Building LGPS portfolios for an increasingly volatile world

Written By:

Colin Cartwright
SPP Public Sector Committee member
Head of LGPS, Aon

How liquid alternatives and real assets can help LGPS funds smooth the investment journey – without sacrificing the long-term growth that members need

Local Government Pension Schemes (LGPS) are structurally long-term investors. Strong funding outcomes from the 2025 valuations, combined with the direction of travel under the Fit for the Future framework, give many funds a valuable opportunity: to lock in improved positions while reshaping portfolios to be more resilient to future market shocks.

That means keeping equity at the heart of growth strategies but supplementing it with a broader mix of diversifying and real assets to smooth the journey.

LGPS investors can build that resilience, drawing on recent thinking on preparing portfolios for choppy equity and credit markets and the role of liquid diversifiers and real assets in particular.

Why volatility matters less for LGPS – yet still matters a lot

LGPS funds are well placed to tolerate short-term volatility. They have long time horizons and ongoing contributions, allowing them to ride out market cycles. Equities remain one of the few assets capable of delivering the level of real return required over decades.

However, recent history shows that volatility still matters. Equity markets and credit spreads are periodically “priced for perfection”, leaving little cushion when macro or geopolitical risks materialise. News driven swings in markets have become larger and more frequent, amplifying mark to market funding volatility.

For LGPS, the implication is clear: do not abandon growth assets but do use today’s stronger funding to reduce unrewarded risk.

From reacting to events to constructing robust portfolios

Constructing robust portfolios is essential, rather than shifting strategies in response to geopolitical news. Investors need to think about many risks other than just geopolitical ones, and diversified portfolios help manage this.

For LGPS, that translates into three practical disciplines:

Clarify objectives and time horizon
Are you in growth fund or stabilising? What level of volatility can you accept?

Review portfolios from a position of strength
You are in a better place, position your portfolio accordingly

True diversification
Introducing zero correlation asset classes to contribute to return and reduce beta reliance

The role of liquid alternatives as real world diversifiers

Liquid alternatives can play a central role in building resilience.

Liquid alternatives are investment funds that aim to improve diversification and manage risk by using a broader set of strategies than traditional equities or bonds, while still allowing daily dealing and easy access.

They are designed to achieve more stable returns, reduce reliance on traditional markets, and greater resilience in stressed conditions, without the complexity or illiquidity associated with private markets.

Why consider them in an LGPS portfolio?

Mitigate equity and credit risk through genuine diversification
The biggest benefit of a liquid alternatives allocation is its ability to reduce dependence on equity and credit beta via real world diversification. Instead, introducing strategies that can go long and short, exploit relative value, and even benefit from heightened market volatility.

Steady absolute returns
Well-designed portfolios of liquid alternatives have delivered relatively stable returns, often expressed as cash plus a modest spread (for example cash +3%), with limited correlation to equities. For LGPS funds, this can improve the probability of meeting shorter-term funding objectives without relying on favourable equity markets at each valuation date.

Real assets and private credit: resilience with an equity like punch

Real assets and private credit have the potential to deliver equity like returns over the long term, while adding resilience by virtue of different return drivers and imperfect correlation to listed markets.

For LGPS, real assets and private markets align well with long-term horizons and inflation linked liabilities:

Real assets (including infrastructure, renewable energy, real estate, and certain natural capital strategies) can provide:

Long-dated (often inflation linked) cashflows
Exposure to structural themes
Protection from unexpected inflation or regime shifts

Private credit (such as direct lending, infrastructure debt and asset backed strategies) offers:

Contractual income protected by daily market moves
Illiquidity yield premia over public credit
Tailored risk/return profiles and sector exposures

The diversification benefit is twofold:

Return streams are driven by underlying cashflows and covenants not short-term market sentiment; and
Lower correlation with listed equities and bonds

Thus, supporting the overall objective of reducing total portfolio volatility without sacrificing expected return.

Putting it together: a resilient LGPS portfolio in practice

Every fund’s circumstances are different, but common themes emerge when translating these ideas into practice for an LGPS fund.

Maintain a meaningful equity allocation – but seek de-risking opportunities:

Equities remain the primary engine of long-term growth
Use funding strength to reduce reliance on equity beta and introduce diversifiers

Introduce or expand liquid diversifiers:

Allocate a portion of growth assets to liquid alternatives designed to deliver positive returns across market environments and low correlation to equities and credit
Focus on outcome-oriented targets (e.g. cash +3-4% over the cycle) and clear downside expectations

Increase strategic exposure to real assets and private credit:

Use improved funding to build or accelerate long-term programmes in infrastructure, renewables, housing and private credit, calibrated to each fund’s liquidity needs
These allocations can be framed as “equity like return, lower journey risk” components, directly supporting the ability to sustain current or lower contributions over time

Embed resilience in governance as well as in assets:

Agree in advance how the fund will respond to extreme market events. For example, by rebalancing towards strategic weights rather than de-risking at an inopportune time
Ensure that monitoring focuses on whether the combined portfolio is behaving as expected in different environments not just on short-term performance

Building resilience from strength

LGPS funds emerging from strong 2025 valuations and implementing Fit for the Future changes have a rare chance to shift from simply chasing returns to consciously engineering resilience.

Maintaining a material allocation to equities remains essential to deliver long-term real growth. However, surrounding that core with thoughtfully chosen liquid alternatives, real assets and private credit can materially reduce reliance on equity and credit beta, improving the likelihood of meeting future obligations across a wide range of market conditions.

The key is to act from a position of strength – use today’s robust funding to diversify, not to delay decisions. By doing so, LGPS investors can build portfolios that are genuinely fit for the future; capable of weathering volatility while still delivering the returns that members and employers depend on.