Adding up the numbers

Written By: Matthew Craig Industry Specialist

If all goes well, in less than 12 months from now, eight new asset pools will take on the task of managing approximately £200 billion in pension fund assets, currently run by 90-odd local government pension scheme (LGPS) funds in England, Wales and Northern Ireland.

While the constituent members of the asset pools have been known for some time, and the asset pools have now been approved by central government, much needs to be done to turn plans into reality. Colin Pratt, investments manager at Leicestershire County Council and communications workstream manager for LGPS Central, commented: “April 1, 2018, might seem a long way off, but when you understand what needs to be done, it is not. We have decided where the pool will be based and staffing issues are now being addressed. We have to appoint a CEO, CFO, and CIO, for example, so we will be advertising for a CEO in the near future, as he or she needs to be in place by the end of June, in order to get FCA registration and authorisation completed in time. There are some long lead-in times for getting people authorised and meeting the FCA regulatory requirements, and there are not many people who have done this before and can advise on it.”

Merseyside Pension Fund is part of the £35 billion Northern pool, along with West Yorkshire and Greater Manchester pension funds, and Merseyside’s head of investment, Peter Wallach, commented: “This logistical elements are the most challenging aspect of pooling at present. We are not co-locating investment teams, so we don’t have to deal with that as an issue. Operationally, we are working together and getting all the necessary arrangements in place, but the timescale is very tight.”

When the asset pooling process began, central government originally wanted to see around six super-sized LGPS funds with £25 billion in assets each. However, eight asset pools are now on course for launch in 2018, with the size by assets varying from £13 billion to £36 billion. The two smallest asset pools are currently at around £13 billion in size; the Welsh LGPS funds and the Local Pensions Partnership (LPP). Among the other asset pools, the London CIV currently has £25 billion in underlying assets and the Brunel group around £23 billion, while the Central, Access, Northern and Border to Coast asset pools have between £34 billion to £36 billion in assets each. One obvious benefit of having fewer, bigger pools for LGPS assets is that the pools are expected to make significant savings through economies of scale and greater bargaining power. This is starting to happen according to various reports. Pratt commented: “Previously, managers could be appointed by 89 LGPS funds in England and Wales, so they could keep their fees quite high, safe in the knowledge that someone would appoint them. But if they want to be involved in the LGPS sector in the future, there are only going to be eight pools. Portfolios will be bigger, with economies of scale, and managers will have far fewer people to sell to in the LGPS. Managers will have to decide if they want to play in this area or not, and accept that fees will be lower in future.” Wallach has a similar perspective, saying: “We are very much aware of the way that LGPS asset pooling is driving down external manager fees, and we are proactively having conversations with our existing asset managers. They are aware of the need to be competitive.”

When it comes to saving money through lower manager fees, an obvious win is for the new asset pools to combine any investments with existing passive equity managers, as this is a commodity business. Legal & General Investment Management (LGIM), BlackRock and State Street Global Advisors (SSGA) have all been involved here, even if some of this predates the asset pooling exercise. For example, the London Borough of Hillingdon moved a £215 million mandate from SSGA to LGIM in October 2016. LGIM is understood to be one of the largest external managers for LGPS funds, with over £40 billion in assets under management. Adam Willis, LGIM’s head of index & multi-asset distribution, commented at the time of the Hillingdon win: “Our understanding of the specific challenges facing the local authority sector means we are able to use our scale and expertise to offer low cost investment solutions that meet our clients’ needs.” LGIM was also appointed by a group of Midlands LGPS funds in 2015 for a £6.5 billion joint mandate, while the Welsh LGPS grouping appointed BlackRock for a £2.8 billion mandate, replacing LGIM and SSGA. By pooling passive equity assets, very low fees are understood to have obtained, particularly from managers keen to stay in the local authority market.

Getting a clear picture on investment costs is notoriously difficult, so understanding how much asset pooling saves in total is not easy. As part of their asset pooling submissions, the new pools submitted detailed proposals to the UK government, which compared their investment fees as per their annual reports, with their true costs of investment on a fully transparent basis. For the LGPS Central pool, the eight Midlands funds showed £168.2 million in investment costs in their annual reports, compared to £196 million on a fully transparent cost basis. Pratt explains this difference as follows: “If you go back a number of years, all that was reported in the annual report was the physical payment made to investment managers, effectively for quarterly invoiced amounts. That was the historic way of measuring investment management fees, and 20 years ago it was probably relevant, as the vast majority of fees were paid that way. But in recent years there has been a move away from large segregated mandates to more specialist mandates, with more pooled investment vehicles used. For many of these, fees are deducted from the unit value used in the pooled fund, rather than fees being invoiced to investors.”

Compared to the other LGPS pools, the Northern pool is focusing more on alternative assets, rather than listed equities or bonds. Wallach said: “In the short-term, we are concentrating on where we can get the biggest bang for our buck, which is in alternatives. I think that’s different from the other pools, which tend to be looking at listed assets first. We are not ignoring fixed income and equities, as we will continue to re-tender and drive costs down, but our main focus is on alternatives.” Wallach explained that in alternatives, the three funds working together can do things differently. “In private equity, the fact an investor is writing larger deal tickets doesn’t particularly reduce costs, but we can reduce costs by investing less in fund-of-funds and more through co-investments. By having three funds working together, it provides greater resources and will enable us to invest more in co-investments than previously. It is more about investing differently, than investing in something different.”

The three Northern pool funds are also working together on infrastructure investing, through the GLIL (GMPF and LPFA Infrastructure LLP). Wallach said: “Collectively, we have committed £1.3 billion to GLIL and at the moment £207 million is at work, with more likely to be committed, as there are a number of opportunities in the pipeline.” He added that GLIL is open to other investors: “It is very much our ambition to widen its appeal to other investors, who want to invest in a similar way to us. It is not run as a profit centre, we merely recover costs, and it is our intention to maintain this arrangement, making it a cost-effective way for other funds to invest in infrastructure, if they so choose.”

As part of their detailed submissions, the new asset pools have also given details of their estimated set-up costs. This shows that even if external manager fees are reduced, the new asset pools face significant set-up costs. For the LGPS Central, the estimated cost savings are expected to exceed the estimated set-up costs in 2025-26, as its investment expenses fall from an estimated £181.1 million in 2017-18 to £152.2 million in 2032-33. Pratt commented: “While I expect to see very significant savings in investment fees, there will also be significant set-up costs in creating the new pool, with an investment and management team, and making it an authorised financial institution, which will be offset against the savings. There will also be costs of running the pool as an FCA authorised investor, which are not currently incurred by any of the individual funds, and which will also eat into any investment management fee savings. Ultimately, we will be able to see how the set-up costs compare to the investment cost savings in five years’ time, and I think the savings will prove to be meaningful.”