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IPE special report May 2018

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UK government to force £85bn shift to passive in LGPS funds

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The UK government has launched a consultation on the creation of two collective investment vehicles (CIVs) for the 89 local government pension schemes (LGPS) in England and Wales.

The consultation was created following a call for evidence on the future of the LGPS, and independent analysis by Hymans Robertson, a consultancy that dominates advisory services to the LGPS.

It proposed the creation of two CIVs for the funds, one to manage entirely passive investments in equities and bonds and one to actively manage alternatives such as private equity, infrastructure and property.

The government decision to move towards CIVs comes after speculation it would propose one of three options, including the merging of local funds, or creating geographical CIVs.

In a bold move, the government has proposed that funds shift all active listed equities and bonds into passive arrangements, via a new CIV.

According to the Centre for Policy Studies, a right-leaning think tank, the funds jointly have around £85bn (€103bn) in active listed assets.

The government cited analysis from Hymans Robertson that claimed funds would not have seen lower returns had assets been managed passively over the previous 10 years.

The consultancy said the 89 funds would also pay £230m less in management fees in a passive-only CIV.

Without taking into account any impact on returns, it also claimed asset turnover fees, for the buying and selling of assets, would have been £190m lower in 2012-13 under passive arrangements.

Several funds, however, have defended their employment of active managers, arguing that it has provided outperformance of the market by 5.7% over the last three years.

The government is to consult on how it will dictate to funds. It will consider forcing them to shift all active listed mandates to passive, forcing a percentage allocation, implementing a ‘comply or explain’ mechanism, or the status quo.

Regarding the alternative asset CIV, the government said its creation would still allow asset allocation to remain at fund level, a critical point against mergers highlighted by respondents to its prior consultation.

Hymans Robertson’s analysis showed the LGPS funds could save as much as £240m a year, within 10 years, by aggregating mandates.

Schemes currently allocate roughly 10% of assets to alternatives, where it accounts for 40% of fees.

The government criticised the heavy use of funds of funds – an expensive yet common way LGPS funds currently access alternatives such as private equity.

It also said a CIV based on active alternatives management would allow the funds to further access infrastructure projects by pooling risk.

Brandon Lewis, the Conservative minister responsible for the LGPS, said the move would reduce the unsustainable cost of public sector pensions.

“The proposals I am setting out today will help reduce investment costs by £660m a year,” he said.

Linda Selman, head of LGPS investments at Hymans Robertson, said CIVs might allow the funds to further reduce fees, and reduce the use of active management and funds of funds.

“Active management still has an important role to play in accessing market opportunities but should be deployed selectively, when it adds value,” she said.

“Ultimately, the balance between passive and active should depend upon the fund’s governance budget, investment beliefs and objectives, and the expected net of fee returns.”

Gavin Bullock, pensions partner at Deloitte, warned of the potential impact on the UK asset management industry.

“Both the move to pooling vehicles and the potential shift to passive will have a major impact on the UK asset management industry, given the £178bn assets currently under management by the LGPS,” he said.

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