The 89 funds within the UK local government pension scheme (LGPS) should pool assets into two or three infrastructure pools to service the half a dozen multi-asset arrangements, according to BNY Mellon, which also called for the government to stop promoting a “passive investment is best” agenda and mandate a uniform approach to discount rates.

The recommendations, among others, were made in the investment company’s submission to the government’s consultation on reforms to the LGPS, which closes on Friday.

BNY Mellon said the government’s asset pooling proposals would help drive down costs, achieve better investment outcomes and stimulate new infrastructure investment.

It took issue, however, with certain aspects of the government’s position – for example, for advocating that LGPS should increase their use of passive management to lower management costs.

It described this as promotion of a “passive investment is best” agenda.

Paul Traynor, international head of pensions and insurance segments at BNY Mellon, said the government’s proposals “confuse price and value”, and that active management was “worth paying for”.

“LGPSs shouldn’t move into passives and hope for the best,” he said.  

In the context of the government’s aspiration for the consolidation of the LGPS to boost infrastructure investment, BNY Mellon said two or three “infrastructure superpools” should be created rather than each of the six asset pools proposed by the government having their own infrastructure pool.

While six LGPS pools “seems sensible”, said Traynor, BNY Mellon also said six LGPS infrastracture players was “too many”.

“[F]rom an infrastructure perspective, limiting it further to two or three pools with portfolios in excess of £6bn (€7.7bn) would create even more synergies,” said Traynor.

Others have previously suggested a single infrastructure pool should be created, but BNY Mellon said it would lack competition even though it would provide even greater scale.

BNY Mellon’s report, entitled ‘LGPS Pooling: The Collective Good?’, said several factors, such as a growing population and low interest rates, support the government’s proposals for increased LGPS investment in infrastructure.

But Traynor warned that the LGPS “shouldn’t be seen as an easy way to plug the nation’s funding gap”, citing the risks that come with investment in this asset class, such as construction and reputational risk.

From social housing to discount rates

BNY Mellon makes eight recommendations in total, for the schemes and the government.

They are wide-ranging, with the remainder addressing issues such as the formal structure of the LGPS pools, tax efficiency and the importance of allowing competition among pools.

The investment manager also calls on the government to clarify its policy on social housing and IORP II, the EU directive on occupational pension funds currently being revised, “to give certainty to potential investors”.

Another recommendation is for a “proper governance structure” to be established with respect to the decision-making powers of LGPS pools “to safeguard fiduciary duties of the trustee and prevent breaches of European Union competition laws and rules governing collective investments”.

The final recommendation is for “some” local authorities to own up to the cashflow challenges they face in the medium to long term.

“Whatever the overall health of the LGPS’s funding, some outlier local authorities are on course to face significant challenges to their ability to pay retirees pensions in the medium to long term,” said the investment manager.

“The sooner these challenges are faced, the easier it will be to address them.”

BNY Mellon also raised the issue of schemes’ funding from the point of view of data accuracy, noting that local authorities use different discount rates that make meaningful comparisons difficult and could be a stumbling block in the context of deciding on pools to partner with.

To address this issue, it said the government should mandate a uniform approach to discount rates to facilitate the partnering process.