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IPE special report May 2018

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Local Government Pension Scheme: Is bigger always better?

After years of discussing local government pension reform, the government is no closer to a formal policy to restructure the system. This has not deterred frontrunners from exploring different methods of achieving scale and lowering costs, finds Jonathan Williams

The question of the scale and costs of UK public sector pensions have been discussed numerous times in the past five years. Debate started when the Conservatives, since 2015 the sole governing party, first came to power as part of a coalition government in 2010. 

The Local Government Pension Scheme (LGPS) is, on the one hand, one of the largest funded pension schemes in the world, with assets in excess of £200bn (€276bn). On the other hand, it is a loose collection of 101 pension funds regionally administered by local councils, each pursuing their own investment strategy and with a unique set of problems relating to their deficit and local sponsoring employers. 

It is for this reason that the Department for Communities and Local Government (DCLG) set out in 2014 to reduce costs by examining active management within the funds. It said at the time the measure could lead to savings of £660m over 10 years – at least for the 89 English and Welsh schemes directly affected by the measures.

Despite a long-running consultation during the last parliament, which weighed up the option of mandating passive investment across the entire system or establishing a limited number of collective investment vehicles (CIVs), the May 2015 election came and went without any discernible attempt by the DCLG to clarify its position. 

A senior DCLG civil servant, Bob Holloway, blamed his department’s inaction on “tensions” within government on the matter.

Speaking in April, shortly before the Conservative Party was re-elected, Holloway said he could not predict if a future government would make any announcement on reform to the LGPS. “I can’t anticipate that, but what I can guarantee you is that this [structural reform] will be on the shopping list of incoming ministers both within DCLG and Cabinet Office.”

The prediction proved true, and the Treasury – rather than DCLG – gave the first indication in July that structural reform had not fallen by the wayside as new ministers settled into their offices. Buried within the documents for chancellor George Osborne’s summer Budget was a commitment to work with the LGPS to ensure “pooled investments significantly reduce costs”.

Reforms already mooted have involved wholescale mergers or the establishment of CIVs to pool assets. The 33 funds based in London have taken the idea of a CIV seriously, and after planning for two years in early 2015, the London CIV got ready to act as a pooling vehicle for joint mandates and announced Hugh Grover as its chief executive.

Grover, a former civil servant at DCLG and policy director for London Councils, the representative body for the city’s local authorities, has been the CIV’s programme director since last October. The CIV is now in the process of recruiting staff to oversee the mandates it will award, decided upon in conjunction with its nearly three dozen members. Grover says he sees the announcement in the Budget as encouraging and, in absence of any further official word from DCLG, his project is “continuing at full steam, as we always have been”.

“We have not seen anything in the announcement that would suggest that we should in any way stop or pause, or anything else,” Grover adds.

The announcement is also unlikely to slow the momentum building behind the London Pensions Fund Authority (LPFA) and its two partnerships with the Lancashire County Pension Fund (LCPF) and the Greater Manchester Pension Fund (GMPF). 

LCPF has teamed up with the London fund to establish a £10.5bn joint entity to manage assets and oversee administration. George Graham, director of LCPF,  is adamant that neither of the funds’ in-house investment staff will suffer as a result. “The people who will suffer in terms of [the partnership] are not necessarily our staff but our fund managers through the renegotiating of fees.”  

GMPF, meanwhile, has joined forces with LPFA to invest in infrastructure and two Scottish councils have also decided to jointly invest in the asset class. The Lothian Pension Fund, in the throes of moving its in-house team to an external company wholly-owned by the council and registered with the Financial Conduct Authority, is working closely with the Falkirk Council Pension Fund on infrastructure holdings. Lothian has begun advising its fellow Scottish scheme on how to deploy £30m of its holdings into renewable energy projects. 

Grover views changes to the way the LGPS is allowed to invest as more important. The current investment regulations, last amended in 2013 to allow for greater infrastructure exposure, could be changed to  bring them in line with rules for private sector occupational funds. 

However, he raises the prospect of DCLG returning to the debate on passive versus active mandates, albeit not by directly excluding the latter to the benefit of the former. But he also says that any attempt to limit the use of active management could have consequences. “There is no doubt that a number of LGPS funds use active management and do get outperformance, so I think those funds would want to debate with government quite how they are going to continue that outperformance.”

Grover also raises the spectre of central government dictating investment strategy and who, in such instances, should then be made to pay for any deficits that would arise. “I don’t really think that’s a matter they will want to go into in too much detail.”

Investment partnerships and asset pooling are not the only way schemes have been seeking to co-operate and reduce costs. Joint tenders between several local authorities were not uncommon prior to 2011’s Independent Public Sector Pensions Commission, but momentum began to build in its wake.

The National LGPS framework, spearheaded by Norfolk Pension Fund and supported by a further six local authorities in 2012, has since led to savings of about £16m, according to Norfolk, which deems it successful enough to warrant a dedicated procurement officer. It has so far launched frameworks for legal services, investment advice and custody services, among others. 

But frameworks are not without problems, despite proven commercial viability. A tender by the Environment Agency Pension Fund, which last year sought to appoint a sustainable equity manager, did not proceed as a national framework despite the EAPF’s involvement in the Norfolk project. “This was partly because we were getting very mixed signals from the government about this,” says Mark Mansley, CIO of the fund, “and the fact that the consultation that came out last summer was quite negative on frameworks.”

Despite this, the Cabinet Office, the government department directly supporting the prime minister’s policy objectives, still appears to support the approach as a way of lowering costs. 

GMPF has also been busy executing the government’s initial desire to consolidate through mergers, albeit not to the scale envisaged. While consolidation into five regional funds was mooted, the only remnant of this policy is the Ministry of Justice’s consolidation of 35 pension funds for probation officers with the Greater Manchester Fund.

The direction of travel for the LGPS seems fairly certain, even without more than a paragraph of government policy. Those proactive enough to set up CIVs or joint ventures will likely sidestep any further intervention.

But the many medium-sized LGPS funds that have so far only created joint procurement frameworks or combined administration platforms could see the long arm of central government loom large.

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