The review focuses on three areas;
1. Asset pooling
- Administering Authorities (AAs) to be required to fully delegate investment strategy implementation to their pools;
- AAs would be required to take ‘principal advice’ on investment strategy from the pool;
- Pools are to develop internal investment management capabilities and be regulated and authorised by the Financial Conduct Authority (“FCA”); and
- All AA assets to be transferred to the management of the pool.
2. Governance
- AAs will be required to prepare a governance and training strategy;
- AAs will be required to identify a senior LGPS officer with overall responsibility for management and administration of the fund; and
- AAs are to participate in a biennial independent governance review.
3. Local Investment
- AAs need to formalise their objectives and target allocation to local investments;
- Local investment plans will need to be developed with AAs to identify and put forward suitable investment opportunities;
- Pools will assess and manage local investment opportunities
The whole exercise is structured towards a centralised control of LGPS asset allocation. How this will impact investment returns, only time will tell, but there is a possibility it could cause tensions between optimising portfolio efficiency and prioritising locally based investments.
Aligning with European pension models
It’s clear that the proposals draw some alignment with other consolidation frameworks, such as the likes of the industry wide pension schemes that have developed within Europe. Whilst comparisons can be made at a high level, there are some distinct differences laid out in the detail which need addressing to make the model sustainable so that the independence and effectiveness of the AAs are maintained into the future. The need for independent advice and oversight is an obvious start, to ensure accountability is clear and investment decisions are truly value-additive.
The proposed model may weaken AA control and ownership. However, further clarification is needed on whether an AAs fiduciary duty is met by setting high level objectives and delegating implementation, a concern shared by LGPS Scheme Advisory Board (“SAB”) in their response to the consultation.
The role of investment advice and potential conflicts
One of the biggest proposed changes, is that pools will be required to provide ‘principal advice’ on investment strategy to AAs, which may create a conflict of interest, unless appropriate independent advice and oversight is sought. AAs should be able to set their own asset allocation based on independent advice, and if there are any discrepancies, it should be the responsibility of the AA to decide the outcome. Notably, most experience and skill within strategic and dynamic asset allocation lies within the private sector.
We think that the advice from pools should not be the only perspective available to AAs; independent, professional advisory firms should also provide guidance - a model that works very effectively in the private sector. Using this method, accountability is clearly defined at outset with ongoing monitoring ensuring that any policy implemented is maintained over time.
The rationale for pools implementing investment strategies makes sense for both AAs and the pool as AAs can delegate investment decision making and the Pools can scale strategies. However, unlike private sector asset consolidators, pools face two key differences: 1) no competition, as pools are the sole provider for AAs, and 2) lack of independent oversight, which is standard in the private sector to ensure decisions align with the best interests of scheme members and sponsors.
From the government’s perspective, the proposed review makes sense, as more concentrated asset pools enable investments aligned with their priorities. However, we would question whether this is truly in the best interest of members and sponsors.
From a governance perspective, increased training, and the designation of a senior LGPS officer are necessary to support the changes. However, given the proposed shifts, the role of the senior officer may concentrate too much power in one unelected individual. Boards could benefit from engaging professional governance firms with accredited trustees to support officers and pension staff in this significant undertaking.
Concerns around pooled asset implementation
Concerns remain around implementing pooled assets, particularly regarding AAs inability to allocate between passive or active allocations. This limits their ability to address Environmental, Social and Governance (“ESG”) priorities. The concept of local investments also needs further clarification, as they may indeed boost local economies but could yield lower returns. Furthermore, the definition of ‘local’ can is vague and the requirement to invest ‘locally’ should never override the AAs fiduciary duties. If better risk-adjusted returns are available outside the UK, that would also deliver better member outcomes, they should take precedence.
Most pools will require significant transformation to become FCA-approved investment managers and expand their expertise. This may involve significant changes to personnel and investment processes.
Whilst we eagerly await the government response and/or amendments, we can’t help but think more work is needed!
Stefano Carnevale, Senior Investment Consultant and Paul Francis, Principal Investment Consultant – Quantum Advisory
