Natasha Browne examines the industry's response to the government's consultation on LGPS funds
Funds of the Local Government Pension Scheme (LGPS) may be compelled to use passive management under proposals from the Department for Communities and Local Government (DCLG).
In its consultation- Local Government Pension Scheme: Opportunities for collaboration, cost savings and efficiencies - DCLG estimated the move to passive fund management of all listed assets would save £420m per year.
It would be accessed through common investment vehicles (CIVs) and is predicted to cut investment fees by £230m and transaction costs by £190m. The switch away from funds of funds in favour of CIVs would produce additional savings of £240m.
The government wants to avoid hurting investment returns, and said the move could be achieved by using a ‘comply or explain' approach, or by requiring funds to invest a specified proportion of their listed assets passively. Alternatively, funds could be expected to merely consider the advantages of this approach.
Aon Hewitt principal Dave Lyons thinks ‘comply or explain' is as far as the government should go in making passive investment mandatory for the LGPS' 89 funds.
He says: "The LGPS is about £180bn of assets and illicit assets are probably about 90% across equities and bonds. Clearly, moving that proportion of assets out of active management into passive management would be a huge undertaking. It would be a phenomenal decision if the government were to conclude that would be the best way forward.
"If we can improve the average by lifting the lower performing funds up to better performance then that's a better outcome for the LGPS than forcing everybody down to the passive average. If you look at the fee savings that were identified in the report to DCLG they're really a drop in the ocean when it comes to improving or repairing the deficit that exists within LGPS."
Figures from the National Association of Pension Funds (NAPF) suggest the LGPS deficit is £47bn. Lyons believes active management and outperformance of assets would have a quicker and greater impact on this than the fee savings achieved by shifting all funds into a passive approach.
JLT Employee Benefits director John Finch backs the suggestion that LGPS funds could manage their own active allocation. He says: "The 89 English and Welsh schemes are not, in all regards, the same in terms of their liabilities profiles. You need to take that down to a more local level because it is the local elected members who have a responsibility to the electorate to manage those affairs. If you put it into one amorphous mass then you lose accountability. We don't see the value in that proposition."
He also warns of losses driven by a switch from active to passive. He says: "We don't think the big wholesale move to passive will achieve best value for members; it might make it low cost but the loss of performance doesn't make it best value.
"We also think that there is a lot more collaborative work going on between authorities to reduce costs. We've seen that in the work that the southwest has done with its framework agreement, and the national framework agreement that's coming in."
Axa IM local authority business development manager Tracey Milner (pictured) argues the government should concentrate on trying to replicate the behaviours of funds with successful active management, rather than forcing all funds down the passive route. She says: "In our view a ‘comply or explain' policy implies that any solution that is different from the default passive management and CIVs is an exception. A fund that is making investment decisions based on their own individual needs and objectives should not be treated as an exception.
"Low cost is not always the best cost. Costs should not be assessed in isolation from the value that is being delivered. If anything, a ‘comply or explain' policy should focus on the objective of achieving value for money and not a prescribed solution for how the value should be achieved. Value for money can be measured in numerous ways, but will likely consider long-term returns net of fees and risk management."
Blackrock head of UK local authorities Chris Head favours a combination of active and passive management, alongside exposure to alternative assets, for funds to meet their targets. He says: "We therefore believe that de facto mandating a move to passive strategies for all funds simply on the basis of cost would not be in the members' interests and would be counterproductive in the long term.
"We suggest substitutes to managing the cost of active and alternative strategies without reducing investment choice. We believe this can be achieved in a simpler manner than establishing national common investment vehicles (CIVs) where no current governance structures exist to support such structures. We are, however, supportive of regional efforts to back the creation of CIVs with an appropriate governance structure where investment aims have been agreed."
London Pension Funds Authority deputy chairman Sir Merrick Cockell agrees with the move for reform but was against prescribing "a narrow solution". He supports an Asset and Liability Management (ALM) Partnership model to reduce costs, and thinks this would give direct access to infrastructure and housing to better match liabilities. He says: "This would increase the chance of maintaining stable contributions and eliminate deficits over time. Our model can happen within existing legislation and we are already working with like-minded funds to develop a partnership."
The LGPS is one of the largest funded pension schemes in Europe with assets of £178bn. It has a total of 4.68 million active, deferred and pensioner members.
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