LGPS pooling puts in-house investment in the spotlight

Last month, chancellor George Osborne announced plans to form six "British wealth funds" from local authority pension assets, each worth around £25bn.

The pension funds of Cumbria, Surrey and East Riding are the latest to announce pooling plans, with the option of increasing in-house management.

Between them, the funds have assets worth slightly less than £9bn, but are currently in talks with six or seven other Local Government Pension Scheme members to join the pool.

Finding common ground

The three funds have chosen each other based on their investment mindset rather than geographical proximity, said Mark Lyon, head of investment of the £3.6bn East Riding Pension Fund. 

“We started having discussions fairly shortly after the Budget announcement. It quickly became clear that we shared a certain investment ethos about what we should be doing,” he said. 

We started having discussions fairly shortly after the Budget announcement. It quickly became clear that we shared a certain investment ethos about what we should be doing

Mark Lyon, East Riding Pension Fund

This is the sixth pool that has been started by LGPS funds.

Most London boroughs have formed a platform for joint investment via the London Collective Investment Vehicle, which last week received Financial Conduct Authority authorisation and will open an active global equities sub-fund managed by Allianz Global Investors before Christmas.

Hugh Grover, London CIV’s chief executive, said it was “a nice small package we can open up to get things running” and will allow it to test the systems that will be used. Initially, three boroughs will invest a combined £500m into this.

Internal capability

East Riding’s Lyon said the three schemes want to maintain performance and reduce costs, while focusing on active management.

“We’re all looking to reduce costs wherever possible but not to the detriment of performance,” he said. “We’re all well performing funds over the long term and we wanted to maintain that.” 

While investment management is currently outsourced at Surrey and Cumbria, the East Riding scheme is managed in-house save for overseas equities, and the new structure could mean the other two county funds follow suit in order to save costs.

Lyon said: “The other two funds would like to under certain circumstances access the ability to do more internal management… it’s an option for them to do, but they don’t have to do it if they don’t think it’s suitable for them.” 

Phil Triggs, strategic finance manager at the £3.2bn Surrey County Council Pension Fund, said the three funds were like-minded “in terms of how they’re managed”.

He pointed to East Riding’s “strong internal capability”, but could not say whether some of Surrey’s external managers – more than a dozen including those for private equity – would see their mandates disappear.

The funds all focus on active growth. Surrey’s scheme is largely actively managed to help recover the fund’s deficit. 

Triggs said the three funds also have an emphasis on good governance, where “strong training and knowledge of committee members” was important. 

Each host authority will retain its responsibility for asset allocation, subject to what the government allows.

Governance risks

Karen Shackleton, senior adviser at AllenbridgeEpic Investment Advisers, said bringing assets in-house once the six British wealth funds are set up would be a logical step. 

“It’s inevitable that when we get these super-funds established, even if initially they outsource everything, the next logical step is to look long and hard at the underlying assets that they invest in and then ask the question, ‘Could we offer better value for money by bringing some of that in-house?’.

“And certainly where the existing in-house team has done quite a good job for the LGPS there’s a very strong argument to bringing assets in-house,” she said.

But Shackleton also voiced reservations about governance and effective scrutiny of internal managers. 

She said with external managers, “you always have the option of firing them and then hiring another external manager. That’s a lot harder to do with an in-house team”.

The governance structure of this latest pool is yet to be determined, but Lyon said there will be “some form of oversight board or committee, which will have equal representation from the constituent funds [and] equal voting rights”, adding that independent directors with an advisory role might also be on this board.