Last month, final submissions to the government’s consultation on the future shape of the Local Government Pension Scheme (LGPS) were made by stakeholders across LGPS and beyond.
This is a vitally important initiative. Earlier this year, John Ralfe, an independent pensions consultant, estimated that the LGPS’s cash funding deficit was closer to £100bn in 2013, rather than the £47bn announced in the 2013 triennial valuation.
The need for positive change to address this deficit is clear, and we therefore welcome the consultation. However, disappointingly the consultation missed a trick, with the proposals announced in May focused towards collective investment vehicles (CIVs) through passive fund management. Encouragingly though, the consultation left the door open for “any feasible proposals for the reduction of fund deficits”.
LPFA does not agree that CIVs in the format proposed by the consultation, (i.e. stand-alone, single asset class entities) would provide the economies of scale and savings required to sustain the viability of the LGPS in the longer term. CIVs like the London Councils’ proposals are likely to deliver some investment-related cost savings and improved economies of scale. However, there is the opportunity for bigger, bolder steps that would help to transform the funding position of the LGPS over the coming decades. We support collective investment as a means to realise the many benefits of scale, but caution against any proposal which dilutes the connection with the liabilities the investments are supposed to meet.
We strongly believe that an asset liability management (ALM) partnership model would be the optimum structure with which to reduce costs, increase the chance of maintaining stable contributions and eliminate deficits over time. The ALM model would deliver the same economies of scale as CIVs while ensuring the assets selected (listed and alternative) were chosen precisely for the consolidated liability set of the partners. This integrated approach, voluntarily bringing together LGPS funds to deliver asset and liability management, enables bites out of the deficit from both ends. It also provides scope to enhance and rationalise governance.
Effective governance can create a dividend in fund performance and is an essential tool in tackling the LGPS deficit. In recent years, thanks in large part to the skills and expertise of our board, we have adopted a liability-driven approach that has already been the catalyst for change within our portfolio. We have invested more of our fund in illiquids, such as housing, private equity and infrastructure, whose returns profiles better match the liabilities of pension funds. A further element being introduced to our investment strategy is a concentrated “buy and hold” approach to equities, which delivers savings through reduced transaction fees and in-house management.
Investing in skills and training has clearly been shown to impact positively on fund performance, and without the benefit of our board, many of whom are experts in illiquids, we would not have been able to make these changes to our strategy, which are helping to manage our deficit down.
This is an enormously important time for public sector pensions in the UK – a once in a lifetime opportunity to ensure the LGPS is fit for purpose and able to provide for public sector employees in their retirement for generations to come. We are confident ALM partnerships are the answer and are already working with like-minded funds to make this happen.
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