The Lancashire County Pension Fund Committee and the London Pensions Fund Authority Board (LPFA) have pooled combined assets of £10bn with the aim of saving at least £32m in costs.
The announcement today concludes talks that began in December to set up an asset liability management partnership to boost performance and cut costs, including on administration.
The pension service organisation will be initially known as Lancashire and London Pensions Partnership (LLPP) and is expected to be up and running by 1 April 2016.
It will provide jointly managed administration and pooled asset and liability management activities through newly created corporate structures while maintaining the funds' local accountability.
LPFA chief executive Susan Martin told PP: "We believe that achieving scale through bringing our in-house resources together we can deliver improved performance, good returns, as well as improvements in fund service for customers so we can reduce the deficit."
Partnerships between funds are increasingly popular particularly in the local government pension scheme which is under immense pressure to reduce costs.
The partnership is expected to save LPFA and Lancashire more than £32m in combined costs within five years according to calculations at a high level, said Martin.
The funds had put together a high level business case including a five-year financial review to identify any red flags. The figure has come partly from looking at the savings from managing investment in-house as well as the potential savings from combining resources.
Martin said: "We can go to our current fund manager partners and ask ‘what fees would you charge for a combined approach, and can you sharpen your pencils considerably?'."
She said further improvements and savings are expected, which will come out of the detailed five-year business plan which is the funds' next stage.
Over the summer they will put together an application to the Financial Conduct Authority for authorisation of the investment pool and the entity that will run it.
They will also look to recruit a team of non-executives for the new entities including a chair and three independent directors.
While attracting talent in-house from the private sector can be challenging, Lancashire County Pension Fund director George Graham told PP that "given this is a unique proposition, we would attract high quality candidates".
He added that it was about "quality of life" and "not always about the money".
"We are never going to be paying people a £1m basic salary and £1m bonus. But if people want to do something that's worthwhile in its own right and that has a value, and work in an environment that's open to new ideas and ways of investing," he said.
The funds' longer-term vision is to make this into a £30bn-£40bn pension service organisation which could include other LGPS funds.
Graham said the partnership must firstly be operational, however, as adding more views into the mix at this stage "would be difficult".
He said: "At the point we're operational we'll be very happy to talk to other funds. At that stage if other funds want to come on board, the structures we're creating are designed to facilitate that if they want to."
He pointed out that both LPFA and Lancashire already provide services such as pensions administration to other funds and "would hope those funds would come with us on this journey".
The schemes looked at funds in Canada, Australia, the Netherlands, and Sweden when planning the partnership.
Graham and Martin said they both liked Dutch investment fund PGGM because of its customer-focused and shareholder-orientated approach as well as its mixture of public and private sector ethos.
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