How the LGPS is adapting to 'Fit for the Future' rules on principal investment advice

In May this year, the government published its response to the ‘Fit for the Future' consultation. This included the requirement for pools to provide principal investment advice.

Along with the current regulatory consultation, the Local Government Pension Scheme (LGPS) pools and partner funds are waiting for draft guidelines to be published which provide the next level of detail.

But the requirement for pools to provide principal investment advice will have far-reaching implications for pools, partner funds and investment advisors.

LPPI chief investment officer Richard Tomlinson says: "Requiring the pools to be the principal source of investment advice will be a big change for most partner funds but in a decade's time it will likely be seen to be a good decision."

Strategic asset allocation advice

Principal investment advice will take the form of the pool working with partner funds after every triennial valuation and carrying out an asset and liability study. This will give a recommended strategic asset allocation for the pension fund committee.

The process will be informed by the partner fund's current asset allocation and how they arrived at that decision.

LGPS Central chief client and advisory officer Trevor Castledine explains: "It's often the case that the way the current strategic asset allocations have been described is not consistent with the way the government envisages them being described it in the future."

Depending on what advisor local authorities have used in the past, strategic asset allocation statements might look quite different.

"Allocations are often split between growth, protection and income categories, whereas the government template shows the portfolio being divided across nine specified asset building blocks," says Castledine.

Funds will be required to express their strategic asset allocations in this new format quite quickly after the Bill becomes law, he adds.

Building capability

This, together with the requirement to take principal advice from the pool, means that pools will need to be capable of providing this advice pretty much immediately.

"The advice will need to be of the right standard given by properly qualified people supported by the right level of analysis, and subject to rigorous review and quality control," says Castledine.

Principal advice will need to be tailor-made. "Each partner fund will have a different funding level, short-term cashflow requirements and a long-term liability profile."

Developing strategic asset allocation advice will therefore need to be a bespoke process to meet each partner fund individual requirements.

This new role means LGPS pools will need to have the necessary in-house expertise to provide the bespoke advice required by each partner fund.

Castledine says: "LGPS Central is in a strong position. We have several colleagues with consulting backgrounds which enabled us to put together a pragmatic plan for government approval."

Since LGPS Central's plan was approved, the pool has hired or internally transferred people. Castledine adds: "We already have the core capability in place and have just a couple of remaining hires to make to fully staff the team."

In terms of resource, LGPS Central is on track. "We are working on specifying a model needed to support delivery of strategic asset allocation advice and have in interim solution in the meantime," says Castledine.

In July 2024, Border to Coast's partner funds signed off on its 2030 strategy, part of which to build an advisory function. In other words, the pool had already decided to build an advisory function before the current consultation.

Border to Coast head of advisory Peter Gent says that, as the pool runs partner fund money both internally and externally, it already has asset management and research capability in-house which can be leveraged to implement partner funds' strategic asset allocation.

Learning from LPPI

Tomlinson says LPPI is the only pool which has always provided principal investment advice to its partner funds. He says: "We have been through three triennial valuations now and also do an annual health check in between."

The pool has some advice for pools looking to build their own in-house advisory services. "You will need to develop sufficient capabilities to gain a deep understanding of the specific needs of each partner funds," explains Tomlinson.

Each will have unique funding levels, liability profiles and risk appetite. "Each pool will need a clear handle on the risk appetite of each partner fund and how they want to balance this between investment and funding strategy," he adds.

Pools also need to establish transparent governance. "You can't pretend conflict doesn't exist so it's best to acknowledge it and mitigate it effectively," notes Tomlinson.

A long-term commitment to talent and analytic capabilities will also be vital. Tomlinson explains: "Setting the strategy, investment beliefs and overall mandate is critical to long-term investment success – you need the resources to undertake this critical activity."

He adds: "Pools must not treat advisory as a cost centre to minimise but instead view it as a core service. Nor can they offer a one-size fits all approach which undermines partner fund sovereignty. And they must not obscure conflicts of interest through opacity."

Longer term goals

Border to Coast wants to build a strategic advisory function which works alongside its partner funds and is focused on the LGPS's long-term nature and strategic need to save costs to make sure benefits remain affordable, says Gent.

The other advantage of having this strategic advisory function in house is it will allow the pool to align investment strategy with implementation.

Gent explains: "Once all the additional partner funds have joined to take the total to 18, we can generate a consistent approach which will mean we can ensure what we build on the asset management side will link up with the strategic need of those funds."

In other words, the pool will no longer have to second guess what the strategic need is of its partner funds, he adds.

Continued external advice

Pools are waiting for the regulation to see if there are any restrictions or obligations on partner funds to take additional advice.

"We recognise advisory services are very relationship driven and it's difficult to parachute in a new advisor and expect immediate trust," says Castledine.

It would be reasonable to expect some oversight over LGPS Central's advice by the previous advisor at least for a few years until capability has been demonstrated and trust been built, he adds.

The way the consultation has been drafted seems to envisage the role of an independent advisor to provide that challenge.

"Whether the challenge is provided by an existing or a new independent advisor, it can help to enhance the advice we provide," says Castledine.

Gent adds: "The current wording of the consultation says the partner funds can get independent strategic investment advice for ‘exceptional circumstances' although there will need to be guidance on what those might be."

Mercer head of LGPS investment Tony English notes: "I don't see how the government can fully define ‘exceptional circumstances' in the regulation." Ultimately the funds will have a choice to be able to seek external opinion, he adds.

While there might be a transition period, over the long-term the pools will need to provide that principal strategic investment advice, he says.

Not clear cut

But pools believe that requiring administering authorities to take principal investment strategy advice from the pool may have some interesting implications – with Mercer's English noting that the consultation's wording would mean there are a host of other areas where partner funds would need to seek advice.

Responsible investment campaign remains high on the government agenda and climate change will continue to be an area of contention where pools will need advice, he adds.

Pools will continue to develop their capability to provide that advice on climate change, net zero and sustainability. "But it will be up to the funds to decide whom they take that advice from," adds English.

LPPI's Tomlinson agrees: "There is plenty of additional investment advice provided by consultants which goes beyond setting the strategic asset allocation.

"There is likely to be debate about what role an investment consultant can play in helping partner funds to develop, for example, their investment strategy statement and sustainable investment philosophy."

Tomlinson adds that the investment strategy statement will specify their investment beliefs. He says: "This is not a simple task and may benefit from external advice."

He adds that getting this document right is vital to help the pool to ensure it implements the strategic asset allocation correct.

"Defining the complete investment mandate for a pool – including the ISS and sustainability – is not a simple task which could need a heavy consultant input for some," says Tomlinson

Key drivers

Assuming the administering authorities retain their ability to seek external advice outside of the principal investment strategy advice, there are a number of factors which could drive them to make this choice.

First, if the pool's strategy is to only provide that principal investment advice, then the partner funds will need to look elsewhere for additional advice.

Mercer's English says there is also a question around whether the pools will have the bandwidth to deliver this additional investment advice to the partner funds – noting that, with many of the pools currently taking on multiple new partner funds after the dissolution of ACCESS and Brunel, they may already have their hands full.

Charlotte Moore is a freelance journalist

At the end of last month, the government published a technical consultation on the regulations which will provide the detail for the implementation of ‘Fit for the Future' via the Pension Schemes Bill. Interviews for this feature were carried out before the publication of this consultation.