What are the obstacles to DB consolidation?

Yet efficiency initiatives, such as the Local Government Pension Scheme asset consolidation, are yet to be replicated across the DB pension universe.

So, what are the main barriers to implementation?

Resources

Few trustee boards, management and investment committees, or pensions departments would claim to have surplus resources beyond those required to meet the day-to-day challenges of running a pension fund. Strategic planning is typically focused around risk budgeting, asset allocation, decision-making and member engagement.

The topic of consolidation, if raised at all, has traditionally come from the sponsoring employer.

As funds expand their internal investment teams, they also need a larger in-house risk team

In the corporate DB sector this has usually been where employers want to rationalise the management and administration of assets in multiple schemes across national boundaries, into a consolidated investment structure.

Pooling of assets in the vein of the LGPS consolidation is therefore a very rare event. It is commendable how staff within the member funds have adopted the initiative, taken ownership and driven the project forward despite the resource challenge.

Risk

There are significant benefits to be gained from consolidation. Economies of scale, sharing of knowledge and pooling of resources all help drive down operational costs. 

For smaller funds it can bolster their bargaining power when it comes to engaging the specialist expertise they need from external asset managers. For larger funds, it offers the chance to access previously unfamiliar investment opportunities.

However, with these opportunities come significant challenges that need to be considered, including various forms of risk.

One such risk arises when consolidating service providers. As schemes pool their assets, they may wish to reduce the number of external providers they use, such as asset managers, and move some investment capabilities in-house at the same time.

The more capabilities they manage internally, the more risk they inherently bring in-house.

Therefore, as funds expand their internal investment teams, they also need a larger in-house risk team, and must have the governance structures in place needed to back them effectively.

In addition, funds pursuing a diversified investment strategy will need to take on specialist talent.

Investment professionals with expertise in niche asset classes are in demand — as are those with risk management, data analysis, and board-level skillsets.

While insourcing is appealing to many funds, it is not a panacea. External third parties will likely continue to play a vital role, as a key partner in certain functions.

Governance

Another core objective of pooling is to establish strong governance and decision-making frameworks.

However, many funds do not have the structure or strategies in place to manage critical elements of governance, such as board composition, the balance of responsibilities between the board and investment staff, and transparency of reporting.

The proposed transfer of decision-making around investment manager appointments to a fiduciary manager responsible for a regulated fund structure, such as an authorised contractual scheme, is one way to address this.

As board and stakeholder demands to cut costs intensify, pension funds also face increased pressure to operate efficiently and maintain sufficient investment returns to fund acceptable levels of retirement income for members.

However, pooling resources should not only be viewed as a cost-saving measure, but also as an important means of developing new capabilities, opening up fresh opportunities and improving governance.

Andy Todd is head of UK pensions and banks, asset owner solutions, at State Street.