Get the governance right and the rest will follow

by

18 Jul 2014

The government’s consultation on how the Local Government Pension Scheme (LGPS) can better work together on investment and address the £5.7bn annual price tag closed last Friday– and this week some parts of the industry made the gist of their responses available.

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The government’s consultation on how the Local Government Pension Scheme (LGPS) can better work together on investment and address the £5.7bn annual price tag closed last Friday– and this week some parts of the industry made the gist of their responses available.

The government’s consultation on how the Local Government Pension Scheme (LGPS) can better work together on investment and address the £5.7bn annual price tag closed last Friday– and this week some parts of the industry made the gist of their responses available.

What largely came out of these – perhaps unsurprisingly – was a consensus that one size certainly does not fit all when it comes to the LGPS. Because of the fact there are 89 funds under the LGPS umbrella, all with different funds structures and liability profiles, a homogenous structure across the board would not work and should therefore be avoided, people cried.

The DCLG is concerned with the increasing cost of funding the LGPS and the consultation outlined four ways to address this. These were: moving all listed assets into passive management; investing a specified percentage of listed assets passively, or progressively increasing passive investments;  managing listed assets passively on a “comply or explain” basis; or just expecting funds to consider the benefits of passively managed listed assets.

However, the National Association of Pension Funds (NAPF) labelled the government’s vision as “too narrow”  because it focused too much on cutting costs rather than addressing the bigger picture. In its response, the NAPF ruled out a wholesale shift to passive investment and said investment in one type of collective investment vehicle (CIV) should not be made mandatory.

Indeed, the four options outlined in the consultation should not be mutually exclusive and the government should realise the LGPS needs the flexibility to allow individual funds to look at alternative ways of co-investing. Therefore, a comply or explain approach is perhaps the best way to avoid penalising funds that are performing well.

But of course this all hinges on investment governance, which many, including the NAPF, have argued was a key point missing from the consultation. The government should have focused more on finding ways to increase governance levels in the LGPS rather than focusing explicitly on costs.

Investment education at local government trustee level does seem to be lacking. Speaking about illiquidity this week at portfolio institutional’s conference on alternative credit, Hammersmith and Fulham Pension Fund vice-chairman Michael Adam said: “Local government funds need to be educated in this. We are not capturing any illiquidity premium.”

It seems many local authorities are struggling to convince the powers-that-be about the merits of diversification and other assets classes and perhaps missing out as a result. In some cases, funds are sticking to traditional equities rather than embracing alternatives. Adam added local authority funds had “an argument to fight” in order for this to change.

This is backed up by a chat I had with Richard Greening, pensions sub-committee chairman at the Islington Council Pension Fund, who is disappointed the London CIV has decided to invest in passive equities rather than more illiquid assets, such as infrastructure and property that smaller funds with limited governance functions would benefit from.

With added governance comes an open mind and with improved thinking and the support that goers with that, LGPS funds could embrace asset classes that will benefit them from a risk/return perspective and better match their liabilities.

This could well come through CIVs or a combination of management styles, but get the governance right and the cost savings will follow.

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