George Osborne’s merging of local government pension scheme assets presented the new pools with challenges which they are not just meeting, but surpassing, finds Andrew Holt.
It is five years since the then chancellor George Osborne announced that the assets of local government pension schemes (LGPS) were to merge and three years since this pooling came into effect. How has this overhaul developed? A good starting point for making an assessment is by comparing the original rationale for the LGPS pooling approach.
Here Osborne was motivated by two factors: The first was that small local pension funds lacked “the expertise to invest in infrastructure”. He cited that across £180bn of assets, only 0.5% has been put to work in such projects.
Second, Osborne said pooling the 89 local authority pension funds into eight wealth funds would “reduce costs, saving the beneficiaries of the schemes millions of pounds every year” – has this been borne out?
portfolio institutional spoke to three of the key pension pool players to get the inside track on how Osborne’s pensions revolution is shaping up.
Case study one
The LGPS Central experience
Looking at the first of Osborne’s assertions: that small local pension funds lacked “the expertise to invest in infrastructure” – has this changed with the merging of LGPS assets?
“Yes,” replies Mike Weston, chief executive of LGPS Central, unequivocally. “The pools I have knowledge of, including our- selves, have all pushed forward with infrastructure investing and have begun to increase the overall percentage of LGPS assets invested in infrastructure.”
LGPS Central’s commitment here is evident through a dedicated in-house infrastructure and property team, part of the broader private markets team. “This team has a collective 38 years of infrastructure investing experience and, as a resource, is larger than any of our individual partner funds had themselves before pooling,” Weston says.
The team launched an open-ended infrastructure fund – which several partner funds have already invested in. And the proof of a successful fund is, of course, in its performance.
What about Osborne’s reduction in costs – has this happened? Yes again, says Weston. He cites strong data in support: The Ministry of Housing, Communities and Local Government annual statistics from all the pools, including cost savings and highlighted, overall gross cost savings from pooling amounted to £300m to date.
To back this up, Weston gives his own numbers: “At LGPS Central we have delivered gross savings for each of the pooled active investment products we have launched since our establishment. We are confident that we are on track to achieve £270m net cost savings by 2033/34.”
Challenges since inception
During the evolution of the whole process there have, nevertheless been challenges. “All our partner funds have the same aim of providing returns to their scheme members, but they are still individual funds, which have different asset allocation strategies and liabilities,” Weston says. “And so we have to work with partner funds to create products that they are all willing to invest in.”
And putting one key challenge in perspective, Weston notes: “Starting a company from scratch is no small challenge. We have had to build our team, build our processes and embed the right values in the right way. We have achieved much in a short time – the challenge now is to keep the momentum.”
There have also been unforeseen problems. “Obviously Covid-19 has had huge implications on all of us,” Weston says. “But we continue to focus on delivering strong investment performance on the assets already transitioned into the pool, launching new pooled funds in more asset classes and build- ing our internal skills and capabilities.”
Successes of LGPS pooling
So far LGPS Central has approximately half of the total partner fund assets under its stewardship, in a broad range of pooled investment funds across public and private markets.
Weston emphasises leveraging the scale benefits of pooling has increased the effectiveness of responsible investing, particularly around climate change. “Our dedicated, and fully integrated, responsible investing team are delivering tangible positive outcomes such as Barclays to become net zero by 2050 following shareholder pressure, our plus £2bn launch of a cli- mate factor fund, meeting with the vice president of Brazil on deforestation and climate risk reporting to partner funds.”
Case study two
Border to Coast: more than cutting costs
On how George Osborne’s infrastructure LGPS pooling ambitions have shaped up, Rachel Elwell, chief executive officer of Border to Coast, identifies some fundamental shifts. “We’re already delivering for our partner funds. With our scale and in-house expertise, we have been able to open investment opportunities, which smaller investors may have previously been unable to access in an effective manner. One example of this is our recent co-investment infrastructure deal in renewable energy.”
However, standing back from Osborne’s criteria, Elwell makes the point that simply creating investment opportunities isn’t really sufficient. “As long-term investors we believe that integrating ESG factors into investment decisions delivers better investment returns.
“While ESG reporting has improved in public markets, there is a need to enhance standards, transparency and how we measure ESG risk, opportunity and performance in private markets. It’s for this reason we are driving ESG reporting standards in private markets.”
On reducing costs, Border to Coast has made real strides. “We have been successful in delivering savings,” Elwell says. “For example, when we launched our £5bn Global Equity fund, we negotiated a £3.5m a year cost saving for our partner funds.”
Expanding on this, Elwell adds: “And, most recently, in transferring to one of our internally managed fixed income funds, one partner fund alone saved more than £700,000 a year. We have also enabled our partner funds to make savings when effecting their asset allocations, arranging for ‘crossing’ opportunities with one such opportunity alone saving £3.5m in trading costs.”
More than just savings
However, for Border to Coast’s partner funds, pooling was always about more than just cost savings or making it easier to access infrastructure investment opportunities, Elwell says. “We are building a resilient and sustainable organisation with strong in-house expertise – including in portfolio risk, investment research and responsible investment,” she adds. “With these in place, combined with our focus on developing our people, we are creating a flexible and open to change culture that is equipped to develop new capabilities as the needs of our partner funds evolve.”
This in turn means greater collective strength. “Thanks to the stronger voice that pooling brings, we can also have more influence on behalf of our partner funds in areas ranging from active stewardship, cost transparency and ESG reporting standards in private markets,” Elwell says.
There are, nevertheless, challenges with the whole process. “I don’t think we can underestimate the challenges of pooling,’’ Elwell admits. “In our case, 12 separate partner funds came together and agreed a common vision and strategic priorities. Alongside this, we established and built an FCA-regulated asset management company in Leeds – and we’re now responsible for managing more than £25bn of their assets.”
