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Pooling: One size (does not) fit all

14 Jan 2020

With the eight LGPS pools opting for different approaches to managing their assets, Mona Dohle asks if they can continue to work together in such a diverse setup.

In 2015 the then Chancellor of the Exchequer, George Osborne, promised to “shake Britain out of its inertia” by pooling local government pension scheme (LGPS) assets into sovereign wealth funds. This, he hoped, would see fees fall and investment in infrastructure rise. Fast forward four years and a lot has changed.

Eight LGPS pools have been formed across the country and billions of pounds worth of assets have been merged, but the “sovereign wealth fund” label was discretely ditched along the way. Amid political concerns that central government could interfere with the investment strategy of local authority pension schemes, a much more laid-back approach to consolidation has been taken. As a result, eight different approaches to merging pension scheme assets have emerged.

The first announcement to pool the assets of 89 local authority pension schemes proved controversial. Whilst welcomed by some for its potential cost and efficiency benefits, the proposals were opposed by public sector union Unison. It feared that the government could use the more than £200bn of savers’ assets managed by such schemes to make up for the lack of infrastructure investment by the state. Another concern was that the policy could expose members to excessive risk stemming from having higher allocations of illiquid assets. Moreover, fears were being raised that any cost savings could benefit the government, rather than scheme members.

Unison was not alone in having reservations about the policy. Indeed, within two months of Osborne’s announcement, more than 100,000 people signed a petition calling on the government not to interfere with the investment strategy of local authority pension funds.

The Ministry of Housing, Communities and Local Government – the department responsible for the pooling process – accommodated some of these concerns in its 2015 pooling guideline by stating that local authorities were invited to “lead the design and implementation of their own pools”. The only common standards set out were a minimum size of £25bn, which is no longer applicable, and transparency regarding any cost savings and infrastructure investments. At the same time, the ministry set an ambitious timeline of all eight pools being formally established by April 2018.

This initial formation stage took place in the context of two general elections, a referendum on EU membership and under the governance of three different prime ministers, while the Ministry of Housing, Communities and Local Government was led by no less than four different ministers, a fact which is likely to have contributed to the relative independence with which LGPS pools were able to shift billions of pounds of assets into their new structures.

GROWING APART

The eight pools can be ranged according to varying levels of integration. Among the early adopters of the pooling progress are Local Pensions Partnership (LPP) and Border to Coast, although these pools have chosen quite different approaches. Border to Coast, which manages some £45bn in assets for 12 local authorities, has set up its own investment team based on pre-existing capabilities in its member schemes. Having started off merging its most liquid assets, it announced the launch of four new funds in November: a £5bn global equity fund and £1.8bn to be invested in three private credit and infrastructure funds.

While Border to Coast has progressed significantly with the pooling process, the independence of individual partner funds remains a key element of the collaboration. Collaboration between the partner funds and Border to Coast will be at the heart of making pooling a success according to Chief Executive Rachel Elwell.  “While partner funds are accountable for their investment strategy – the weighting of equities versus bonds, for example – we are responsible for the development of the building blocks to allow them to successfully execute it.  

We need to be the positive alternative to the traditional asset managers that our partner funds would have used before pooling came along.

Mike Weston, LGPS Central

LPP has merged more than 80% of its assets and has launched seven sub funds, according to deputy chief investment officer Richard Tomlinson. But in contrast to Border to Coast, LPP sees the provision of investment advice as a key task of the pool. “Our delegated structure enables us to have a view of the whole portfolio. We are not just managing one bit of it; we have the whole picture.

“In the pensions world we often tend to think that we always need to meet the fund managers but there is a time and a place for that. A lot of the investment strategy is process driven, our role as a pool is to put in place the structure.

“So, in addition to asset pooling, we have also pooled risk management, administration and all associated support,” he adds. “We think our clients get far more benefit from us dealing with the big issues they face rather than deciding whether fund manager A or B deals with their equity portfolio.”

The £45bn LGPS Central pool appears to have a similar view. “We need to be the positive alternative to the traditional asset managers that our partner funds would have used before pooling came along,” LGPS Central chief executive Mike Weston says. “That is all about being FCA-regulated, because there is a long-term focus, and benefitting from a total lack of conflict of interest. Partner funds are our clients and our owners,” he adds.

While LPP, Border to Coast and Central have launched their own Authorised Contractual Scheme (ACS), a transparent tax structure that is an alternative to open ended investment companies and unit trusts, the £30bn Brunel Pension Partnership has appointed a third party to manage it for them. “Although we are not the operator or authorised contractual director, we are the ACS’ sponsor and investment manager. So, there is a two-way relationship going on, which is working very well,” says Mark Mansley, Brunel’s chief investment officer. “In contrast to some of the schemes that are using outsourced providers, we are in control of the process,” he adds. “We are using FundRock as a platform because it is an expert in fund administration. It liaises with the FCA, which is not something we are experts in and so are quite happy to outsource that.”

Access in turn has pursued an entirely different approach. The £46bn pool has appointed Link Asset Services as a fund operator, meaning that it is ultimately in charge of manager selection. The pool sees itself more as a facilitator for the individual authorities, says Access chair Andrew Reid. “We are facilitating the opportunity for funds to simplify their structures, should they wish, or indeed to further diversify their portfolio.”

