First and foremost, Mercer is comforted by the consultation’s acknowledgement that:
- Pension funds are under substantial pressure on a number of fronts;
- Fiduciary duty is pre-eminent; and
- Administering Authorities are responsible for setting the investment strategy of their funds.
We are also broadly supportive of the consultation’s over-arching approach of encouraging voluntary action within a strengthened framework, on a comply-or-explain basis.
We welcome many of the recommendations, including a requirement for a training policy for pension committee members, consistent reporting of asset classes (where possible) and the clarity that the definitions for levelling-up investments would bring.
We fully understand the government’s desire to set a deadline for pooling listed assets, however we are of the opinion that 31 March 2025 is too soon from a practical perspective:
March 2025 is not aligned with the fact that funds would not ordinarily be looking to make significant investment changes until after the 2025 actuarial valuation cycle. This could see assets move twice, firstly to hit the pooling deadline followed reasonably soon after by further changes to implement any revised investment strategies following the 2025 valuation cycle;
March 2025 does not allow sufficient time for the investment regulations to be changed and communicated.
Whilst we appreciate the 10% allocation to private equity is stated as an ambition, we have three key issues to raise:
- Such guidance goes against the principle that Administering Authorities are responsible for setting the investment strategy and could potentially limit the extent to which Administering Authorities can manage pension fund affordability and contribution stability;
- We foresee practical issues in defining private equity, particularly if it is the government’s intention to exclude other private market investments such as infrastructure from the definition; and
- The interaction between the government’s levelling up plans for the LGPS and the 10% allocation to private equity needs to be defined e.g. are they mutually exclusive allocations or would a levelling-up allocation in private equity also count towards the private equity ambition?
We welcome the definition of “Local” within the levelling up framework to be ‘UK-wide’. We also support the comply-or-explain nature of the proposals, which is consistent with the consultation’s statement that Administering Authorities are responsible for setting the investment strategy of their funds. We refer back to our earlier comment that any reporting on Levelling Up needs to be cognisant of the many pressures facing the LGPS and their officers.
In terms of optimal pool size, the consultation references moving towards a smaller number of pools, each with assets in excess of £50bn. Whilst larger pools may offer the potential for greater economies of scale, assets under management should not be the only consideration. Key governance considerations should include the number of partner funds within a single pool, the way in which the pool operates (we note a variety of structures among the pools) and the specialisations and strengths and weaknesses within the different pools. Other external factors, such as location, may influence whether a specific pool is suitable to merge.
We suggest a larger number of partner funds with a wider spectrum of committee views could potentially lead to diseconomies of scale, regardless of pool size. Pool mergers could also be more costly and disruptive than anticipated, particularly given most of the pools’ offices are geographically dispersed across the UK. Finally, we would also highlight the risk of unintended consequences of calling into question the continued existence of some of the pools e.g. in terms of attracting and retaining staff over the short to medium term or acting as a barrier to further investment in the pools until any fund mergers have been completed.
The consultation raises the possibility of pools specialising in certain asset classes and other pools being able to access this expertise. We are broadly supportive of this recommendation, subject to cost considerations given the risk of creating multiple layers of fees e.g. if one pool levies a management fee and the other pool levies an oversight fee.
Environmental, social and governance (“ESG”) factors (including climate change) are important considerations for LGPS funds when investing. Pooling presents a great opportunity in terms of collective engagement on ESG matters, with many excellent examples of company engagement and stewardship by the pools. However it also presents challenges to the extent that funds have differing ESG policies, as some funds would find it very difficult to invest in vehicles that materially deviate from their own ESG policy. We think this tension needs to be clearly acknowledged as part of the consultation, such that all stakeholders can work together to find solutions to this tension.
The consultation also appears to favour pools building internal asset management capabilities to replace the use of external managers, but we would caution against being too directive to any one model of managing money on behalf of funds for the following reasons:
- There would need to be strong evidence that it would lead to better outcomes in terms of net performance and/or risk management. The consultation does not provide evidence to either prove or disprove this.
- Since pooling began, the flow of public market, predominantly passive, assets into the pools’ remit has been strong. We note that the 4.3% of LGPS fund assets that are currently invested in private markets is largely held outside the pools, some of which have not yet built up the requisite expertise and operational structures to manage these assets. It is questionable whether it is cost-effective for them to begin to do so in all cases.
- Attracting and retaining appropriately experienced staff can be more challenging under public sector remuneration packages, particularly for private markets expertise.
In terms of passively managed funds held outside the pools, we would strongly caution against a “pooling at all costs” approach. Whilst the pools have demonstrated cost savings in terms of annual management fees to date, any further savings need to be carefully weighed on a case-by-case basis against the transition costs for moving the assets into the pool.
Whilst we appreciate a voluntary framework requires transparent reporting to assess compliance, in aggregate the reporting recommendations for both the annual report and Investment Strategy Statement represent a significant reporting burden which is likely to result in a significant increase in time and costs for producing and auditing the reports. We therefore recommend consideration is given to removing some of the reporting requirements e.g. reporting net returns against a consistent benchmark.
We are supportive of the consultation’s proposal for Administering Authorities to set and review strategic objectives for their investment consultants. This is something we have already implemented as best practice with our LGPS investment clients. With regard to the consultation’s reference to pools providing investment advice to LGPS Funds, it is clearly for the LGPS Funds to decide from whom they receive investment advice. However from a governance perspective we would argue that independent advice, scrutiny and oversight of the investment decisions taken by the pool is essential.
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- Head of LGPS Investment, Mercer