In this way, listening to their partner funds has been fundamental, Elwell says. “For example, last year we held 127 customer meetings to listen and develop key areas such as fund design, a common responsible investment policy, performance and accounting reporting templates and a governance frame- work.” The partner funds now nominate two non-executive directors to sit on the board.
Elwell also appreciates how the partner funds supported the group in its journey. “Early on they recognised the importance of compromise to make pooling work. While compromise could lead to the lowest common denominator prevailing, due to our open and honest dialogue, I believe it has resulted in more robust decisions that will deliver greater value for partner funds and stand the test of time.”
Looking back on what has been achieved, Elwell observes two successful developments “First, we have built a company on solid foundations of clear cultural values and strong risk and governance frameworks. This gives us the ability, flexibility and confidence to manage change and adapt to new circumstances.”
The second is the investment opportunities that have been developed. “To date we have launched five equity funds, two fixed income funds, as well as investments in infrastructure, private equity and private credit. We are developing with our partner funds a range of other investment opportunities, such as real estate.”
But Elwell stresses, the main success of pooling is this: “We have maintained a strong and collaborative relationship with our partner funds based on trust and our long-term vision. This is fundamental to our long-term success and the importance of this has been amply demonstrated throughout the pandemic.”
In addition, Elwell highlights another argument in favour of pooling: one that deals with in an imbalance emerging between asset owners and asset managers. “Pooling more generally in the UK has started to address this imbalance, by ensuring asset owners have a stronger voice and the professional expertise to work with asset managers to develop propositions that best suit our needs.”
Concluding, Elwell says: “Over the next five years we have a real opportunity to build the capabilities that will enable Border to Coast to realise the full benefits of pooling on behalf of our partner funds as a mature, long-term, innovative and responsible multi-asset investment business.”
Case study three
A united response: The Case of Brunel Pension Partnership
Pooling has no doubt created a new way of working and with it new challenges. “It takes a lot to make pooling work, but it is impossible to even make a start without a close partnership,” says Denise Le Gal, chair of Brunel Pension Partnership. “Each of our clients already had extensive investment experience and expertise managing their LGPS fund for their members. So, for our clients, pooling meant suddenly working with nine other regional funds via a pool to find shared solutions.”
Le Gal calls this “a game changer” adding: “To make any partnership work, there needs to be transparency, trust, collaboration and a genuine respect to see all points of views engaged to find a mutually beneficial solution.”
It does work effectively – because all groups pull their weight. “Our clients chose to make it work by engaging fully and co- ordinating to develop shared investment funds that reflected common goals,” Le Gal says. “It’s for that reason that we will have transitioned around £25bn to listed markets funds by this summer,” she adds. “That’s out of total expected client transitions across all asset classes of around £35bn – and we were only founded in 2017 and given FCA approval in 2018.”
The rapid transition of assets was only possible because Brunel’s clients already had a strong sense of unity, Le Gal says, with most of them in the southwest and already co-ordinating in lots in ways – and because they all had their eye on the endgame: creating a new suite of funds that offered access to a greater range of asset classes and risk profiles.
“While also providing us with the added clout – in assets under management terms – needed to reduce fees and hire the best managers to ensure the best chance of strong performance,” she adds. Also vitally important, was that they also had a strong, shared commitment to responsible investment, aspiring to bring change to the wider industry, especially on climate investing. “This is a priority issue for our clients and that commitment has never wavered over time, only increased,” Le Gal says.
Challenges and benefits
The biggest initial challenge was just meeting government deadlines with a small staff. “Later on, it became ensuring the safe transition of assets – with a small staff,” Le Gal says. “All the while, of course, there was a lot of detail to communicate to all our various stakeholders.”
There has nevertheless been a real benefit. “The biggest bene- fit from pooling has been establishing a stable, regulated entity that can manage risk and build portfolios to achieve performance ambitions and thus deliver good financial outcomes for our client funds,” Le Gal says, adding: “Creating something new has also enabled our wider partnership to show what it means to be a responsible asset owner.”
Case study four
An alternative narrative
The LGPS model is not popular with everyone. A consistent critic of the LGPS pooling model since its inception has been Michael Johnson, research fellow at UK think tank the Centre for Policy Studies.
Johnson believes that the measures announced by George Osborne would not deliver the much-needed improvements in infrastructure spending – but that is only part of the problem. “What we are witnessing is mere tinkering, masking the fundamental truth that the LGPS is not sustainable,” Johnson says.
As an alternative, Johnson thinks the government should deconstruct local government pension schemes and use their assets to seed an infrastructure-focused sovereign wealth fund. This would spread the benefit of the assets across the whole of society, Johnson says. “We all use airports, roads and railways. Thereafter, LGPS obligations should be met on a pay-as-you-go basis, in the same manner as almost all other public sector pensions.”
Expanding on his criticism, Johnson notes: “The LGPS has become a bloated, inefficient self-serving empire, extremely costly to operate and, not unrelated, delivering below-market returns. It remains mind numbingly inefficient: fund management fees of more than £1bn per annum, for what is, ultimately, a single occupational pension scheme.”
Johnson therefore asserts: “Taking the LGPS’ assets ‘in-house’ would provide the government with a unique opportunity to establish a sovereign wealth fund that could, over time, become a global centre of infrastructure investment expertise.
“It should embrace simplicity and transparency and be subject to forensic independent governance,” he adds. “Implementation would, by necessity, need to be spread over years to pro- vide sufficient time for orderly divestment and the appraisal of potential projects for investment.”