For years the government has been on the hunt for efficiencies, collaboration and a reduced burden for local taxpayers for the 89 Local Government Pension Schemes (LGPS) in England and Wales.

In 2013 the Department for Communities and Local Government said that it would gather evidence on achieving cost reductions through the merger of schemes or asset pooling. This approach was ruled out this year, although the department said it was not “wedded” to the current number of schemes. In setting out its reform consultation earlier this year, the government instead proposed passive management for listed assets and establishing asset-specific common investment vehicles to allow funds to access economies of scale and reduce costs.

The LGPS has already shifted from a final salary to a career average pensions model and there have been changes in governance.

The total cost of the 89 English and Welsh LGPS funds to sponsoring employers, many of which are taxpayer funded, was £6.2bn (€7.7bn) in 2013. In England, costs between 1998 and 2013 rose from £1.5bn to £5.7bn. Investment management fees, the government claims, cost in the range of £409m in 2013, up from £340m in 2011.

In late 2013, the government commissioned Hymans Robertson to analyse the performance and investment management costs of the 89 funds. It found, on an aggregated basis, that investment returns would have been no different to the current mix of active and passive mandates, had the funds invested passively over a 10-year period.

The government asked whether it should force all listed assets into passive management, mandate a proportion of assets be moved or allow a ‘comply or explain’ policy.

The Centre for Policy Studies, a centre-right think tank in favour of a shift to passive management, estimates that LGPS funds have around £85bn invested in listed assets. Much of this is invested actively, meaning any mandatory shift could affect scheme management, investment strategies and asset managers.

Many responses to the consultation say the political focus on costs is misguided. As the figures show, investment management fees make up less than 10% of the overall cost base. Some suggest the best response should be to deal with governance, collaboration and centralised procurement.

Many see merit in common investment vehicles: 28 of the 33 London borough pension funds have committed to creating a collaborative investment framework by June 2015. But, it is the shift to passive that causes most concern.

The Environment Agency Pension Fund (EAPF), a member of the LGPS, says in its consultation response that the focus should be on net-of-fees return. While a reduction in fees would increase this, all things being equal, there could be a significant impact should changes occur to managers and mandates.

EAPF touched on larger funds: “These funds may have lower costs, but they have not been focused on costs; instead they have taken a balanced view of their priorities and have emphasised sound management. A collaboration focused on costs alone is unlikely to achieve the same success, to read across from these larger funds, the focus must be on a high level of overall fiduciary standards.”

Others agree. The head of Mercer’s local authority investment business, Jo Holden, says savings targeted by the government plans are unachievable. The inclusion of performance related fees in Hymans Robertson’s analysis means savings cannot be verified, she adds.

“Over the longer term, for funds that do not do so well on the governance side, and have a lot of active management, moving to passive and sharing resources is perfectly sensible. But, I just feel this route is one option for all, and moving all towards average rather than excellence.”

The EAPF believes the reforms would not cause any fall in expenditure.

Even if the government’s calculations are correct, it would be 2022, at the earliest, before actuaries would be able to set a contributions reduction. “Any savings will be so swamped by moves in real yields and assets. Thus the proposals will deliver no meaningful cost savings in the short to medium term. No council tax will be reduced or front line services saved this decade as a result of these proposals,” RBWM says.

Nick Greenwood, manager of the RBWM pension fund, says the move could be a recipe for disaster and could result in higher council tax: “The consultation has been influenced by interested parties who could gain a lot from this,” he comments.

For his fund, in particular, a move to passive would mean a change of the asset allocation and a situation where it would have to sell assets to pay pensions.

The move to passive could also cause concern for stewardship. Shareholder engagement has been a long-term policy for the government’s Department for Business, Skills and Innovation, currently run by the coalition’s minor partner, the Liberal Democrats. This was after the Kay Review advocated better engagement to boost long-term investing.

LGPS funds are some of the most vocal in terms of stewardship, with the Local Authority Pension Fund Forum (LAPFF), a collective of 60 funds, actively voting at annual general meetings.

While passive stewardship is still possible, Saker Nusseibeh, chief executive of Hermes Fund Managers, describes the potential wholesale shift to passive equity as an “unmitigated disaster for the United Kingdom”.

He says: “It would work entirely against everything the Kay Review advocated. Even theoretically, passive investing is an absurd way to invest. It is based on the false promise that you save money, but you then have complete disengagement. Problems at companies that have absentee landlords get exacerbated.”

Making passive improvements: the LGPS consultation

• In the spring of 2014, a government consultation, LGPS: Opportunities for Collaboration, Cost Savings and Efficiencies asked whether the 89 local government funds in England & Wales should shift out of active management for their listed equity and fixed-income investments.
• It proposed the creation of common investment vehicles (CIVs) for funds to collaborate on alternative investments and stop the use of funds of funds.
• The proposals were based on analysis conducted by Hymans Robertson, which suggested that passive equity returns were in line with active over 10 years when looking at the funds in aggregate, and that passive management would save the LGPS £420m (€528m) a year in fees and costs.

Nusseibeh says for funds to achieve their stewardship duties, many would have to outsource engagement to third-party firms, thus negating any positive impact of lower passive management fees.

“It is a false saving. It is flawed in principle and in practice. What the government is proposing is that the ordinary citizens be forced to buy a flawed investment index, disengage with the companies they own, as that is the best way for them to accumulate wealth.”

All the Hymans Robertson report demonstrates, he says, is that it is hard to find true active management skill, although it works for those who pay for it.

A number of consultation responses highlight flaws in the government’s thinking, and advocate a comply-or-explain-policy.

However, with less than nine months left until a general election, the government has to devise a solution acceptable to all parties. The National Association of Pension Funds, which represents many local authority schemes, called on the government to postpone the reforms until after the election.

Unless work is rapidly undertaken, this is highly likely. The department responsible for local government only closed off a second governance consultation in August. Many of the LGPS 2014 reforms, the vision of the government when it came into power in 2010, remain scattered. To add to this, in a July 2014 reshuffle of ministers, Brandon Lewis was promoted with junior Conservative Kris Hopkins taking his place.

Whether Hopkins can push through reforms before May 2015 remains to be seen, and the outcome of the election will dictate how far reforms go. Changes to the way local government operates have long been a strong Conservative election pledge, although other parties have been less vocal.

Asset managers remain watchful: for the larger players a shift in assets causes less concern. Boutique active managers are less upbeat.