Managing growth through volatility

LGPS funds continue to operate in a complex and evolving environment. Heightened geopolitical risk, volatile commodity prices and rapid technological change are creating a less predictable backdrop for asset allocation decisions. At the same time, funds are managing competing objectives: maintaining growth to support long‑term affordability, supporting cashflow management as contribution rates change, and demonstrating a robust approach to risk management in a governance efficient manner.

Against this backdrop, some investment committees are reassessing whether their current equity allocations are delivering growth in a form that is consistent with their long‑term strategy. This is not only about the level of expected return, but also about the shape of potential returns: particularly the scale and timing of drawdowns, and their implications for cashflow, rebalancing and member contribution stability.

For LGPS funds with material equity exposure, a key question increasingly arises: how can growth be retained, while reducing the likelihood that sharp market falls undermine funding resilience, affordability or governance capacity?

A role for defensive equity?

One approach investment committees may consider, in combination with their pool, is a defensive equity strategy. By combining equity market exposure with a systematic equity option‑based risk management overlay, the aim is to participate in equity markets while seeking to reduce the magnitude of drawdowns and dampen volatility.

Such an approach does not remove market risk or guarantee outcomes. However, its objective is to create a more controlled and resilient experience of equity exposure — particularly during periods of market stress. For LGPS funds, we believe this can be valuable where large and sudden equity drawdowns would otherwise create pressure on contribution rates, rebalancing decisions, or the timing of asset sales to meet cashflows.

In this sense, defensive equity is less about making tactical calls, and more about engineering a steadier return profile that aligns with long‑term funding and governance objectives.

When might defensive synthetic equity be appropriate?

The role of defensive synthetic equity is not to predict the next shock, but to help portfolios remain robust to a wide range of outcomes. While today’s concerns may include geopolitical tensions, energy price shocks or AI‑related disruption, history suggests future sources of volatility will look different again.

What remains constant is the challenge of balancing growth with resilience. Defensive equity seeks to preserve long‑term participation in equity markets, while targeting improved downside characteristics — smoothing the journey rather than attempting to time the destination.

Practical use‑cases for LGPS funds

Long‑term growth allocation: Within the growth portfolio, a defensive equity allocation can act as a partial substitute for traditional equity exposure. For funds seeking to maintain growth to support long‑term funding while being mindful of downside risk, this may help improve the overall risk profile without materially reducing expected equity participation.

Supporting cashflow management: As LGPS funds continue to deal with changing contribution rates, managing negative cashflow becomes increasingly important. Reducing the severity of drawdowns can help limit the need to realise assets at depressed prices, potentially supporting more predictable cashflow management over time.

Governance and implementation efficiency: For funds already using option strategies or dynamic risk management overlays, a pooled defensive equity structure may offer a simpler governance solution. This can reduce operational complexity and reporting burden, while seeking to retain systematic downside risk management within the portfolio.

Strengthening portfolio resilience

In an environment where uncertainty is persistent rather than episodic, the challenge for LGPS investors is not identifying the next source of disruption, but ensuring portfolios are structured to cope with disruption whenever and however it arises.

We believe that defensive equity strategies represent one potential way to strengthen portfolio resilience — enabling funds to remain invested in growth assets, while seeking to reduce the destabilising effects that large market drawdowns can have on funding, cashflow and governance outcomes.