By David Moreton, Partner and Head of LGPS Investment, Barnett Waddingham
These key areas include:
Governance
Strategic Asset Allocation (SAA); and
Implementation.
Governance
As we now know, the Bill gives potentially sweeping powers to the Secretary of State. These include:
enabling the Secretary of State to direct LGPS funds to join or leave a pool company;
providing guidance to pool companies;
And perhaps most surprising of all, the ability to direct a pool company in 'prescribed circumstances’ on how it manages its activities or the decisions it makes or to follow guidance.
In the past, the government has shied away from directly mandating the actions of what are effectively private companies (the pools). It’s clear that the government does not feel that the full benefits of pooling have been realised since its inception in 2015. As a result, the Pensions Bill takes the implementation of investment strategy out of the hands of each of the funds and puts it in the hands of the pools.
However, the government also appears to have included an ‘insurance policy’ that reserves the power to directly manage the activities and decisions of the pool in ‘prescribed circumstances’. This could be the case that the pools fail to align with government expectations when it comes to pooling and the investment of LGPS assets – think favouring ‘UK productive finance’ investments over global investments opportunities here.
While the use of those powers for the reason above might seem a remote possibility, this provision opens up huge questions about how future Secretaries of State might deem ‘prescribed circumstances’, and whether the LGPS members and employers will always remain the most important consideration when it comes to the investment of LGPS assets.
Perhaps a more positive spin on why these powers were included could be they enable the government to act as mediator in disputes between funds and pools. If that’s the case - and the Bill and its subsequent regulations are amended to reflect that remit - I can see these powers supporting stronger governance within the LGPS.
The importance of oversight
I’ve talked many times on the importance of oversight and accountability in any properly functioning market, not least private sector fiduciary management.
With plenty of new relationships to be built (see the SAA section of the blog), new ways of working (implementation section), and the new powers the Bill provides to government (see above), there would seem to be no better time for high-quality, independent oversight to help LGPS funds navigate the challenging changes to come.
Practical SAA considerations for funds
Two areas immediate spring to mind here – compromise and innovation.
Why are we talking about compromise in the LGPS when a pension scheme of comparable size in the private sector can get pretty much exactly what it wants in its portfolio? There’s some broadbrush approximation in that statement, but it mostly holds.
Well, one of the central points of the Bill is consolidation, with the aim of ‘creating scale’ in investment strategies. Building scale means not being able to accommodate the specific requests of all partner funds in all areas – that would reduce scale by having a multitude of different investment options to satisfy all needs.
So compromise will be needed, and I would argue this on all sides. LGPS funds ultimately remain responsible for their liability to fund and pay pensions. While the pools now face the challenge of delivering advice and implementing large scale investments on behalf of many LGPS funds, there will potentially be many relationships to build with new partner funds - building trust will require open conversations, and those new relationships unlikely to succeed if it’s the funds doing all the compromising.
The setting of the SAA should be a collaborative process. In the past, this has always been the remit of individual funds, and they can still establish their high-level SAA using the prescribed template. However, funds might find themselves asking the pool to produce a first draft of the SAA – giving the pools an opportunity to build the relationship and demonstrate the innovation they can bring to their advice.
The fund then has a base to challenge the recommendation, overlaying their skills, knowledge and beliefs. And of course, it’s the funds that have a huge amount of experience and knowledge when it comes to managing cashflow requirements, both from an asset and liability standpoint.
By starting with an engagement process that sees the SAA proposal produced by the pool, and which enables the fund to understand, consider and seek potential improvements, the pools will get the opportunity to demonstrate they understand each fund’s aims and beliefs, showcasing innovation whilst starting from a realistic place.
Doing things that way around might mean the process of compromise starting from a better place – that of course remains to be seen…
Implementation
Finally, we come to an interesting practical consideration for how the future of pooling might evolve - the Bill allows the pools to ‘procure’ services from other pools.
The idea of pools being ‘centres of excellence’ for certain asset classes has been discussed in the LGPS previously, but seemed to be off the agenda as six pools received approval to carry on. The Bill specifically rules out funds choosing to be a client of more than one pool, but it does allow pools to procure services from one another.
Over time, this could encourage pools to specialise in specific areas of investment or advisory approaches - time will tell whether there is a real impact of this provision or not.
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