Colin Pratt: The evolution of investment management in the LGPS

Colin Pratt is leaving his post at Leiciestershire County Council’s pension fund for a position with Central LGPS. He looks back at the evolution of investment management.

At the beginning of May I will be leaving Leicestershire County Council after over 32 years within the investments section. In line with a significant number of others that have worked at individual funds for many years, I will be joining one of the eight investment pools – the ‘dark side’ as some of my colleagues would have me believe.

It is a new and exciting challenge for me personally, and a time of significant change within the sector that I believe will achieve big benefits for funds. I am acutely aware, however, that my optimism for the future is not shared by everybody within the LGPS world.

There are quite a few that can lay claim to an even longer career within LGPS investments, but the move that I am making provides me with an ideal opportunity to look back and think about how things have changed over my years at Leicestershire.

Yesteryears

To be perfectly honest, what I see now is almost unrecognisable from what I entered as a young lad and, from my perspective, it is an almost universally good thing.

We tend to look back on our yesteryears and remember the good things with an undue fondness (if pogo sticks and Sherbert dips were so good, why don’t you see them now?), whilst conveniently forgetting things like bread shortages, three-day weeks and power cuts.

Get the LGPS Quarterly Briefing

The memories of my early years within the LGPS (I began in 1985) probably suffer from exactly the opposite; an unreasonable and irrational embarrassment about how unsophisticated we were. The saving grace is that I can justify this unsophistication very easily — it wasn’t our fault, as nobody really knew any better.

Back at that time the standard way of managing assets was to appoint two, or more, “balanced” managers (now called multi-asset class, so even the names have improved) and to ask them to outperform the average local authority pension fund.

By default, half of them failed and they were generally sacked after a few years of underperfomance, to be replaced by those that had outperformed, who then went through a period of underperformance because we hadn’t yet fully grasped that performance is cyclical.

Then the whole thing started all over again. Managers went from hero to zero, and back again, but relatively few funds stood back and supported managers when they hit bad times that were a direct consequence of their investment style. I believe that the tendency to panic after a few years of poor performance has now reduced significantly, and will reduce further in a pooled world.

And who set the asset allocation when I began my career? It was rarely set by a fund, and, as managers were judged on performance relative to other LGPS funds, they became fixated on where everybody else was invested and set their asset allocations accordingly.

By and large, a manager didn’t get the sack for being unwilling to take views — despite the fact that their performance was almost guaranteed to be average — but risked being fired for taking views that were wrong (or, often, too early).

Hence closet tracking of the (asset allocation) index was born — and clients generally sat back and allowed the lack of courage among managers happen, because we didn’t have the expertise, or willingness, to challenge them.

Specialisms

In the mid-90s, and following a period of disappointing performance by many balanced managers, specialism came on the agenda.

It was obvious that not all managers could be good at investment within every asset class — something that had slipped our collective notice for years — and the way to avoid this was to appoint expert managers to individual asset classes, or so the theory went.

This came with a requirement for a fund to decide its own asset allocation and although for many years there was a tendency by many to hug the average, it was a seminal moment in the evolution of the LGPS.

An asset allocation benchmark that meets the risk/return profile that an individual fund wants, or needs, rather being just an amalgam of what everybody else happens to be doing, must be the most sensible way of investing? Specialist management generally came at a substantial extra cost, but this cost would surely be worth it because of the additional performance that would be generated?

Sometimes it was worth it, most times it probably wasn’t, and on many occasions disappointment came as a result of closet indexation within stock selection — an unwillingness by managers to take sufficiently strong positions to give a reasonable possibility of achieving sometimes challenging performance objectives.

The LGPS now has the tools and expertise to challenge managers on positioning within their portfolios, but there is no doubt that some managers are still more interested in protecting their commercial position and not getting the sack. Pooling will flush this out for good.

Loving cousins

Recent years have seen a massive improvement in the professionalism of the LGPS: We understand more about investment, and know our own requirements far more than we have ever done in the past. And we have embraced asset classes such as infrastructure and private debt because we recognise that they can give us things which more traditional forms of asset cannot; we do not buy them just because a manager or consultant says they are good.

I strongly believe that pooling will strengthen funds significantly in the long-term, despite the loss of key individuals that some will suffer as a result.

Pools will be a tremendous resource for funds to seek advice from or bounce ideas off, and pools should be willing to gently challenge the rationale behind the investments of their partner funds.

Just because something has always been done a certain way does not mean that it is optimal. Funds and pools should have more than a client and provider relationship; they should be loving cousins looking after each other’s interests at all times.

Not knowing any better is not an excuse that we can use in the future.

Colin Pratt is investment manager at Leicestershire County Council Pension Fund. He joins LGPS Central as investment director, manager of managers and total return.