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LGPS wealth funds must make the best possible return on assets

Neil Sellstrom, treasury and pensions advisor at the Chartered Institute of Public Finance and Accountancy (CIPFA), discusses the opportunities and challenges of pooled assets for the Local Government Pension Scheme (LGPS).

A year ago, at the Conservative Party Conference, the then chancellor, George Osborne, called for assets of the 89 LGPS funds in England and Wales to be merged into six ‘British Wealth Funds’, each containing at least £25bn of scheme assets. 

The proposal fits with an ongoing series of reforms to the scheme, which aimed to meet the challenges of the increasing pensions burden, while also allowing them greater exposure to domestic infrastructure.  

Today’s Conservative government looks very different, but pension schemes, by their very nature, are required to run a far longer course and must be robust enough to weather changes, so as to meet member entitlements. 

With some 5.2 million users and more than 7,000 employees, the LGPS is easily the largest funded (meaning contributions are paid into an investment fund and pensions are paid out of this pot) pension scheme in the country, controlling assets exceeding £200bn. 

And although in long term the LGPS has delivered results that compare favourably with the corporate sector, over recent years the scheme has faced a number of difficulties that have compounded the overall cuts to the budget, most notably the fall in interest rates, which has increased the present value of liabilities. 

The rationale for the wealth funds is that by pooling investment, administrating authorities can deliver reduced costs through economies of scale, while maintaining overall investment performance and delivering the wider benefits of shared expertise. Effectively, this means the selection of fund managers will be made through the investment pool operator on behalf of a number of co-operating administrative authorities. Meanwhile, each administrative authority will continue to have responsibility for determining their own individual investment strategies, including asset allocation. 

Proposals from eight groups were put forward by the 15 July deadline this year, which now have until April 2017 to publish an investment strategy statement. DCLG has already set out a number of criteria necessary for the investment pools, specifically: that the asset pools achieve the benefits of scale and can demonstrate how benefits are realised; that there is assurance of strong governance and decision making; that there are reduced costs and excellent value for money; and that there is improved capacity and capability to invest in public infrastructure. 

Strong governance structure important 

It is important that central to any such reforms is the protection to members’ benefits, while keeping the costs to taxpayers and employers to a minimum. A strong governance structure will be vital to ensuring the asset allocation decisions are made effectively and that the best fund managers are selected. 

There will naturally be a number of different structures and operating practices in relation to the investment pooling arrangements, but each administrating authority must be able to demonstrate strong governance in how it continues to manage its LGPS fund. Much of the governance framework will mirror the principles that are required for all local government organisations: that acting in the public interest implies primary consideration of the benefits for society, which should result in positive outcomes for service users and other stakeholders.

But as laid out in CIPFA’s Investment Pooling Governance Principles guidance, this framework needs to evolve to fit the new asset pooling arrangement and be considered alongside principles for investment decision making. Examples of the latter include, the administrating authority demonstrating a robust knowledge of the asset pooling arrangements and having sufficient expertise to identify and manage conflicts of interest. They must also deliver an overall investment objective, which takes account of the scheme’s liabilities, the potential impact on local taxpayers, and the appetite for risk of both the administrating authority and the scheme’s employers. Speaking of risk, liability management remains the responsibility of the administrating authority. 

Performance assessments, alongside acting in a transparent manner and communicating with stakeholders on issues relating to their management of investment, must also be a key underpinning of an administrating authority’s governance. 

The pooled assets, which were a key plank in Osborne’s plans to ‘get Britain building’, present both a raft of challenges and opportunities for LGPS, but any reforms to the long-term structure must keep the relationship between the assets and the liabilities firmly in mind. Any investment the funds enter into must make the best possible return on assets, as they are held in trust for the benefit of the people who have made contributions to those funds. The funds must not become the investor of last resort, for example, for politically desirable infrastructure schemes that the markets do not see as investment grade proposals.

FOR MORE INFORMATION

W: www.cipfa.org

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