As a transparency code is launched for the Local Government Pension Scheme, Stephanie Baxter looks at how it could set a gold standard across the industry.
In recent years the Local Government Pension Scheme (LGPS) has come under a lot of scrutiny for not having a complete picture of what it pays asset managers.
Like the whole UK pension sector, a world of low returns, regulatory pressures and breakdown of trust in finance have forced the scheme to sit up and take notice. As the only funded public sector defined benefit (DB) scheme, the LGPS must prove to local taxpayers it is cost efficient.
Last week the LGPS Scheme Advisory Board (SAB) made a big leap by launching a transparency code to help funds get a better handle on investment costs. The code, which asset managers can voluntarily sign up to, will help funds get necessary data to report costs transparently, after encountering difficulties.
The template that underpins the code is a data collection spreadsheet, which was developed by Dr Chris Sier and negotiated with the asset management trade body, the Investment Association (IA), and piloted with the West Midlands Pension Fund (WMPF).
The template, which will show costs in pounds and pence, stems from a proposal set out in a 2015 paper written by Sier for the Financial Services Consumer Panel, which was based on the Dutch cost disclosure model.
Managers that sign up to the code will demonstrate their commitment to transparent cost reporting, will be listed on the SAB's website and will be able to use the logo on marketing literature.
This is significant for private sector pensions too, because the IA is developing a very similar code of transparency and template, also based on Sier's proposal, for the wider sector.
It has been a long battle for Colin Meech, Unison national officer for capital stewardship, who first raised concerns about opaque costs across the LGPS several years ago.
"I'm pleased the mantra that ‘costs don't matter, performance does', has fallen off the edge of the cliff of the Flat Earth Society. We're now in a different ball game where costs are recognised as an issue," he says.
"Having personally put it on the agenda in the first place and endured mass resistance from asset managers, local authorities, accountants, and treasurers in the meetings of the SAB sub-committees, I'm very pleased that sense has prevailed."
Part of the reason for the resistance was to avoid embarrassment and accusations over why it was allowed to happen over decades, he notes.
WMPF, which played a important part in the code's development, has been leading the way on cost transparency in the LGPS.
The fund's chief investment officer Jason Fletcher says it has been worth the effort: "When you understand your costs, you can manage them properly. We're better investors for knowing what our costs are, and can negotiate our costs down from having greater transparency. It's difficult to ask your manager for a cost cut if you don't know what you're paying. Full cost transparency also helps to build a trusting relationship with your asset manager."
Will it catch on?
Getting the different parties to agree on the template has been dubbed a huge achievement in clearing the path towards full transparency.
As Fletcher says, "Having both investors and asset managers collaborating on the template is really positive, and I prefer this route rather than being forced from above, which hasn't always worked well in other markets where the government has regulated cost templates. This is the route we should be taking. It's important to collaborate and have a meeting of minds to avoid people going in different directions."
There are concerns the code's voluntary status will limit how far it will be adopted - although the Dutch waited around four years before making theirs compulsory. This is partly due to all parties acknowledging the template will likely develop over time.
Meech says "we've now got a stick with the carrot", and "we'll create merry hell at a local level."
"We're preparing all our board members and branches to interrogate each fund over what it is doing or not doing," he adds.
Local Government Association head of pensions Jeff Houston, who was also involved in the project, is hopeful the code will catch on: "If in 12 months' time asset managers haven't signed up to it, then don't be surprised to be asked why. If you haven't got a good answer, then why should we use you?"
Some managers will need time to develop or change internal systems to make the data available in the required way. But after 12 months of making ‘best efforts', they need to be doing it properly, says Houston.
It is hoped over time the code will lead to better alignment of interests between pension funds and asset managers. Of course, much of this is being driven by regulation across the whole industry, with the threat of hard rules if managers do not play ball. Meanwhile, pooling will almost certainly create winners and losers out of managers.
"The balance of power is changing," says Houston. "We have an advantage in the LGPS as we're pooling, so asset managers have an interest in ensuring they're in the ball park to get the business of the pools."
The next stage
Importantly, the code is just the start of a much longer journey for the LGPS. Once the funds receive costs in a standardised format, the next stage is what they actually do with the data, which will require a whole other level of analysis for which some funds may not have the resource.
Houston says: "We can get to a position where managers send the template, but have a situation where, for whatever reason - such as lack of resource - templates just sit on desks."
So, the SAB is now considering whether the LGPS can jointly procure something that can do multi-level analysis which could be beneficial for all. It is looking at another proposal put forward by Sier: a cost data collection utility to collate and check the data for the LGPS funds. It would be independent, not-for-profit, and be workable for both asset managers and pension funds, by avoiding benchmarking and ensure accuracy and confidentiality of data.
Schemes could get the data in the format they require rather than struggling with masses of complex data, without having to hire or train staff. Meanwhile, managers would be rewarded for reporting their costs transparently by receiving a kite-mark or standard.
Sier explains: "The aim is not to do peer-to-peer, one-on-one benchmarks as this is not popular with any of the stakeholders. What is seen as acceptable is to build industry standards for cost - mean, range and standard deviation by market or strategy, perhaps.
"The important thing to remember is that cost alone is not the answer. But cost in the context of performance and risk. These are the more subtle measures for value for money."
He believes it is important to change the industry without completely destroying the current structure.
"We need to work within the structure," he says. "Part of that is finding a way for people to change willingly rather than unwillingly. People understand there's a problem; now we just need to get them to change."
The SAB will look again at Sier's proposal at the end of May, ahead of a June meeting when the board will tie down exactly what it wants.
While it is still early days, the LGPS with £217bn total assets now has a big opportunity to be part of something truly innovative that could end up being adopted across the wider marketplace.
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