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IPE Views: The UK's local government reforms could be revolutionary

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As the UK industry awaits the government’s response to LGPS reforms, Taha Lokhandwala wonders what collective investment vehicles could mean for the future

In the coming weeks, the UK government is expected to launch a consultation on its vision for the future of the Local Government Pension Scheme (LGPS). Local government schemes, unlike the remainder of the public sector, are funded defined benefit (DB) schemes, and, with combined assets of around £148bn (€177bn), and more than 4.5m  members, the schemes together create a formidable force.

However, their assets are in no way combined – there are 89 of them in England and Wales alone. This has been a constant source of annoyance for the current coalition government since it came into power. Many of the schemes are heavily underfunded, remaining open to new members and ever-accruing liabilities.

As a result, the Department for Communities and Local Government (DCLG), the section of government responsible for the LGPS, opened a call for evidence on the future structure of the schemes, the results of which it will soon publish.

What basically is known is that it wants scale, and it wants it big. When local government minister Brandon Lewis announced his vision of the funds, it involved the creation of five super pension schemes based on the merging of funds by geography.

However, there has been ever present resistance to merging liabilities, essentially due to the complex demographics of the LGPS. This is why several options remain on the table, including the formation of collective investment vehicles, namely around five, based on either geography, or perhaps even investment strategy.

Schemes are as reluctant to merge asset allocation as much as they are liabilities, which is problematic for a general collective investment vehicle, and which is why the latter option should intrigue the industry most.

The concept is mildly comparable with that of Sweden’s AP6 private equity fund, which, in a recent review of the AP system, was singled out for praise.

Why this could benefit the LGPS is simple. The biggest arguments against the current system are the schemes being a beacon of inefficiency with regards to external costs on asset managers and consultants.

Vehicles focused on specific assets, however, still give full control to each individual scheme in terms of allocation and liability management, but remove the inefficiencies of management and manager selection fees.

The biggest win from such a system could be infrastructure – long has been the call for UK schemes to combine and invest. The LGPS funds are prime candidates for this given their open and long-dated liabilities, taxpayer-backed covenants and, frankly, their £148bn in assets.

Some of the larger schemes, Strathclyde and West Midlands, have also committed to the Pensions Infrastructure Platform. While this fund lacks a tailwind, it does highlight the funds’ commitment to the asset class.

Greater Manchester is another example of a local government scheme keen on infrastructure, as it has moved to build housing and communities in its own region, while London schemes have already made similar moves.

A combined infrastructure fund from the LGPS could open the door for smaller schemes to push assets towards it, removing cost barriers and political risks, while allowing long-dated assets. Aside from infrastructure, this could translate across other asset classes such as hedge funds, real estate and private equity, while also saving fees on passive equity and fixed income.

The benefits for the schemes’ assets could potentially be unlimited, as they could be for the wider communities and economy as a whole, as government ministers tire of calling for insitutions to step-up.

Which route the government will take is still unknown. However, should it choose collective asset-specific funds, we could potentially look back at this decision as the day it modernised public sector investing.

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