In 2015 the chancellor announced proposals to pool the assets of the 89 Local Government Pension Scheme funds across England and Wales into at least six 'British Wealth Funds', each with a minimum size of £25bn.
The government stated that two of the key motivations for implementing the LGPS reforms are to benefit from economies of scale and to promote the use of in-house asset management.
Schemes have now responded with a submission of their pooling proposals, and we have analysed the results to assess whether these key motivations are supported by the numbers.
The economies of scale are certainly borne out by the numbers. Calculations based on annual reports show that the average total costs for LGPS schemes in 2015 was 39 basis points, of which 31bp was investment related. But as is shown in our first chart, larger schemes benefit from having much lower relative costs than smaller ones. LGPS schemes that are more than £5bn in size have overall costs of 25bp, 70 per cent lower in basis point terms than schemes that are £2bn-£5bn in size (44bp).
This finding – that larger schemes benefit from having much lower relative costs than smaller ones – is supported by equivalent work we have done with private sector schemes. Those schemes in the private sector with more than £5bn in assets have overall costs of 29bp, 62 per cent lower in basis point terms than schemes that are £2bn-£5bn in size (48bps).
Cost-efficient public sector
The economies of scale in the private and public sector are interestingly similar. But another thing that emerges from this comparison is that LGPS schemes tend to be slightly more cost efficient overall on a like-for-like basis than their private sector equivalents.
This may be because LGPS schemes are on average larger than private sector schemes. There are 89 LGPS schemes with some £180bn in assets between them – an average of some £2bn per scheme. The 330 private sector schemes with more than 5,000 members each on average have assets of more than £2.5bn, but the remaining 5,700 or so smaller schemes have average assets of only £50m.
The first chart also shows that the average investment management cost for LGPS schemes in 2015 was 31.2bp. Smaller schemes, with less than £2bn in assets, pay higher than average costs for investment management, at 38.2bp. In contrast, the largest schemes, with assets of more than £5bn, spend 20.1bp in investment costs on average.
Similarly, larger schemes incur the lowest governance costs excluding investment management expenses. Schemes with more than £5bn in assets spent 5.2bp on average in other governance and administration costs, compared with 9.7bp for schemes with less than £2bn in assets. The overall average for LGPS was 7.6bp.
What of the second motivation: to promote the use of in-house asset management? Jonathan’s analysis shows that this is in fact supported. As is shown in the second chart, investment costs for schemes with in-house asset management capabilities were significantly lower than they were for schemes with greater use of external third-party asset managers. Schemes that allocated more than 50 per cent of their assets to in-house asset managers paid 6.5bp in investment costs, on average. The equivalent figure for schemes that outsource more than 75 per cent of their investments is more than five times higher, at 37.9bp.
Magnus Spence is managing director of Spence Johnson
