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LGPS series: Piecing together the pooling puzzle

19 Sep 2018

portfolio institutional is launching a new series on LGPS pooling, tracking changes to investment strategies and updates on the consolidation of assets to keep a finger on the pulse of local authority pension fund pooling.

What started off as a bumpy ride might have become relatively successful three years on from George Osborne’s initial  ambition to create “British wealth funds” by pooling local pension assets.

Today, the strategy has created eight such pooled funds. The initial targets that the former Chancellor of the Exchequer set were grandstanding: Six British wealth funds with at least £25bn in assets per pool should be established, targeting annual cost savings of up to £300m through enhanced economies of scale.

As the April deadline for local pools to be formally established has passed, the boundaries for the new local authority pension landscape are starting to emerge. Eight local pools have been launched. With the exception of two – Wales and the Local Pension Partnership – all managed to exceed the initial asset target of £25bn.

The largest pools are pools Border to Coast Pensions Partnership and the Northern Pool, which each have assets exceeding £40bn. The pooling process is now starting to take shape with assets currently being transferred, executives being hired and investment strategies articulated.

Yet the state of progress varies broadly from pool to pool. While Border to Coast has established a consolidated investment management team, launched two funds with more than £7bn in assets collectively and releases reports on its strategy, others, such as the £46bn Northern Pool still report as its individual schemes and are yet to confirm their team structure.

The implications of these steps for asset managers, consultants and scheme members are potentially dramatic, as cost pressures and competition between providers are set to increase. The question is, how do the eight newlyformed pools square up against the chancellor’s initial targets to reduce fund management costs and bolster infrastructure spending?

INVESTMENT STRATEGIES – INDIVIDUAL APPROACHES

It is worth noting that while the eight pools are aiming to collaborate in the process of merging their assets, their investment structures vary widely. The differences in approaches are rooted in a multitude of schemes with quite significant differences in asset allocation strategies. On average, LGPS pools tend to have 60% of their assets invested in equities, of which a relatively higher share of 37% in global shares.

However, some schemes, such as ALM Partnership, now known as Local Pensions Partnership (LPP), or the Wales Pension Pool have historically had a stronger emphasis on liability driven investment. The Northern Pool in contrast has a relatively high allocation to property and alternatives.

Some, including Access, have appointed a pool operator whose tasks range from
establishing sub funds to appointing third party managers, preparing for Financial Conduct Authority (FCA) authorisation and overseeing the launch of the pool’s first sub fund, a £1.6bn global equity fund scheduled for launch in October.

Unlike other schemes, Access has a stronger emphasis on passive investments. At around £11bn, they represent more than a quarter of the pool’s overall assets. By appointing a single firm to manage its entire passives portfolio, the pool anticipates making an annual saving of £5.2m in this sector alone.

Others such as Border to Coast have opted for an internal investment management team, led by a chief investment officer (CIO), which takes a lot more direct responsibility for the investment process.

Similarly, the significantly smaller LPP, which is a collaboration between Lancashire County Pension Fund, the London Pension Funds Authority (LPFA) and Royal County of Berkshire Pension Fund, has already launched six in-house investment funds and has teamed up with Greater Manchester Pension Fund to form a £1.3bn infrastructure joint venture fund.

Moreover, the availability of internal investment management knowledge played a key role in deciding which strategies to manage in-house and which to outsource. Border to Coast, for example, has a relatively experienced team of portfolio managers covering emerging market equities and alternatives.

In July it launched its first two internally managed funds, a UK-listed equity fund and an overseas developed markets equity fund, which collectively cover £7bn of assets. It is currently in the process of appointing three asset managers to take charge of another £1bn UK equity mandate.

Meanwhile, Brunel has launched its pooled infrastructure, private debt and property portfolios on an advisory basis. It is looking to expand to other strategies, such as liability driven investment (LDI), hedge funds, multi-asset credit and diversified growth, in the next two years, yet the bulk of its investments continues to be outsourced to external managers.

What many of these pools have in common is a preference for an Authorised Contractual
Scheme (ACS) as the structure for the majority of their sub-funds. This structure allows for the co-ownership of multiple sub funds, offers tax advantages and can be Ucits compliant.

However, it is not compatible with investments in less liquid assets such as private equity, or infrastructure, which is why pools have had to choose different structures for their alternative sub fund ranges.

CUTTING COSTS

Saving money on fund management costs through economies of scale was the key motive behind the initial pooling proposals. Initial data suggests that when it comes to saving money on asset managers’ fees, pooling has indeed been a success.

Brunel Pensions Partnership, for example, expects to make annual cost savings of £550m, offsetting the £5.2m implementation costs for the pooling process, which the pool incurred over the past two years.

The West Midlands Pension Fund, which is part of LGPS Central, reports slicing £10.2m off its costs in the past two years, largely a result of lower management fees. Cynics could argue that these savings represent the low hanging fruits of the initial consolidation process, whether the increase in efficiency can be sustained longer term remains to be seen.

Yet overall, the evidence suggests that scale does result in lower investment management costs. According to a 2016 report, the average investment cost for LGPS schemes as of 2015 was 31.2bps, while schemes with assets of less than £2bn tended to pay higher manager fees at 38.2bps. Schemes with more than £5bn of assets tended to pay an average fee of 20.1bps. The report also revealed that larger schemes typically spend less on governance and administration, at an average of 5.2bsp, compared to 9.7bsp for schemes with assets of less than £2bn.

INFRASTRUCTURE CHALLENGE

While the immediate benefits of pooling are the most tangible in relatively liquid investments, such as passives or equities, a key ambition of the process to merge pension fund assets was to give them more firepower to invest in infrastructure. Given the severe need for infrastructure funding across the country, the benefits of using institutional money to build or repair roads, airports, train stations or sewage systems are obvious.

A successful example is the £1.3bn GLIL infrastructure platform, which was re-launched earlier this year as cross-pool collaboration between the LPFA and the Greater Manchester Pension Fund.

Indeed, some pools have announced that they will use pooling as an opportunity to bolster the share of infrastructure investments in their portfolio.

This includes Brunel Pensions Partnership, which is looking to double its infrastructure
investments to 10% of its overall portfolio and has appointed a private markets team of five, which will be responsible for sourcing in-house investment opportunities.

However, the asset class remains tricky due to its illiquid nature and regulatory constraints. Many bigger pools such as Access and Border to Coast have therefore opted to initially consolidate their most liquid asset classes, while infrastructure remains to be separately managed for the time being.

This is an obstacle to pooling infrastructure reinforced by the fact that the ACS fund structure, the legal framework of choice for a lot of pools, does not accommodate infrastructure
investments. Schemes are therefore encouraged to establish LGPS-wide collaboration through multi-asset pools which could deliver greater economies of scale. Yet with the exception of GLIL, these initiatives are yet emerged.

With reporting activity likely to be focused on the pooled platforms, issues around governance and transparency for legacy assets managed individually are likely to emerge.

OUTLOOK
Over the next few months, portfolio institutional will continue to report regularly on the latest pooling progress, interviewing senior executives of the biggest pools, provide updates on new fund launches and cross-pool collaborations.

In the second part of the series, our October edition will feature an interview with Rachel Elwell, chief executive of Border to Coast. She discusses the pool’s new investment
management strategy, its approach to environmental, social and governance (ESG) and shareholder engagement. |

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