The transitioning challenge facing pools was discussed at an LGC roundtable event sponsored by Legal & General Investment Management. Claire Read reports
Chris Bilsland, former chamberlain of the City of London and non-executive director, London Collective Investment Vehicle (roundtable chair)
Andy Burns, director of finance and resources, Staffordshire CC and president, Chartered Institute of Public Finance and Accountancy (Cipfa)
Catherine Darlington, head of transition strategy Legal & General Investment Management
Nigel Keogh, operations and development manager, National LGPS Frameworks
Chris Lyons, client director, Legal & General Investment Management
Karen Shackleton, senior adviser, MJ Hudson Allenbridge
When Chris Bilsland used to talk about transitioning local government assets, the conversation tended to be a relatively straightforward one. “Transition of the Local Government Pension Scheme previously was generally done for investment management reasons: if there has been a change of strategy or a change of manager.
“When I used to deal with transitioning, I said there is a cost – the implementation shortfall – but it is justified by the benefits of this strategy and manager change.”
Yet as LGPS pools became a reality, he fears that sort of straightforward discussion may become a thing of the past. The danger was that funds lost higher performing managers as part of the transitioning, even if their strategy remained the same. And, it could be added, what is the capacity of successful fund managers to absorb new assets?
Mr Bilsland – the former chamberlain of the City of London and a non-executive director of the London Collective Investment Vehicle – was speaking on the eve of the 2018 LGC Investment Seminar as he chaired a roundtable convened by LGC and supported by Legal & General Investment Management (LGIM). The question facing the panel: what are the practical challenges of transitioning member funds’ assets to pools, and how can these be overcome?
Over the course of the discussion, communication and collaboration between the pools emerged as key means of lessening the risk.
Catherine Darlington, head of transition strategy at Legal & General Investment Management, said: “We know that there’s a lot of work and collaboration going on across the pools. The pools and their member funds are increasingly engaging with us in the transition management industry, both on an exploratory basis and an implementation basis.”
The nature of transition management engagements would be “quite unique probably to the pool and their specific requirements, the structures that they have set up and how they wish to transition assets over, and at the pace that they wish to do that”, she said.
Among the factors transition managers would consider when devising plans were investment objectives, investment performance, stakeholder engagement and governance structure.
For Karen Shackleton, senior adviser at MJ Hudson Allenbridge, the concerns set out by Mr Bilsland “hit on the real issue that will be hotly debated at committee level” as pools become legally established.
“Clearly, if you’re going to get fee savings, and if you’ve got an underperforming manager, then pooling makes huge sense, and it’s very easy to assess what the cost of transitions will be.
“I’ve had clients who’ve done this, they’ve said: ‘Right, based on the expected transition costs, we expect to be recovering those costs through net cost savings in a year’s time. The first year will cost us more but after that we will be making savings.’
“But I think as we move on with pooling, it’s going to be a bigger problem. Especially where they’ve got their favoured managers who’ve done well for them.”
Clearly, if you’re going to get fee savings, and if you’ve got an underperforming manager, then pooling makes huge sense, and it’s very easy to assess what the cost of transitions will be
Karen Shackleton, MJ Hudson Allenbridge
It was one of many arguments made in support of crystal-clear communication with all stakeholders about the specific aims of transitioning assets to pools. “Having worked with clients who have gone through the process, I think [an important] part of it is the client understanding exactly what’s in the portfolio that’s being transitioned and the objectives,” argued Chris Lyons, client director at Legal & General Investment Management.
According to Andy Burns, director of finance and resources at Staffordshire CC and president of the Chartered Institute of Public Finance & Accountancy (Cipfa), such communication will need to be grounded in an understanding of the scale of the change.
“It’s a bit like an IT project where it’s not about just plugging in new kit, it’s about managing the change around it that’s really, really important. It’s almost like the ‘how’ of the transition as much as the ‘what’ that is really important.”
