Set up to manage the approximately £40bn of investment assets of nine Midlands-based LGPS funds, LGPS Central is one of the biggest of the eight Local Government Pension Scheme pools emerging in England and Wales.
As chief executive Andrew Warwick-Thompson explains, it has ambitions that go far beyond just making the pooling experiment work within local government.
“Pools do have the potential to deliver outstanding cost-savings for local authorities but I also think they have the opportunity really to transform the way the investment management industry runs funds for pension schemes,” he tells LGC Investment.
“I think the pooling approach being adopted by local authorities can show the way for private sector pension schemes as well. I think we can act as a force for good in terms of the relatively poor reputation the investment industry has for transparency and value for money.”
LGPS Central was formally launched on 3 April – spot on the government’s deadline – bringing together the LGPS funds of Cheshire, Derbyshire, Leicestershire, Nottinghamshire, Shropshire, Staffordshire and Worcestershire, plus the West Midlands Pension Fund and the West Midlands Integrated Transport Authority.
Initially there will be three pooled funds, all managed via an authorised contractual scheme (ACS): global equity passive; UK equity passive; and global dividend growth factor equity. The funds include assets transferred in from the West Midlands Pension Fund.
In addition, the pool is currently responsible for eight advisory and discretionary mandates on behalf of its partner funds, with the mandates and funds combined amounting to £12bn of assets. Next on the horizon will be an ACS for global active equity, expected to be in the region of £2.5bn, followed by an emerging markets fund, expected to be worth £2bn, in the autumn.
Looking back, now that we are through the April deadline, what does Mr Warwick-Thompson identify as his main learning points from this transition process?
“The biggest challenge for us has been building an FCA [Financial Conduct Authority]-regulated asset management business and the infrastructure you need to support that and an ACS from a standing start and ready to go live in April. I joined the business in July last year, I was the first employee, and we then had to start recruiting pretty much from scratch,” he says.
“In terms of the transitions to the first funds, there weren’t any particular problems with those – they were assets that were already being run internally on a passive basis. So they transitioned in specie [without changing] into the new funds.
“The challenges will probably get greater as we move into the next phase, the launch of our global equity funds in the autumn. We will then have assets that are transitioning from a multitude of different third-party portfolios. We will have multiple sources of those assets and we will need to co-ordinate their transition, from multiple partner funds, into the new funds when they launch.”
Getting the right teams on board is another near-term priority. Including those who have transferred in from the partner funds, the pool now has a permanent staff of 40, with further recruitment to come. There is, for example, a request for proposal (RFP) out for the global active equity portfolio, and managers set to be appointed in time for the launch in the autumn.
“We also have RFPs out for emerging markets but again that’s in a fairly early stage. We will be running internally managed global equity portfolios. So there will be a combination of the third-party mandates plus our own internal mandates, which we hope to have up and running certainly by the end of this year, if not by the autumn,” says Mr Warwick-Thompson.
“The choice we will offer our partner funds when we’re fully operational will be a full range of asset classes, a choice between active and passive mandates and between internally managed and externally managed mandates. That gives our partner funds the opportunity to retain a considerable degree of control over how they allocate their assets and the asset allocation strategy they follow, while also allowing us to keep the number of sub-funds that we run to the absolute minimum.
“The reason for that is the fewer the sub-funds that we run, the lower the underlying costs and the greater the beneficial impact that we will derive for the partner funds in relation to cost savings.”
As well as equities and emerging markets, infrastructure, property and private equity will be further important areas of focus in terms of investment strategy, Mr Warwick-Thompson says.
The fewer the sub-funds that we run, the lower the underlying costs and the greater the benefi cial impact that we will derive for the partner funds in relation to cost savings
“On infrastructure, we are clear that we want, as far as possible, co-investment and direct investment rather than investment through funds. That may well mean that we continue to use organisations like the Pension Infrastructure Platform (PIP) or we could use a range of other similar arrangements for bringing investors together for when particular infrastructure opportunities arise,” he adds.
“Our investment director for infrastructure is looking at the design of the product that he would like to offer to our partner funds because the other important thing is that, while we had one of our partner funds investing directly itself before April through PIP, we now need to create a pooled opportunity.
“In all probability the ACS structure, which works very well for equities and bonds, won’t work particularly well for illiquid assets like infrastructure, and we will need to find some other form of vehicle to invest in, some sort of special purpose vehicle (SPV).
