Response to LGPS investment consultation | July 2023

Local Government Pension Scheme (England and Wales): Next steps on investments

We write on behalf of Barnett Waddingham (BW) in response to the above consultation including proposals for LGPS pooling, levelling up investment and investment in private markets. We submit these comments as both actuaries and benefits and governance consultants who mainly operate and advise on the LGPS in England and Wales.

By way of background, Barnett Waddingham is a pensions and actuarial firm.  Our Public Sector Business Area provides actuarial, benefits and governance consultancy services, and is the Fund Actuary for 20 of the LGPS funds in the UK. In addition, we participate in various industry wide technical groups, Scheme Advisory Board sub committees and working groups, and other groups and meetings concerning the LGPS and its operation and development. 

We are therefore experienced in the workings of the LGPS at scheme, fund and employer level and we have an insight into difficulties and issues experienced by stakeholders in its operation and investment, including in the aspects covered by this consultation. 

Our response to the consultation is set out below and we would be pleased to expand, clarify or discuss any of the comments made. Please note that our response reflects our thoughts, experience and knowledge as actuaries and benefits and governance consultants and should not be taken as legal advice.

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Response to questions

Chapter two: Asset pooling in the LGPS

Question 1 - Do you consider that there are alternative approaches, opportunities or barriers within LGPS administering authorities’ or investment pools’ structures that should be considered to support the delivery of excellent value for money and outstanding net performance?

BW Comment:

BW are supportive of the aims of LGPS pooling in realising fee savings through scale, providing greater and more efficient access to alternative assets and further increasing the levels of professional and good governance which the LGPS displays. The comments included below should be read within the context of that support.

Increased scale through fewer pools

The consultation sets out a view that fewer, larger pools would be beneficial to the LGPS but does not back this up with any evidence nor does it include any proposals on how this may be achieved. 

With regard to scale there is indeed evidence that larger mandates can provide substantial fee savings provided the right manager is selected (for example The Truth About Scale Discounts In Asset Management) but there is no evidence that larger pools in themselves would necessarily result in larger mandates or better manager selection. For example pushing together passive mandates will give a bigger pool but won’t guarantee material cost savings. 

The focus should, and indeed appears to be in other parts of the consultation, on reducing the number and increasing the size of mandates within existing pools while seeking to improve manager selection processes.

Regarding the methodology for achieving fewer, larger pools there does not appear at present to be any incentive for pools to voluntarily merge, indeed the approach of government to date has been one of effectively freezing the position as at the inception of the existing pools. Furthermore the consultation’s unease with inter pool competition would appear to rule out any route for the organic growth of some of the pools.

Focussing efforts on reducing the costs of investing in private markets and preventing pools from inadvertently competing with one another for the same assets would be more beneficial in our view. (see specialisation below). 

Collaboration and specialisation

We would support greater collaboration between pools and in particular the specialisation of some pools in some areas of investment. Such specialisation in the areas mentioned in the consultation, including in-house invested funds, would enable larger mandates to be achieved and potentially avoid duplication and increased costs in those areas. 

Successful private market investment is borne out of available assets and personal relationships/networks.  Its illiquid nature means stability of investment team and ongoing knowledge of the underlying assets - not simply marketplace - is a key to success.  Against a remuneration backdrop that may not be competitive compared to those of private sector private market investment staff, there is a risk that turnover is higher at pool level and risk increases as a result of the loss of specialist knowledge.

By fostering a cross pools methodology for accessing private markets (e.g. a specialist pool that all other pools could invest in) for the areas of private markets discussed later in the consultation could lead to meaningful savings and reduce the risk associated in high turnover in personnel at individual pool level.

We do not however agree that forcing LGPS funds to access such specialised vehicles via a fund or sleeve created by their own pool is a cost-effective way of achieving this outcome. Provided that the local pool has been consulted, a direct investment by the LGPS fund into the specialist fund of the other pool would seem a more appropriate and cost-effective route to take.

In house management

The consultation endorses the use of in house management in some pools and suggests that other pools may achieve significant fee reductions by embracing. 

To an extent this view is borne out by the activities of other large UK pension schemes, for example:

  • RPMI Railpen which manages £31 billion of assets on behalf of the railway pension schemes, announced plans to internalise its trading desk in the summer of 2021. This follows substantial growth in Railpen’s trading activity over the past few years.
  • USS Investment Management is a wholly-owned subsidiary, and the principal investment manager of the Universities Superannuation Scheme Limited, trustee of one of the UK’s largest pension schemes. USS IM invests nearly 70% of the scheme’s defined benefit assets (over £75bn) directly placing the remainder with complementary external managers.

