Uncharted waters: What lies ahead for LGPS pools?

The news, which came in Osborne’s July 2015 Budget, gave rise to a palpable sense of uncertainty.

A lot of asset managers are going to lose LGPS mandates

Andy Todd, State Street

While some welcomed the idea, others were unsure about timescales, how much management to take in-house, and that the focus on the government’s wish for pools to invest in UK infrastructure would dominate the debate.

Pooling progress

More than two years have passed since the government’s pooling announcement, and the April 2018 deadline for individual funds to start transferring liquid assets into the pools is just around the corner.

A huge amount of progress has been made so far, says Andy Todd, head of UK pensions and banks, asset owner solutions at State Street.

“I think all the pools need to be given great credit for adopting… something completely new and pretty unknown to the people involved,” he says.

He adds that while those with a more “hands-on approach to the procurement process” have made quicker progress than others, “everyone’s moving in the direction that they intended”.

The Local Government Pension Scheme pools are all at various stages in terms of senior executive recruitment and procuring service providers, but most of them should be ready for the April deadline agrees Graeme Muir, partner and head of public sector at consultancy Barnett Waddingham. Only the Border to Coast Pensions Partnership has revealed that it does not expect to be ready to commence the transitioning of assets until June 2018.

Deciding on structure

“The main issue is just getting these pools established and up and running,” says Muir, adding that the pools are all doing this slightly differently.

There are a number of pooling structures, and LGPS funds have had to decide which approach to opt for.

There is a ‘build’ approach, for example, which involves creating an in-house operating company from scratch.

Alternatively, a pool can procure an external provider for the structure of its investment vehicle. The LGPS Access pool opted for this process of renting a provider, concluding that they “didn’t have the experience and capacity for the build ‘max’ option”.

‘Build max’ essentially involves a pool establishing its own fund management business, and is what the Local Pensions Partnership and London Collective Investment Vehicle have opted for.

More recently, the Wales Pension Partnership has appointed an external operator to establish and run its collective investment vehicle.

Cutting costs

One of the main drivers for pooling assets is to drive down costs. Last year, a survey of LGPS independent advisers, carried out by consultancy Hymans Robertson, found that about 85 per cent of respondents were concerned about the costs of setting up and transitioning to asset pools.

However, almost 80 per cent said pooling can result in funds benefiting from greater economies of scale.

Todd points out that “the intent of the pool is to bring efficiency and effectiveness to the investment implementation… the investment decision-making is unaffected”, and the asset allocation remains with the member fund.

He notes that “a lot of asset managers are going to lose LGPS mandates and the ones that remain will have far larger mandates, but the expectation will be that, relatively speaking, they’ll be paid less to manage more assets”.

In 2017, it emerged that fund manager Baillie Gifford would be treating certain LGPS pools as one client, claiming that it would help constituent local authorities to reduce costs.

Decreasing the number of meetings will save money, and it is something each of the asset managers is going to have to think about, says Colin Cartwright, partner at consultancy Aon Hewitt. By the same token, each pool will need to think about how they manage this kind of change.

“Will the underlying funds not meet the managers? That is a governance challenge, the way you’ve got to balance your fiduciary responsibility to the pension fund and how that’s running, to the new pooling arrangements,” Cartwright notes.

In May 2017, the LGPS advisory board launched its code of transparency to improve cost disclosure.

Cartwright highlights how the LGPS has been very good at driving transparency around fund manager costs, adding that “the pools should continue to be at the forefront of that… disclosing other costs associated with fund management”.

Pools will face the infrastructure obstacle

When Osborne unveiled pooling plans, he lamented how the different local authority pension funds were investing “little or nothing” in UK infrastructure.

Since then, there has been an increased focus on boosting this allocation through pooling, and over the past few years there has generally been a certain amount of progress with regard to LGPS investment in infrastructure.

GMPF & LPFA Infrastructure, a joint infrastructure venture founded by Greater Manchester Pension Fund and the London Pensions Fund Authority in April 2015, has made a number of UK infrastructure investments – in rail and onshore wind, for example.

Anish Butani, infrastructure specialist at consultancy bfinance, says: “The outlook is very positive in terms of UK pension plans coming together and investing in infrastructure.”

However, “as far as investing in UK infrastructure is concerned, that really depends on the number of opportunities that are there”, he adds.

There has been some success in direct infrastructure investing – such as GLIL teaming up with Dalmore Capital to buy a 15 per cent stake in Anglian Water Group.

When it comes to brownfield infrastructure, “the challenge is that the UK is a very attractive market to overseas investors… so it is a very competitive market in which to invest”, notes Butani.

From a government perspective, the UK is in need of new infrastructure. However, it is not easy getting LGPS investing in greenfield projects. Butani highlights how these projects are more complex and take longer in terms of delivering cash flows to investors.

A wide range of opportunities

Trustees should consider a wide range of investment opportunities and look for the best risk-adjusted returns, says Mark Hodgson, managing director UK of Gatemore Capital Management.

He argues that by pooling and becoming larger, schemes are restricting their investment universe.

“If you take a cynical view, then consolidation of pensions, whether it be corporate or LGPS, means that you’re restricting it to large projects,” says Hodgson.

He adds that those large infrastructure, real estate or private equity projects “don’t necessarily deliver the best returns”.

Todd says that there are likely to be more and better opportunities to invest in some of the more alternative asset classes because of pooling.

However, this does not mean to say a particular member fund is going to increase or create an allocation to infrastructure.

“And even if they do, now and in the future, there’s nothing to say that that infrastructure investment will be UK-based,” Todd notes.

In the medium term, Todd expects that environmental, social and governance criteria will become central to investment decision-making and “the pooling of assets within LGPS is going to be a key catalyst for that becoming mainstream”.

Keeping the stakeholders happy

While the pools appear to be making progress in the run-up to April, there will be plenty of hurdles to overcome in the future.

Cartwright highlights how operating models constantly need to be refined to make sure they are still appropriate for a pool.

Furthermore, managing their stakeholders will be difficult. In London alone there are 33 boroughs invested through a single pool.

The pools “are going to need to make sure their products or investment offerings meet their underlying client needs, which are the 89 administering authorities,” Cartwright says. “I think that will be their key challenge.”