Q&A: London CIV – an opening shot in LGPS consolidation

Hugh Grover

Room151 catches up with Hugh Grover, chief executive officer at London LGPS Collective Investment Vehicle. He tells Colin Marrs that the first sub-fund could launch before the end of the year, and that the proposals fit neatly with government thinking on the pooling of LGPS funds.

What is the structure of the CIV and when is it set to launch?

HG: What we are setting up is a fully authorised and regulated Alternative Investment Fund Manager. We will be authorised to operate as any other AIFM and we are currently jumping through all of those hoops with the Financial Conduct Authority.

Below that we are setting up an investment fund structured as an Authorised Contractual Scheme. That is the UK version of a tax transparent fund. There are various tax transparent funds around the world – Luxemburg, Ireland – I think Germany has one now as well. We obviously want to use the UK version because it means local government pension funds will remain domiciled in the UK. If we did it through a foreign version it would look like we were putting LGPS funds offshore which would look slightly odd.

The ACS will act as an umbrella, under which we will set up a whole range of sub-funds.

The AIFM and the ACS are authorised and regulated separately – although both by the FCA. The former’s application went in in the summer. That is going through at the moment and we are responding to their queries. That is normal. The ACS application should be going in the next couple of weeks. My ideal timeline is that we get our first sub fund opened and funded before Christmas.

How will the sub funds operate ? What scale are we talking about at launch?

HG: For launch, we have been looking at where London LGPS funds are currently invested, looking at commonalities. We are talking to those fund managers about what we might do to bring multiple boroughs – which have similar investments with the same fund manager – together in one relationship to drive efficiencies and lower fees.

We are about to go out to all the boroughs informing them of the managers we have finalised conversations with, and  the sub funds we are proposing to set up with those managers, along with the fees we are proposing to put in place.

During the discussions about what launch might look like we have talked to 15 fund managers. Four have come through the process as the ones we are likely to deal with at launch. Initially, we are looking at nine sub funds.

There is likely to be a mixture of passive and active, but in broad terms more passive than active. Initially we thought that passive was easy so we would concentrate on those. However, when we took the lid off that tin we realised there is huge complexity around passive that you wouldn’t expect, relating to indices, weighting and so on. Picking all that apart and constructing it into a sensible package has taken a lot of work. We absolutely will have passive but we will also have at least three sub funds that will be active.

The fund at launch is not going to look very efficient and won’t look complete, but we are setting up a new and unique structure. We have to get structured and get funds launched and structures stress tested and then the sky is the limit.

We are still at the point where the boroughs need to make final decisions about coming across. If all do, we will be just over £6bn by the end of launch phase.

How liquid will the sub-funds be?

HG: In principle it will be as liquid as anything might be at the moment. Across the fund it will be easy to move from one sub fund to another. There may be less liquid funds. If initially half a dozen invest and then one wants to withdraw, we might be able to replace them with another borough. If one wants to withdraw and nobody wants to top it up, that is a different position. We would have to think through whether penalties for withdrawal would be necessary to protect the other investors. To some degree none of that is new. We will be a fund manager the same as any other – that involves knowing our customers and treating them fairly.

What are the incentives for boroughs to move investments into the CIV?

HG: Fund managers tend to charge on an ad valorem basis – if you give them a little bit, you pay a higher fee – give them a lot and they charge a lower fee. So what we are doing is taking a group of boroughs which are each investing a relatively small amount and often paying the highest fee level. We are bringing those together and aggregating, meaning you start falling down the ad velorum fee scale.

Because of the difference in the deals they are currently on, some boroughs will see significant savings, others will see less. However, all boroughs will at least see a small saving – why would they ever pay more for something they have currently got?

London boroughs currently have around 90 fund managers they deal with. I can’t imagine a scenario where the CIV will have 90 managers.

What is in it for the fund managers then?

HG: A number of things. Firstly, the manager will move from having multiple relationships to service to just one. The CIV will become their sole client, so there is some level of saving for them there. They only have to report once.

In addition, many of the managers recognise there is a step change going on across the LGPS in terms of looking for ways to drive down cost. Many of the managers have realised what we are doing in London is likely to be the first of a number of moves to similar structures. Even before the government came out and effectively insisted that the LGPS worked more collaboratively, a number of fund managers saw the writing on the wall; that what we were doing in London was real and tangible and would be delivered and London would exert the power of scale. A number saw that was likely to move on further. When they are looking at the mandates they are not just thinking about these mandates today but the longer term opportunities

Will you open up the CIV to other LGPS funds?

HG: As an ACS, we have to be open to any qualified investor. They have to be a professional investor in order to be able to come in. In principle that means we are open to the entirety of professional investors, be it private or public sector. We are focusing on the London LGPS at the outset but we will be a full fund manager.

We have already had approaches from other LGPS funds. At the moment, when I am approached I am meeting with them and make sure they properly understand what we are doing. If they want to use us as part of their response to where the government is going, then that is fine – it is a decision within your authority to take.

Do the rumours that the government will be looking for LGPS pools of around £25bn-£30bn complicate matters?

HG: Nothing that I have seen or heard so far in terms of where the government might be going has changed what we are doing. I haven’t done the maths recently about the full scale of London assets is between £25bn and £30bn.

What is the post-plan launch? How will you grow the CIV?

HG: We have a group – I was going to say small but it isn’t that small – of section 151 officers and pension fund managers from across London boroughs. It will meet for the first time shortly and will be engaging with colleagues across all other boroughs to think about how we might want to grow the fund over time. For example – what sub funds would they want opened and in what order? We can’t do everything at the same time.

When we launch we won’t have any fixed income sub funds but it is likely boroughs will want to open some fairly swiftly. The group will consider, for example, whether that or a private equity fund is the priority. We then have to go through normal processes to consider what that sub fund might look like, which manager might run it for us and put each sub fund to the FCA for authorisation and then open it and fund it. That process will happen over the next 18 months to two years. It is an ongoing cycle. Inevitably over time some will close and others open.

It will be more challenging in this stage when there are fewer commonalities between existing investments. Without wishing to sound too trite challenges are there to be overcome. We will have to continue to put together compelling economic packages for the boroughs. It is going to be incumbent on us to put together attractive packages. If we can’t do that then I guess the boroughs won’t move. That is fine. It puts us under pressure to be efficient and negotiate good deals. We will continue to do that over time.

It is difficult to put definite numbers on any of this but our business plan in the application to the FCA is simply as broad as £5bn by the end of this financial year, £10bn by the end of next financial year and £15bn by the following financial year. If all the boroughs are sufficiently reassured and become enthusiastic investors we will overshoot the targets – but the opposite also applies.

Will you eventually move to in-house management of funds?

HG: A number of people have been saying all the London CIV is doing joint procurement and handing out to other fund managers and that is all it is going to do. However, we are delegating out to other fund managers at the outset because it is the quickest way to get to launch and get systems and processes in place. But we will be authorised to do in house management if we chose to do it in future. I am not saying we are definitely going to do in house fund management – but don’t think that just because we are adopting a delegated structure at launch that we are not able to it. We absolutely are.