Regardless of these examples we would urge caution in this area in order to maintain the focus of LGPS funds on pooling their liquid assets, developing effective private market strategies and further improving on the management of both.  The reluctance to pool exhibited by some participants may be an indicator of a lack of trust at some level in the current approaches.  Pushing for a move to a substantially internally managed approach may increase that reluctance. Consequently, whilst it may lead to fee savings greater internal management may be better considered as a future evolution and not be a source of focus at this point in time.

For those LGPS funds who may wish to pursue this path we would agree that rather than creating in house teams from scratch it may be beneficial for those without access to in house investment via their own pool to be able to invest in this way via other pools which already have a proven track record in this area (but see our comments on collaboration and specialisation above).

Long term investors?

The LGPS is a long-term investor however this can, to some extent, be both obscured and disincentivised by short term fluctuations in asset values especially when looking at private market and venture capital type assets. Measuring performance over a short time period (for example as part an automatic review following a 3 year valuation process) could produce results which lead to pressure to divert from a long-term strategy including illiquid assets which have a much longer return period. 

Accordingly it would be helpful if guidance could include the extent to which for LGPS funds should/can consider longer term performance measures and/or asset smoothing mechanisms.

BW Comment: Any deadline date set out in guidance would have to recognise the potential issues involved in hitting it. For example the timing of publication, if guidance is delayed will LGPS funds still be asked to transition at short notice, or would it be better to set a time period from publication of guidance? Other issues include, transition costs, the impact on asset values of significant shifts of assets, tax implications and the timing of transitions given market conditions. In the rest of our answer we will however focus on the definition of assets to be transitioned by the deadline as we consider a clearer definition of the assets to be transitioned by this date would be required. 

The consultation includes definitions of pool owned and pool managed assets with presumably all other asset types being outside of pools? 

Pool owned is clear that in the assets must sit within a fund set up and controlled by the pool with asset managers appointed by the pool. 

Pool managed is however less clear, for example does this include investments in external funds for which only the ongoing monitoring has been moved to the pool but the pool has no manager ‘hire and fire’ responsibilities? If this is not the case then it should be made clear that pool managed only includes assets where the fund is external to the pool but the pool has full control of the selection, appointment and dismissal of asset managers. This would include funds where the original manager appointment was made by the fund but the responsibility for dismissal, reselection and appointment has been transferred to the pool.

In our view the range of asset definitions could be widened as follows:

  • Pool owned assets – fund run by the pool with managers appointed by the pool
  • Pool managed assets– fund outside the pool but manager control with the pool 
  • Pool monitored assets– fund and manager control outside the pool but the pool has some form of ongoing monitoring role

Given that in some instances the direction of assets by the pool to external funds is entirely appropriate within a diverse and cost-effective implementation strategy, the inclusion of such a tighter definition of pool managed, alongside pool owned would in our view provide a clearer and more appropriate target for transition by the deadline.  

Finally, although we do not have an issue with a deadline for listed assets, given the very low annual charges already associated with the management of index tracking mandates by third party managers, our feeling is that efforts may be better placed trying to facilitate greater engagement in pooling non-listed (higher charging) mandates.

The model of pooling which is described in this section and is therefore the one guidance would promote is weighted toward a more ‘fiduciary manager’ style which may be entirely appropriate to the situation and needs of some LGPS funds but less so to others. 

It is understandable to see a logical extension of pooling into such a model given the credible arguments for greater efficiency and speedier decision making. To do so without considering the unique nature of the LGPS could however put at risk the ‘social contract’ which lies at the heart of the scheme and which must be effectively recognised and addressed if pooling is to be successfully delivered. 

If local taxpayers are ultimately the payers of last resort for the scheme then it is only right and proper that their representatives, local elected members, should be accountable to them for the performance of the scheme. While accepting that strategy rather than implementation drives performance there is an enormous grey area between the two and the more that decisions in this area are delegated to the pool the looser that accountability and therefore the ‘contract’ between taxpayer and elected member becomes.

This grey area can and does include investment decisions around climate and, impact (levelling up) which the government is keen for LGPS funds to focus upon and which for a variety of reasons (both in terms of scale and local politics) investment decisions may sometimes be more appropriately made at the fund rather than at the pool level.
The incorporation within the model of LGPS funds obtaining advice from pools may be particularly contentious if taken to the extreme. A pool which is the sole source of strategic advice is in our view straying dangerously close to a fiduciary manager model which may be neither appropriate, nor even technically legal for an LGPS fund to operate under. At the other end of the scale an LGPS fund which does not seek to consult with its pool on available and planned asset vehicles and funds when determining its investment strategy is hindering its ability to effectively implement that strategy. 

Any shift toward a full ‘fiduciary manager’ model may also raise questions from the CMA and from the rest of the FM marketplace with regard to the ability of LGPS funds to continue use their pool company without some form of procurement process or competition. 

