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Our greatest enemy is uncertainty

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Although the tribulations within the Local Government Pension Scheme are significant, given its importance to the millions who depend on it, they are overshadowed by other current affairs.

Meeting at Celtic Manor, so soon after the NATO Summit gathers there, underscores the impact of geopolitics on pension funds.

Pension funds’ success relies greatly on global stability, political certainty and economic growth. The balance between success and failure remains poised and delicate, particularly given the adverse implications for national economies of sanctions being imposed in response to international tensions and border disputes. Uncertainty remains the principal enemy of successful investments.

 

UK politics

The relevance of this unsettling scenario to the LGPS is keenly obvious to those who gather at the LGC Investment Summit but it would be far from the minds of those so-called pension experts who think they know what is right for the scheme, who are anxious to impose unproven, poorly-judged policies on a highly successful, locally-managed income generator.

For each area of policy reform, every government has its core priorities. The coalition’s priorities for the LGPS appear to be based on savings, fairness and viability. This is not a million miles from the LGPS policy mantra, introduced in 2006 by the previous administration, of affordability, sustainability and fairness.

But lately matters have gotten out of hand. One key element has become too dominant over the others, which have been erroneously diminished by the political priorities of the moment: the savings objective is now being zealously pursued from the centre. This new approach sadly contrasts with the hitherto balanced, bespoke, holistic policy-making role of the responsible department, working closely and wisely with core stakeholders.

 

Centralisation

Lord Melbourne’s acute observation, “God help the minister that meddles with art”, could very easily be transposed to the recent experience of the cumbersome ministerial handlings of the LGPS in England and Wales. The past twelve months have seen a mixture of the reasonably acceptable, such as most elements of the 2014 benefit structure; the bad, for example, the confusion of policy around structural reform leading finally to a radical push-back; and the downright ugly. By this I mean the use of optimistic and untested consultants’ survey findings to justify a potential centralisation of investment decisions to save very modest sums. This is hardly re-assuring evidence based-policy making.

Lord Hutton’s past actions have sparked some reasonable and long-espoused reform elements across public service pension schemes’ benefit structures. These gains, however, are set against a most unhappy complicity with the Coalition to achieve a greater degree of LGPS centralisation and the establishment, through the 2013 Act, of unnecessary levels of expensive and potentially damaging so-called governance. Some believe these have the aim of diluting DCLG management of the LGPS and local political stewardship of LGPS fund authorities.

This could threaten scheme solidarity and local democratic control; witness the LGA-led Scheme Advisory Board’s visible ambition for powers over the LGPS beyond its statutory station, heavily influenced by the trade unions and their quest for so-called democratic control of pension funds. This scenario now seems to have been grasped belatedly by the scheme in an Emperor’s new clothes moment. The DCLG will hopefully provide a clear and unequivocal response to these tensions when it delivers the final governance regulations, due to be operational from April 2015.

The centralist intentions within Whitehall will, I hope, be curtailed by superior rational argument from those in the LGPS who truly know what they are talking about. For the past two years the radical, academic theorists have held sway, with ministers eager to claim savings to catch the eye of those sections of the press that enjoy knocking the public sector. The opportunity now exists to conclude sensible adjustments to the reform programme and to prepare for the certainty of the 2016 valuation exercise and its undoubted challenging outcomes.

 

DCLG consultation

Looking back to the once again very successful LGC Pension Fund Symposium held in June, generously supported by Permal as the main sponsor, presentations and discussions continued to focus on the future structure of the scheme. There was much criticism of the wasted opportunity to update the investment regulations in place of seeking very modest savings, at the expense of huge upheaval of extant mandates. Central government inference with locally determined investment strategies was also bemoaned. The delicate relationship between these and the coalface deficit management, as determined by elected councillors, was also a hot topic. Many wondered if the government would take responsibility for any consequent losses if ministers introduced more radical options for investment reform.

The DCLG consultation on opportunities for collaboration, cost savings and efficiencies produced a vociferous response from the investment industry and from individual LGPS pension fund authorities. The suite of options, set out in a generally constructive document, seem guaranteed to create a united front from the sensible wing of the scheme. There has been a severe disappointment across the sector with the Coalition’s concentration on cost reduction, at the expense of democratic accountability and local choice of investment strategies as currently is the case and which the vast majority of scheme interests believe should continue alongside improvements in better, locally driven governance.

Once again, ministers and their advisers appear to misunderstand the symbiotic relationship between individual fund deficit management, locally chosen investment strategies and each funds’ triennial valuation exercise and the importance, particularly to council tax payers, of bespoke, locally agreed pension fund deficit recovery plans. The liabilities of the LGPS are local ones, unlike the funded centrally managed schemes which are national ones.

Ministers’ failure to further comprehend that the 89 separate LGPS fund authorities, unlike private sector funded schemes, are not required to be 100% funded, remains a mystery. Solvency in the LGPC is clearly defined in the regulations as it applies to each individual administering authority. There is no risk to pension payments where an LGPS fund is not actuarially certified as being 100% funded. Whatever the funding level, pensions are guaranteed. Payments do not hinge either on the existence of a pension fund. They are guaranteed by statute, rather than the funding level of each LGPS fund. The scheme is not party to arrangements around the Pension Protection Fund, nor affected by the strictures rightly imposed by The Pensions Regulator on private sector, funded occupational schemes for all these reasons.

 

Passive vs active

When considering the benefits of active and passive assets, many fund managers and others cited, in in their responses to the May consultation, their record of delivery and return and supported the fourth option in the document. Rather than forcing funds to invest some or all of their portfolio in passive, or demanding they ‘comply or explain’ with a passive approach, this option would require them to “consider the benefits of passively managed listed assets”; a sensible approach which places the substantive decisions with the relevant pension fund authority.

Indeed, the Hyman’s Roberson report, somewhat coyly, sets out ground rules which the government would do well to quickly develop. Based on Hymans Robertson’s assessments of the successful and good active management by LGPS fund authorities, the following characteristics were identified:

  • A limited number of managers were appointed
  • Managers were retained for long periods
  • Simple investment strategies were adopted [equities, bonds and property]
  • Limited use made of alternatives
  • Some use of internal management arrangements

The essence underpinning these high performing authorities is good quality, authoritative governance. The Hutton changes are not applicable here, even if their ethos can be applied. This is not about representation and nor should it concern the trade unions. It is about the betterment of the professional and technical management of the investment process at local level and, as fund managers have argued, the greater use of experienced, independent advisors. Too modest a level of high quality governance is evident across the scheme. There are pockets of excellence, a variable middle core of achievement and a small number of under-resourced examples of low quality governance. The priority here, led by government and with the help of the treasurers’ societies, CIPFA and the DCLG investment review group, must be to mastermind a new statutory framework for investment governance, as part of the next phases of reforms. This could be done in parallel with the long awaited update of the regulations themselves.

The challenges now for fund authorities, their elected members, officers, advisers and fund managers, are massive. Their stewardship, governance, judgement and professional skills will be tested to the maximum once again and, equally as demanding, they must potentially deal with the ambitions of new ministers after the general election next year.

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