That included cost transparency, he suggested. “If we can engage with people, explain why as well as what we are doing in a way that is as open and transparent as it can be, then you’ll give people confidence that actually the right things are being done. For this to be a transition where there’s a safe landing and a good start, I think tending to those things is really important.”
Nigel Keogh, who was heavily involved in the development of the National LGPS Framework for Transition Management and Implementation Services, said the team had “made a point” of saying transition managers bidding for inclusion had to be able to create “fund by fund analyses” of what transitions will cost.
“Because there will be those around the country who will want to know that, and you will need to report back to your elected members with exactly what it has cost your fund to go through that process.”
But while ensuring there is a clear understanding of the costs and benefits of transitioning assets to pools may overcome one challenge, it could also present another – deciding just how these costs and benefits are going to be split.
When Mr Bilsland asked if the implementation shortfall of transitions should be shared out equally among member funds, Ms Shackleton’s initial response was concise: “Very good question.”
She continued: “I think it would depend. There must be some costs that should be shared equally, and then there are going to be other costs that are going to be very specific to the mandate that’s being transferred across.”
Mr Burns agreed, pointing to the example of LGPS Central, with its eight member funds. “There are some fixed costs which are shared equally, irrespective of assets under management. There are then some costs which are shared in proportion with assets under management. And then, given that we have some of our member funds who’ve got direct in house management and some external, as things move, there’ll be some costs which will only be borne by those moving assets.
“I think the key thing is that it’s for the pool to agree with its member funds about how to do it, and it might be a bit different in each place.”
The concept of variations between pools was echoed by Ms Darlington.
She suggested that the degree of asset consolidation would vary between asset classes. “The greatest proliferation of managers is probably in the active equity space, so the consolidation will likely be concentrated there, and when we looked at the different manager set-up rosters across the various pools and their member funds, there’s not such a great number of fixed income managers, for example.”
Was there a risk of impact to markets in the event of this sort of large-scale transition, asked Mr Bilsland? The simple answer: yes. Ms Darlington suggested it was a risk which pools needed to consider in advance, and an area in which transition managers could help.
“I think that’s something that certainly it’s important to plan. Take UK small cap as an example: we may need to consider if reporting of ownership concentration would be triggered and how to manage the market impact that might be incurred after that signal. It’s thinking around that and thinking about the timing and working with a transition partner in advance.
“We can sit and work through these things – things that we often have to work through when we’re thinking about large-scale events. Making sure that they are flagged early on and that we’ve proactively thought about how we’re going to manage them. Because, yes, it will be important.”
The key thing is that it’s for the pool to agree with its member funds about how to do it, and it might be a bit different in each place
Andy Burns, Cipfa
Also important, our panellists agreed, would be conversations between pools. Many therefore said it was crucial to work out confidentiality agreements that made such conversations possible.
“I think cross-pool collaboration is going to be one of the key factors that makes this a success,” argued Mr Keogh, operations and development manager for National LGPS Frameworks.
“Given that we are all going to be going through this process together, in order to ensure that we don’t trip over one another when we are going through our plans, I think we have to keep those channels of communication open between pools as much we possibly can.
“Obviously there are conflicts to manage within that, and working out how we can best make confidentiality statements work. There’s also the fact that some of these organisations are FCA-regulated entities, and their duties are to their clients – the individual funds.
“But we have to find a way through so that those channels of communication can remain open,” he stressed. “Because the last thing we want is an instance in which two pools go to market at the same time to implement a transition, and both of them come out it badly as a consequence.
“Those conversations need to take place. Which is why I would encourage pools and the constituent funds to allow the transition managers to talk to one another, in a confidential way, so that those conversations can take place.”
Ms Darlington told the group: “It is good practice for a transition manager to be careful to manage market impact. If there’s a lot of activity in a particular name, then you might take your foot off the accelerator, for example.
“So the extent to which transition managers can be flexible in how they’re interacting with the market will help, and that can happen without necessarily co-ordinating directly with one another.”