Some LGPS funds have already chosen to embrace the model of pooling set out in the consultation for entirely logical reasons but that is not to say they should not have the ability to change their minds at some future point. Conversely there are and will continue to be LGPS funds which do not consider the model to be appropriate to their needs at this point in time but who may move toward it at some future date. 

Therefore we consider it would be more appropriate for government to focus guidance on the outcomes of LGPS pooling rather than the exact arrangements used at any point in time which are arguably more a matter for the FCA to ensure that any arrangements being used for pooling comply with appropriate regulation. 

Requiring LGPS funds to report against independently set benchmarks appropriate to locally determined investment strategy (see our answer to Question 5 below) as well as having to justify why any assets are not within either the pool owned or pool managed classifications (see our answer to Question 2 above) would in our view provide an appropriate framework for progress.  Perhaps a further useful addition to such reporting would be for LGPS funds to report their average (fully transparent) annual management charges per asset class and require an assessment of any savings forgone in respect of assets not pooled.

Yes. It will be important however for such a policy to recognise the unique requirements on and situation of elected members when acting in this capacity. They are not the same as private sector DB trustees, even if many of their responsibilities are similar and therefore both the extent and content of any training should reflect these differences both in terms of the scheme itself but also the legislation, obligations and duties relating to their position within local government.

In broad terms yes in that we agree that consistent benchmarks would be helpful in both measuring the progress of pooling as well as improving the trust in those measures. 

Consistency of benchmarks could enable cross fund and pool comparisons of performance within asset classes. However our understanding is that one of the many challenges encountered by the pools in encouraging funds to transfer assets to them to date is the very wide variety of benchmarks used. 

We would urge any discussions in this area not to simply focus on equities where the number of benchmarks tends to be smaller but to consider some of the complexities in the fixed income and bond asset class. Moreover if inappropriate benchmarks are used they could easily confuse the picture, for example if a benchmark of corporate bonds is used to assess the performance of LGPS credit portfolios containing a wide range of credit assets. In this instance there is a danger that either LGPS funds spend time and effort explaining why their credit performance differs from the benchmark (particularly if such benchmarks lead to league tables of LGPS funds) or worse LGPS funds change their allocations in order to match the benchmark rather than achieve the strategy originally agreed as appropriate to their needs which include the fund's funding position, desirable risk levels and funding/investment objectives.  

For pooling to progress effectively requires the trust of all parties involved. Currently there is a concern amongst some LGPS funds around the cost and performance measures and results being produced around pooling given the interests of the parties involved to see pooling succeed. Regardless of the accuracy of the figures the perception of potential interest conflict does not provide a solid base for progress.

For the above reasons we would encourage government and LGPS funds to commission an experienced third party with little or no ongoing contractual relationship with the LGPS to produce a report on the costs and performance of LGPS pooling. 

The report should include an independent review of the costs and performance outcomes of LGPS pooling to date as well as recommendations for benchmarks for ongoing measures which provide both an appropriate level of consistency as well as recognising the diverse strategies, targets and outcome requirements of individual LGPS funds.

Chapter three: LGPS investments and levelling up

The LGPS has for some time been an active supporter of impact investing as shown by the increasing level of exposure to such assets. Many such investments, if located in the UK will already meet the definition of Levelling Up provided within the consultation and given that the definition is fairly broad each LGPS fund should therefore be able to determine a definition of LU appropriate to its needs. 

There are in our view two significant considerations for LGPS funds when seeking to invest in such opportunities:

  • Location v Return: There will in some cases be a perceived or real local benefit to investing within the area of the fund which will need to be measured against the risk related returns available. Should there not be a material difference it would therefore be understandable for elected members to seek to prioritise location, however there is a danger that such a priority could still be present when the differences in returns are material. There is also the potential for unintended consequences e.g. funds investment activities locally moving the market prices for assets and in turn making these less accessible to local taxpayers.
  • Many of the opportunities in this area are small scale and/or higher risk and would therefore benefit from aggregation in order to provide the necessary diversity and cost effectiveness. However, by their nature such vehicles cannot provide the local prioritisation which some LGPS funds may wish to focus their investment on even where the returns allow this to be done appropriately. It may be therefore that in some cases it may be more appropriate for LGPS funds to invest directly in such opportunities rather than going via a pooled vehicle.

Yes, however as with our response to Question 1 we do not however agree that LGPS funds should only be able to access an aggregated Levelling Up or Impact fund in another pool via a fund or sleeve created by their own pool. Provided that the local pool has been consulted a direct investment by the LGPS fund into the fund of the other pool would seem a more appropriate and cost-effective route to take. 

Any guidance in this area needs to recognise the potential for more than one pool to be competing for the same assets and the constraints placed on them not to manipulate the markets.