This central, eastern and southern shires collaboration has pooled nearly half of its assets and aims to have more than 80% of them pooled by 2021, Reid says. The pool expects to save around £33m a year by managing assets in a pooled structure.

Wales Pension Partnership, which is the smallest of the eight pools with some £16bn of assets, pursues as similar approach to Access in that Link Asset Services provides the pooling infrastructure and Russell Investments advises on manager selection. The pooling process has been a lot more challenging for London CIV, which combines the pension scheme assets of 32 London boroughs. While the pool aims to streamline the processes between its 32 partner funds, it also received scathing criticism in a Willis Towers Watson report which warned that London CIV urgently needed to clarify its purpose, as the individual partner funds had entirely different expectations of the pool. Some were seeing it as a fund manager, while others expected it to act as a fiduciary manager and there were those who saw it as a procurement vehicle.

This highlights a key challenge for the pools. While there have been clear advantages to allowing each one to develop their own strategy based on the capacities that were already in place, individual local authorities might have different expectations of what the pool can deliver.

On the opposite side of the pooling spectrum is the Northern Pool. While the £46bn collaboration between the local authorities in Greater Manchester, West Yorkshire and Merseyside recognised the benefits of collectively managing infrastructure assets early on, it remains sceptical of attempts to streamline the process. As one of the founding members of the GLIL infrastructure platform, the Greater Manchester Pension Fund has pooled the management of its infrastructure assets with other authorities since 2015, which was before George Osborne’s announcement of the government’s pooling policy. Northern Pool also questions whether the benefits of integration extend to all asset classes. Its leadership has therefore taken a much more reserved approach to integration. It is the only pool which has not launched a regulated entity and focusses on only pooling its infrastructure and private equity assets. This stance has put the pool at odds with central government, which targets deeper levels of integration.

But Northern’s approach should not be dismissed and was in line with the guidance set out in 2015, says John Raisin, an independent adviser to the pools. “The government was right in not being too prescriptive and accommodating for the fund’s differences.

“The Northern Pool, in my opinion, is an appropriate pool because they have concentrated on the areas where they can establish the best competitive advantage for themselves,” Raisin adds. “Not in listed equities but by focussing on alternatives and infrastructure in particular.

“If there is a real benefit in pooling that is where it will come, in that respect Northern is ahead of anybody else and they are also managing assets at very low costs.”

OUTLOOK

In early 2019, it looked like the different approaches to pooling might result in a clash. The Ministry of Housing, Communities and Local Government published draft guidance which attempted to speed up the pace of pooling and streamline the process. The document, which foresaw the introduction of a mandatory ACS structure for each pool and a target to complete the majority of the pooling process by 2020, would have put significant pressure on some pools.

And so it was met with resistance, particularly by Northern Pool. In a letter to the ministry, its councillors warned that the new proposals had lost sight of the desired outcomes and instead attempted to impose a “one-size-fits-all” approach to pooling. Northern Pool also warned that establishing an ACS structure would increase costs by between £10m and £15m a year. So, the pool provided a detailed case explaining why the recent guideline was in breach of UK and European law.

Northern Pool argued that the recent draft guidance imposes unfair additional burdens on the pools, fails to take the value for money criterion into account and contravenes the European IORP Directive. The latter says: “Member states shall not request IORP’s registered or authorised in their territory to invest in particular asset classes.” However, a source has told portfolio institutional that there could be a revised draft of the government’s consultation on pooling in the pipeline. At the time of writing, the ministry was not available to confirm this.

Regardless of the evolving regulatory context, most pools are optimistic that consolidating their assets has made them more resilient for a potentially more volatile political and economic climate.

Brunel chief investment officer Mansley argues that shorter term costs will come with longer term benefits. “Pooling works – we are building organisations that are capable and cost efficient. There is now a greater amount of firepower than we have ever seen in LGPS before.

“There is the challenge that pooling may appear to cost more than initially planned. This is partly because of asset allocation shifts into more expensive asset classes (notably, private markets). It’s also because the scope of cost information is radically changing, giving us more information.

“So, previously individual schemes were often in fund-of-fund arrangements where there was little information available on the true total cost, whereas we now have far greater transparency,” he adds. “Improved disclosure is not the same as higher costs, and we believe that pooling will deliver significant cost savings in the long run.

“The biggest danger to the pooling process is being undermined by criticism when there is not a better alternative. Reversing the decision to pool is not a realistic option – more likely is the option of mega pooling. Also, it’s worth bearing in mind that a lot of the criticism regarding pooling comes from people trying to get work consulting for the LGPS funds,” he adds. 

LPP’s Tomlinson is also optimistic. “The success of each pooling strategy is dependent on the market environment. If we enter a world that is facing severe economic challenges, such as distressed assets and liquidity issues, those with a clearer governance structure will be able to act more authoritatively. Within LPP we are managing liquidity in a way that should markets get ugly, we are able to look across the portfolio and adjust our strategy, something that would not be possible in a more fragmented portfolio. “So, this is about seeing the pools as an opportunity to position ourselves for a more challenging investment environment.”

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