Look beyond the LGPS in the pooling discussion

An ACS is a relatively new form of authorised fund designed to be tax transparent, and it is likely to be the vehicle of choice to achieve pooling. 

Asset owners, asset managers and asset service providers are all looking closely at the benefits, opportunities and threats an ACS presents.

At its very simplest, it is a collective investment scheme that has no legal personality and is broadly a pool of assets held for and on behalf of the participants in a fund. 

Pension schemes agreeing to pool must have some commonality in their investment approach, or be willing to compromise or adjust in order to reach the goal

In terms of direct taxes, each participant in the fund is responsible for taxes due and will need to know their share of the income and gains arising.

An ACS allows investors to pool their investments – and thereby achieve economies of scale – without introducing any additional tax drag inside the fund.

This is particularly valuable for tax-privileged investors such as pension schemes, which should retain their entitlement to preferential withholding tax rates or exemptions, even though the investments are held within the fund.

Many other familiar fund structures deny this pass-through treatment, introducing unacceptable tax leakage for the investors. 

It should be noted that there may be operational issues associated with claiming lower rates of withholding tax, and care should be taken to understand what is actually possible within the confines of the asset servicing organisation’s product offering.

Commonality and compromise

However, there are real difficulties over and above any operational issues in achieving the benefits of pooling without simply adding an extra layer of complexity.

Pension schemes agreeing to pool must have some commonality in their investment approach, or be willing to compromise or adjust in order to reach the goal.

Two pension schemes with an allocation to developed market equities, for example, will only achieve efficiencies if they merge those mandates and agree upon a common provider.

Pension funds with widely divergent strategies or asset allocations may have limited scope to pool their assets.

Things to take into account when assessing the opportunity for pooling will include not just the objective of the mandate, but also the outperformance target and whether there is any scope to revisit the mandate and make some tweaks for greater alignment. 

Opportunity for the wider market

There has been a lot of industry commentary around the opportunity for LGPS funds to significantly reduce costs while maintaining overall investment performance through pooling, but it shouldn’t stop there; the opportunities and impacts are potentially wider reaching.  

This is not an LGPS or pension fund-only conversation. Asset managers need to adapt to this new vehicle of choice – not just to protect existing mandates with asset owners but also to capture new business. 

The amounts will be significant: the LGPS market alone is worth around £190bn of assets under management.

This could even be an opportunity for managers with an array of mandates in the defined benefit arena with similar objectives to consider offering a pooled vehicle, such as an ACS structure, to replace segregated accounts.

This would achieve greater economies of scale and so reduce costs for the accumulated clients.

But for the funds in the LGPS the question for now will be: Does the benefit of reduced cost outweigh the reduced flexibility of being tied closer to a single asset manager?

Paul Radcliffe is a tax executive director in EY’s wealth and asset management practice