As stated in our response to Question 7 above, the LGPS has long been a supporter of impact style investing where it forms an appropriate allocation within a diverse portfolio of investments in line with its investment strategy as determined under Regulation 7 of the 2016 Regulations. Therefore it could be argued that a ‘plan’ to invest in Levelling Up opportunities already exists within the Investment Strategy Statement (ISS).

Regardless of the above we do not see any significant issues with making that part of the ISS more explicit in its focus and objectives. Where we do have concern is in the extent to which LGPS funds may feel obliged to go up to or beyond the 5% set out in the consultation and the potential impact of such a perceived or real obligation.

The ISS should be a holistic view of the agreed manner in which the fund will achieve its investment objectives. Having the objective and arguably the actual size of one element effectively set by regulation reduces the flexibility of the LGPS fund to design and deliver such a holistic strategy. LGPS funds may well invest 4%, 5% or more in this area (some already do) if they consider it is an appropriate way of achieving their overall strategy, however a regulation driven plan should not be the sole reason for doing so. 

The consultation appears to go beyond a requirement for having a plan to properly consider the place of LU investments in the strategy and seek to increase the allocation where appropriate. Rather the wording of the consultation appears to assume a significant allocation will be made in this area regardless of the overall strategy. The consultation says ‘up to 5%’ but given the context and overall thrust of the document there appears to be little doubt that somewhere near or above 5% is the expectation of government.  

Not only could such an ‘obligation’ distort the overall strategy of an LGPS fund, but it could also distort the quality and price of the opportunities available. As in all markets any expansion (real or artificial) of demand can result in lower quality and/or higher prices unless the supply of good quality opportunities can be increased to meet that demand. 

We would therefore request that any regulation or guidance in this area clarifies the level of expectation and/or obligation in the phrase ‘up to 5%’. For example it might be more appropriate for guidance to ask LGPS funds to include in their ISS a recognition of the ‘up to 5%’ allocation which the government is seeking from the LGPS together with a consideration of the appropriateness of such investments to their particular investment strategy and the rationale for the level of allocation included in their plan.

Taking into account the reservations expressed in the previous answer, the reporting requirements do not appear overly prescriptive but may require clarification in the area of reporting assets inside and outside the pool. LU style investments may cut across a number of asset classes, therefore any guidance would need to be clear how this reporting requirement dovetails with the overall requirement to report on assets within and outside of the pool. Also guidance should set out how such reporting should be set be against LGPS funds own ESG policies especially where synergies are being created.

Chapter four: Investment opportunities in private equity

Q11: Do you agree that funds should have an ambition to invest 10% of their funds into private equity as part of a diversified but ambitious investment portfolio? Are there barriers to investment in growth equity and venture capital for the LGPS which could be removed?

BW Comment: Our views in this area relate closely to those expressed in our response to Question 9. However, before moving onto those we would first wish to clarify that the ambition in this question relates to the full extent of private markets (PM) rather than just the subset of private equity (PE)?

As with impact (or LU) the LGPS is already an investor in private market assets and sees them as an important element within a diversified portfolio. Our concerns, as with LU, relate to the extent and nature of any expectation or obligation contained in the phrase ‘an ambition to invest 10%’. The same section of the consultation includes the following sentence, one which we wholeheartedly endorse:

‘As with any other asset class, it is important for administering authorities to exercise judgement on their exposure to private equity, as with any other asset class, and any investment in these asset classes should be part of a diverse and balanced portfolio.’

The difficulty for LGPS funds may be to reconcile such an exercise of judgement which results in a current appetite for private markets well below 10% with guidance on the ISS which seeks to include an ambition to invest 10%. 

Might it not be more appropriate for LGPS funds to include in their ISS a recognition of the 10% ambition which government is seeking from the LGPS together with a consideration of the appropriateness of private market assets to their particular investment strategy and the rationale for their current allocation to this area.

While the consultation discusses the potential for up to 15% of a fund's assets to be invested in levelling up and private markets, it fails to mention or give any indication of where the assets to be used to fund these should be disinvested from.  This is a key consideration. Will pressure to invest in levelling up assets simply be funded from UK assets already held?  Will a move to hold private equity simply see a reduction in listed equity and, given the UK element is typically overweight vs market capitalisation for many funds a disproportionate weighting away from the UK listed assets.

Finally there may be considerable cross over between investments in PM and those under the LU banner. Guidance should therefore enable LGPS funds to clearly understand how reporting requirements should work. For example can the same investment be counted under both or will each have to be allocated to one or the other?

Chapter five: Improving the provision of investment consultancy services to the LGPS

Chapter six: Updating the LGPS definition of investments

Chapter seven: Public sector equality duty

Should you have any questions on our response please contact us.

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