Now we are through the government’s April deadline, Phil Triggs outlines the different pooling models and what they may be able to tell us about the future of pooling.
The current Dalai Lama Tenzin Gyatso once said: “In order to carry a positive action, we must develop here a positive vision.” His teachings may be far from those of traditional leaders (for example, he is also known as the “ocean of compassion”) but for those who are interested in building and running long-term, sustainable business entities, these words – that there is more than just the bottom line – resonate.
This ‘positive vision’ test can, I would argue, be applied to the Local Government Pension Scheme pools. Given that we are only recently past the government’s April 2018 deadline, it is clear the eight pools are still very much in their formative years, and will be for some time yet to come.
However, what is going to be important is how the vision of pooling now emerging will in time be turned into positive actions and, in turn, how the pools deliver to the satisfaction of their stakeholders.
This LGC Investment supplement has pooling as one of its key themes, and very understandably given its topicality. Now that we are through the April deadline, this article is going to look at where we now are with pooling, what the different pooling models are, and what this may be able to tell us about how the future of pooling could look. It is designed to be complementary to Charlotte Moore’s article, starting on page 10.
Let us first off very briefly recap how we got here. It all goes back to 2015, when the government applied a broad-brush approach when pooling was offered as a solution after abandoning LGPS-wide compulsory passive index-tracker funds.
One thing clear now is that, back in November 2015, the government had limited focus as to the type of solution required, and the six months that followed were effectively a vacuum.
The Local Government Act tool kit did not completely work for the types of solution that were required: the Financial Services and Markets Act (FSMA) was required as well. Some of the LGPS visionaries cottoned on but the final submissions of the eight LGPS pools to government were varied in the paths on which they had struck out.
The eight pools are still very much in their formative years, and will be for some time yet to come
So, how important is vision and how vital is it that an effective leader should take the helm? Leadership is the capacity to translate vision into reality. The Dalia Lama’s approach to leadership starts with an emphasis on individual action and relationship building.
The LGPS pools have not been short of good examples in terms of taking their respective LGPS pools from vision to existence. Let us look at the five different pooling models.
Model one: Border to Coast Pensions Partnership (BCPP), LGPS Central and Local Pensions Partnership (LPP)
These pools consist of an FSMA-regulated pool and an alternative investment fund manager (AIFM) with authorised structures, notably an Authorised Contractual Scheme (ACS) and others such as exempt unit trusts. All three models are FCA-regulated companies and Mifid II-compliant.
LPP and LGPS Central are up and running already, and there is an interview with LGPS Central’s chief executive, Andrew Warwick-Thompson, on this website. A slight (approved) delay has resulted in BCPP’s expected start in July 2018, with the transitioning in of about £10bn of internally managed funds.
BCPP’s vision is that the internally managed funds will be a vital and growing part of the pool. LPP was an early starter in April 2016, consisting of the London Pensions Fund Authority (LPFA) and the Lancashire Pension Fund (and a commitment from Berkshire). With about £13bn in total assets, it has pooled both investment and liability management.
LPP has a £320m fixed income fund, a £1.3bn credit fund, the £1.3bn GLIL infrastructure fund and a private equity fund. LGPS Central launched on schedule in April with three pooled funds – in global equity passive, UK equity passive and global dividend growth factor equity – totalling £5.5bn.
These three pools are considered to have achieved the government’s vision as to FCA sign-off and the non-inclusion of LGPS committees in manager selection. All three will manage assets through both internal and external management, thus conforming to the desired visions of lower costs and above benchmark net of fees performance.
Model two: Wales Pension Partnership and Access (Central, Eastern and Southern Shires)
These two pools intend to use the same structure as model one but with a rented ACS model and are also Mifid II-compliant.
Overall, the model is very similar to model one but the rented aspect, in theory, takes away the element of the pools controlling their investment managers. Renting an ACS model is not suitable for pools where assets are managed internally, but Wales and Access have no internally managed funds in any case. The ACS will require FCA authorisation.
The LGPS pools have not been short of good examples in terms of taking their respective LGPS pools from vision to existence
Wales has selected Link Asset Services as its authorised operator to set up its collective investment vehicle, and also appointed Russell Investments to provide investment management and advisory services. Russell Investments will give advice on setting up the investment vehicles, including advising on portfolio construction and manager selection.
Link Asset Services will also work with Russell to further reduce costs through a multi-manager structure, currency management, portfolio overlays, transition management and other execution services. Access has also appointed Link and plans to create and appoint managers to a number of investment sub-funds.
Model three: London Collective Investment Vehicle (London CIV)
The London CIV also uses an ACS structure and was first out of the trap in terms of getting off the ground but is perceived to have slipped behind of late, despite having £16bn of assets under management.
A governance review was recently commissioned, with decisions still to be approved with reference to the various governance body arrangements and the investment process. Not all of the London boroughs have bought into the solution and the pool is still seen by some as an option.
This is problematic because, as per the guidance, while there may be a limited number of existing investments feasibly less suitable to pooling arrangements (such as local initiatives or products tailored to specific liabilities), these exemptions should be minimal and should have been set out clearly in the July 2016 final submission.
