Up to a quarter of Local Government Pension Scheme investments may be exempted from the government’s pooling requirements, LGC has learned.
Pension fund officers are currently awaiting official guidance from the Department for Communities & Local Government on the treatment of life funds. However senior figures have told LGC in the short term at least officers will not be required to pull out of existing investments, provided they can negotiate additional savings.
Life funds are generally used to invest in ‘passive’ collections of stocks, which track major indices. They typically have hundreds of investors which some argue means they already benefit from the economies of scale achieved through pooling.
Hugh Grover, chief executive of the London Collective Investment Vehicle pool, told LGC he had already negotiated savings from one life fund manager for CIV members without moving the assets into the pool.
“It is staying outside of the CIV platform, certainly at this point,” said Mr Grover.
He added DCLG had said in a letter to funds that this was acceptable at present but the pool should “manage and report on” members’ investments in life funds.
The 89 LGPS funds must form eight collective vehicles via which to pool their investments to save money on management fees. The pools must be operational by April 2018.
In mid-August, local government minister Marcus Jones wrote to all LGPS fund chairs and lead officers to reiterate his insistence that funds pool all of their assets with “minimal exceptions” where this would not provide good value for money.
However, James Sparshott, head of local authorities at Legal & General Investment Management, a life fund manager, told LGC there had been “zero appetite” for LGPS funds to move their life fund holdings into the pools. He estimated life funds make up around 20-25% of total LGPS holdings.
He said: “If you have £400bn in a life fund, which has all the benefits of scale, and we can pass on those reduced fees to our clients, why would you want to break that apart into separate holdings and hold them in pools?”
Mr Sparshott claimed LGPS funds had an understanding with DCLG that if they can negotiate further fee savings from life fund managers, they may keep these holdings outside of pools, at least for the time being.
“My understanding is the government is comfortable with life funds sitting alongside the pool, as long as the fees have come down. Effectively, you are delivering on the government’s requirement for reduced costs,” he said.
However Jeff Houston, head of pensions at the Local Government Association, said the government had yet to make a decision on the issue and was considering a number of options that could satisfy the DCLG’s requirement for passive investments in life funds to be achieved “via the pool”.
However, he acknowledged that although listed assets, such as active equity holdings, are likely to be pooled within two years, for passive investments such as life funds “it may be a number of years before we see significant movement”.
Most of the pooling groups have set up authorised contractual schemes (ACS) through which to invest collectively. These are tax-transparent investment vehicles recommended by the government for this purpose.
Mr Houston said options might include passive managers moving their current life fund holdings into their own ACS structures in which LGPS pools could invest, or the LGPS pools’ own ACS structures investing in life funds.
“However, there are a number of outstanding practical and legal questions against both of those options therefore an alternative may have to be found, at least in the short term,” Mr Houston said.
“One possibility could be that when LGPS funds’ current mandates with life fund managers are complete, the pool could procure a life fund manager for all of its member funds, while keeping the underlying assets outside the ACS.”
The question partly hinges on whether ACSs, as UK vehicles, can continue to be marketed throughout Europe after 2019. If access to the single market for ACS fund structures is permitted post-Brexit, life fund managers could set up ACSs that could achieve the scale necessary to challenge the cost structures of traditional life funds, Mr Houston said.
But if ACSs are classed as UK-domiciled investors, they may be unable to achieve that scale and therefore some managers may choose to retain life fund structures for passive investments.
When LGC approached DCLG for clarification on its position on life funds, a spokesman said: “We’re committed to the LGPS programme, and have worked closely with both local authority funds and the LGA throughout the design and implementation of the pooling programme.”