“We are having similar conversations in relation to private equity which, again, does not necessarily fit very comfortably inside the ACS structure, and that also applies to property. We are authorised by the FCA to operate an ACS pooling structure but it is also within our articles that we can go back and set up other types of pooling vehicle as and when necessary, and with the appropriate regulatory approvals as and when we launch them.”
Environmental, social and governance (ESG) and responsible investment (RI) will be an important part of the LGPS Central approach, Mr Warwick-Thompson emphasises.
“With ESG, we have a responsible investment and engagement policy in place,” he says. “We see opportunities for engagement primarily, and that will take the form of either going and visiting the boards of key companies ourselves, teaming up with other like-minded organisations for those visits, or operating through the third-party agencies that have an interest in this area.
“We will also be taking particular interest in voting our shares, and voting those in the way that supports our responsible investment policy. I can see that we will participate either as a named asset owner or as an unnamed asset owner in class or group actions as and when that become necessary. And our final resort will be disinvestment, but we see that as the last step when all else has failed.
“In terms of how we embed this, we have appointed a director of responsible investment and engagement, who sits on our investment committee. Each of the investment directors has a responsibility for a particular asset class, and we cover all of the asset classes on the investment committee. The director for responsible investment is there to ensure our RI policy is translated directly into the investment processes for each asset class, and into each of the mandates.
“We’ve taken a fairly unusual position because we believe very strongly in this: that, if you are going to do something more than just tick the box and say you have an ESG policy, you need to empower somebody to work with your investment committee to ensure that that is actually embedded in the processes.
ESG and RI are certainly areas where pools such as LGPS Central can set an example to the wider investment community, Mr Warwick-Thompson believes. But being a force for promoting diversity, inclusion and regionalisation is also on his long-term radar.
“I’m struck, for example, when I attend investment management events how few women there are there. I see us acting as a force for good, not just for our partner funds but for the investment industry more generally, on things like diversity, transparency and value for money,” he says.
“I also see it as an opportunity for us to be able to bring relatively high value financial services jobs into the regions, when they have predominantly in the past been concentrated in London and Edinburgh.
“In our own small way, we will do something to create a small financial services industry in Wolverhampton and Matlock, which are the two offices where we operate, and also to bring a trickle-down to local businesses in the services that we use.”
Looking to the future, what does Mr Warwick-Thompson feel will be the most likely challenges and opportunities, both for LGPS Central and for the LGPS after pooling?
“I think the biggest challenge is this transitional phase where you have partner funds, local authorities that have done their own thing in the past. There will be a transitional period where everyone is getting used to the idea of pooling, and trying to work out where the boundaries are between those areas that local authorities retain control over themselves and those area that they delegate to the pools. We’re still in that process. I expect that to last two or three years as we work our way through that,” he says.
“In the longer term – three, four or five years out – I would hope to see the vast majority of the assets that are in the LGPS schemes firmly within the pools and being run under discretionary mandates or through pooling vehicles, like ACS, that have been established by the partner funds.
“Indeed, to drive cost savings, to drive cost transparency and to deliver the economies of scale, it is really essential that that should happen. I think the pooling idea is the right one. We’re all doing it in a slightly different way but, ultimately, the pools that are being created need to control the vast majority of the assets within a five-year timeline if they’re to be successful.”
How will we know what “successful” means in this context? Will it mean there will need to be a benchmarking process or formula to gauge how different pools are performing? And what happens when, as with any benchmark, there is a top and a bottom?
“I think benchmarking is going to be extremely problematic personally. We’re all running the asset classes in a way that our partner funds want us to run them and we’re all running them slightly differently,” says Mr Warwick-Thompson.
“I think the benchmarking exercise needs to be run extremely carefully. We at Central, for example, won’t be running our equity portfolio in exactly the same way as other pools are running them. I think the benchmarking exercise is fraught with problems of comparing apples with pears and bananas and strawberries. So I think we need to be very cautious about benchmarking.
“I’m far more focused and far more concerned in establishing a really robust and transparent reporting framework for my partner funds so that they can be assured that what they asked us to deliver we are delivering. But [as for] how we then benchmark that against third-party managers or other pools, I think that still needs a lot of very careful thought.”