Ultimately, the secretary of state has the power to intervene under Regulation 8 of the 2016 Investment Regulations, and it remains the case that pooling is compulsory.
In recent months, there has been some chatter or comment within the industry around London CIV having “too many cooks in the kitchen”. But, to be fair to London CIV, it is simply trying to do the right thing: achieve the best outcome in terms of structures and cost.
If London CIV goes for extra choice, it must both understand and be prepared to meet and justify the extra cost
The aforementioned review suggested various ‘blended’ portfolio options and fiduciary solutions being offered to the funds, which reacted by demanding continuation of segregated mandates, and the London CIV agreed on this issue. A pool may offer segregated mandates for an individual fund but those mandates must be negotiated and managed by the pool company, including the selection of and relationship with successful managers, and the assets lodged with the pool custodian.
What this paves the way for is specific portfolios, such as Japan equities, low carbon, tobacco-free sub funds (or any other such portfolio if London demands these). But this will not result in the scale economies and fee savings that were originally envisaged. These portfolios could be subject to the same unreduced fees, with the pool adding a few basis points for its own costs. As a result, there could be slower asset transition and no savings.
Ultimately, if London CIV goes for extra choice, it must both understand and be prepared to meet and justify the extra cost of either a wider range of sub funds and/or the ability to invest via segregated mandates.
What is clear now is that it is not the role of London CIV to restrict any choice based on its own view of effective investment. It must conform, as far as it can, to the funds’ asset allocation wishes. No one really envies London CIV’s predicament at the moment. The absence of a clear vision, framework and principles agreed by the 32 London boroughs from the outset has contributed to the current quandary.
Model 4: Northern Pool
The Northern Pool will comprise pooling of alternative investments, not listed assets. This solution is unique as a pool in some ways.
West Yorkshire is run very efficiently in-house – it is widely regarded as having the lowest costs in the LGPS – and was vocal in its protests that pooling costs would never be recovered. Greater Manchester has one enormous active mandate with UBS and another passive one with LGIM, while Merseyside is regarded as a specialist internally managed fund, focusing on alternatives. These factors were recognised by the government as a justifiable reason for the pool to move to a more formal pooling structure over a period of time.
Therefore, on this understanding, an FCA company will initially pool and manage the alternative investments only. The expectation is still for Northern to move at some point to a more formal structure but no current timeline has been offered.
Northern has appointed a joint custodian to hold assets of all three funds and provide reporting at pool, fund and portfolio level. It will launch Northern Private Equity Pool (NPEP), a collective private equity fund. It has adopted best practice selection and due diligence practices from the three funds and set up a limited liability partnership, to which all three funds will commit and invest collectively.
Northern’s infrastructure fund, GLIL (originally set up by Greater Manchester and LPFA), has £1.3bn committed and about £500m at work, and is close to obtaining FCA registration, which will open it to participation by other pools and funds.
Model 5: Brunel Pension Partnership
Brunel is set up as a gateway to external business, is FCA-authorised and Mifid II compliant, and will make all manager selections.
Brunel has agreed a range of 22 outcome-focused sub-funds with between one and five fund managers within each sub-fund. Its transition plan is under way, with the passive tender complete and the appointment of the authorised corporate director, who will provide the ACS platform, with the first active equity sub-funds in place by the end of 2018.
State Street has been appointed as administrator to Brunel and custodian for the 10 shareholder client funds, as well as providing performance reporting and risk analytics. Brunel will be fully in charge of the selection of managers that go into the sub-funds. It expects infrastructure allocations to be in excess of 5%.
With the eight pools we have five different models in place. The whole approach could either be seen as costly and complicated, or sensibly not putting all your eggs in one basket for something that has not been done before.
Ultimately, over a 10-year period, there will be a winner or winners out of the eight pools. As an academic study for the global pension fund investment management fraternity, LGPS pooling will be a fascinating case study, both in terms of overall cost reduction and in terms of net costs returns.
The whole approach could either be seen as costly and complicated, or sensibly not putting all your eggs in one basket
One challenge is that the means of cost and return measurement must be established and agreed at the onset, and the Chartered Institute of Public Finance & Accountancy has engaged with stakeholders on this specific issue. With minimal leadership from government, which has always been reluctant to be seen as imposing a central solution, I think the LGPS funds have achieved something extraordinary in terms of the collaborative partnerships formed and the variety of solutions offered. This is especially the case given that some view the Treasury’s lack of any definitive guidance at the outset as indicative of not wanting the LGPS to succeed in the national pooling venture.
In terms of the number of different innovations, at best under the current mix of models we have all the bases covered. At worst, the LGPS community could be accused of creating something a bit Heath Robinson.
With the solutions offered being subject to so much variation, some criticism could plausibly be directed our way. One thing does remain constant though: the spirit of unity, co-operation and collaboration that has remained throughout.
Although we are moving in different directions, we are still connected. In most instances, vision combined with effective leadership has indeed been the key to the advances that have been made. Determine that the thing can, and shall be done, and then we shall find the way.
Phil Triggs, tri-borough director of treasury and pensions, Westminster City Council