LGPS consultation welcomed but active/passive debate heats up

Local Government Pension Scheme (LGPS) officers breathed a collective sigh of relief as the government ruled out local government pension scheme mergers – but have indicated their opposition to proposals which could end active investment in listed assets.
Late last week, the Department for Communities and Local Government released a long-awaited report by pensions consultancy Hymans Robertson into the future of LGPS investment.
Responding to the report, the department launched a further consultation, but said that asset allocation will remain with the administering authorities, and that the government does not intend to pursue fund mergers for the time being.
Local government minister Brandon Lewis said: “The proposals I am setting out today will help reduce investment costs by £660m a year.”
His figure is based on an analysis by Hymans Roberston which said that moving to passive management of listed assets like bonds and shares could save £230m in investment fees and a further £190m by reducing transaction costs – assuming all funds were to participate.
Michael Johnson, research fellow, Centre for Policy Studies, welcomed the conclusion, saying: “Hymans Robertson has produced robust evidence from the largest data set in Europe that tells me that we don’t need 80 per cent of asset managers.”
But Nick Vickers, head of financial services at Kent County Council, said many councils would resist the idea that they should relinquish the right to choose active management as an option.
Vickers said that Kent has 30 per cent of its assets invested under active management, and that these investments had consistently produced net returns above index levels.
He told Room151: “We are very satisfied by the rejection of mergers but are bewildered by this idea that we should have more passive because if you do, you cut out the value of fund managers.”
Glen Hammons, head of finance at LGSS, the shared services vehicle covering Cambridgeshire and Northamptonshire county councils, said: “It should be down to the individual funds where they want to allocate their resources.”
And Jo Holden, partner at pension adviser Mercer said: “For a lot of clients, a wholesale move to passive is not acceptable.
“One of my clients has an average fund size of £1.2bn over the past three years and active management has delivered £16m per year to the fund over that period above what would have been achieved through passive management. It can be a powerful tool to help deal with fund deficits.”
When asked if local government was likely to accept the move to passive investments as a price worth paying for the removal of the threat of merged funds, Simon George, director of finance and assurance at London Borough of Harrow, said: “I think that really would be like rolling over and having your tummy tickled. If government says we can only put cash into passive management funds then it is only a step away from them telling us what kind of assets we can invest in.”
But Linda Selman, Head of LGPS investments at Hymans Robertson, insisted: “While some funds have performed well others have not.
“In aggregate, considering the funds as one portfolio of assets, in a decade of investing, returns no better than (the) market have been achieved and with higher cost than through passive investment.”
She said that her firm would expect to carry out further research on the role of active management for the LGPS as part of its response to the new consultation.
The Hymans Roberston report also said that a further £240m could be saved through the use of collective investment vehicles (CIVs).
It said that the highest savings would come if the funds were organised through just one CIV for listed assets – mainly bonds and equities – and a second for alternatives, rather than a greater number.
However, the report added: “Concentrating the scheme into two common investment vehicles may increase its exposure to risk. Several public and private sector responses to the call for evidence also stressed that capacity constraints may begin to apply if a fund became too large.”
Vickers said that the administration arrangements of new CIVs would take some thinking through, saying: “We would want to be heavily involved in any CIV. If you have representatives from all councils managing pension funds then you will have something huge.”
Holden agreed: “There will have to be a conversation about if we are having these collective investment vehicles how do we make sure they are efficient in terms of decision making? There may have to be some delegation in the same way that things currently work with fund managers.”
The report added that further fee savings might be possible at a later stage using in-house teams to manage CIVs, rather than external fund managers.
The consultation is open until 11 July 2014. Access it and the Hymans Robertson report here.