Authority, a £4.2 billion ($6.6 billion) UK local government pension scheme, has been seeking to diversify into asset classes uncorrelated with equity.

The authority runs a £2.7 billion return-seeking pool and a £1.5 billion liability-driven investment pool within its defined benefits scheme, with about 200 employers in each.

It describes itself as a responsible investor that aims to factor environmental, social and corporate governance into its decision-making.

Mike Taylor, the LPFA’s chief executive, says it sees global equities as the natural home for its investments, which are run entirely by external managers. That explains why global equity accounts for 59% of its active portfolio. It has a CIO and a small in-house management team.

However, as Taylor points out, the authority has been undershooting its target return of 7-8% nominal per annum, which he ascribes to the problem with equity markets over the past 20 years.

“Clearly we are not happy underperforming,” he tells AsianInvestor. “We have tried to diversify more in recent years, but we are confident that equities are the right place to be in the long term.”

He says the authority targets exposure to those areas with higher-than-average GDP growth. Yet within its global equity portfolio both Asia ex-Japan (7.4%) and world emerging markets (5.9%) are below the weighting of its chosen benchmark, the MSCI All-Country World Index.

Taylor notes that the LPFA’s exposure to Asia is dictated by its external managers. But he adds that the authority tends to invest in firms with exposure to Asia, rather than to Asia directly. In the same way it gains its exposure to China through firms that trade heavily with the country.

Asked if this was likely to change, Taylor replies: “If corporate governance [in China] improves dramatically and the general level of trust that accounts are right and the government is not going to step in in a detrimental way, then it might.”

As a result of equity market underperformance Taylor estimates that the LPFA has doubled its exposure to alternatives in the past five years, in particular private equity (now 13% of its active portfolio) and infrastructure.

At the same time it has halved its exposure to multi-asset diversified funds (10%). “They are like the old balanced funds of 10-15 years ago, with three times the fees, if you are being cynical,” he says.

The LPFA has also been looking at opportunity funds – taking out of global equity to invest in such things as UK distressed credit. It has also been looking at the potential of catastrophe bonds and other asset classes uncorrelated with equity markets as a way to reduce volatility.

Further, Taylor says the LPFA has also been examining the potential for thematic exposure to the Asia region, in particular to capture trade going across the Indian Ocean.

“I am talking about a manager who says that ports on the Indian Ocean will be key routes of trade for the world, and therefore we will invest in things that are close to or go through those ports,” he says.

However, he notes the LPFA has been unable to find a fund vehicle it wanted to invest in. Asked if a thematic fund for China was beyond the realms of possibility, Taylor replies: “No.”