But, as Mr Bilsland stressed, these sort of closely managed conversations about co-ordination represent a fundamental shift in culture for local government pension schemes. “One of the great strengths I always think about the LGPS funds in England and Wales is there’s always been a great sharing of information, and it’s in the DNA not to compete but to collaborate, but the pools are different beasts, aren’t they?
“They’re regulated entities; they’re companies; many of the people involved with them don’t come from the LGPS; they come from very different worlds. Why would we assume they would want to collaborate or even think it’s important?”
Mr Burns felt it was a valuable point, and saw it as manifesting more broadly. “In the same way, there’s a culture issue between the commercial nature of a company versus the public service ethos which sits behind much of what’s already there.
“There are some competitive and creative tensions between the commercial nature of the new company competing to attract the best staff and pay the salaries they think are appropriate to get the right kind of people on board, versus the public service ethos of ultimately this is all funded by taxpayers. Whether they’re national or local or pension beneficiaries – we’re ultimately funded out of taxpayers’ resources. So there is a tension there, which I think is not going to go away.”
But he wasn’t necessarily pessimistic about the future of collaboration between pools. In fact, he expressed the hope that in the longer term it could be the foundation of real improvements.
“The collaboration I foresee slash hope for: British wealth funds who can invest in infrastructure projects, whether that’s HS2 or HS3, or Liverpool to Manchester to Leeds to Hull link, or Heathrow’s next runway. Major infrastructure stuff, probably too big for individual pools, but them collaborating to ensure that we can make major infrastructure investments that generate satisfactory returns. That’s where I think collaboration across pools has got real potential.”
He did add a caveat: “Of course the issue there is do you buy into that notion that actually creating these sort of pools will enable investment in infrastructure assets in the way that was envisaged by George Osborne back at the very beginning? That’s probably outside the scope of this conversation, but for me that’s where the collaboration benefits could be.”
And Mr Burns admitted he didn’t think “people have got time to think about this stuff yet”. It was a matter first of successfully moving assets to individual pools, with the expert and independent support that will demand. But once that is achieved watch this space.
This roundtable discussion was sponsored by Legal & General Investment Management. The topic was agreed by LGC and Legal & General Investment Management. The report was commissioned and edited by LGC. See LGCplus.com/Guidelines for more information.
Successfully navigating the journey to pooling
Catherine Darlington, head of transition strategy, LGIM
Effective transition management requires forward planning and careful consideration. Transition partners can provide LGPS funds with expert support in the journey to pooling
It has been a busy time for the Local Government Pension Scheme. Each of the pools has been collaborating across its partner funds to build the solution that best meets their collective objectives. As each pool formalises its appointments and the structure is finalised, attention is now turning to how assets will move into the new structures.
Pools and their partner funds are increasingly engaging with transition managers on both an exploratory and implementation basis, and the National LGPS Framework for Transition Management is now in place. Each pool and its member funds are likely to use transition management through a series of engagements as the pooling implementation progresses.
The collective objective of realising savings and enhancing the value of assets delivered to the pools can be translated into some key collective transition objectives. These include implementing change in a measured fashion, seeking to reduce risks and costs, and ensuring that the process is auditable while protecting confidentiality.
We recognise that the circumstances for each pool will be unique depending on its individual requirements.
However, as with all aspects of pooling, having a strong governance framework in place will be an important part of the transition journey.
Working with your transition partners, advisors and stakeholders to establish a robust framework as you begin this journey will help reinforce the achievement of these objectives and deliver transparency and auditability of process and cost.
At its core, this activity is a significant asset management exercise, and cannot be simply defined as a large trade. There is a lot of project management involved: coordinating the volume of information and maintaining clear and effective communication.
Regardless of the exact nature of the individual pool structures, one thing they will each have in common is that they will be creating new process, in new structures, with new teams, as assets are consolidated into the pool.
Working dynamically with transition partners that have asset management and project management expertise could provide help in the planning, implementation and risk management but also lift the operational burden from the pools,which have a wealth of demands on their resources.
LGIM is a supportive partner of the LGPS; we have dedicated transition project managers and provide a range of transition management services to help you on this journey.