By Jonathan Libre, 14 September 2016Market Intelligence | DB Pensions
In spite of the Brexit vote and the replacement of George Osbourne as Chancellor, the Government seems eager to maintain the momentum behind the pooling of LGPS assets. By July 2016, the provisional pools were required to submit their proposed timescales for fully implementing their plans by 2018.
The policy was designed to merge the 89 LGPS funds across England and Wales into at least 6 so-called ‘British Wealth Funds’, each with minimum assets of £25bn. The individual funds were encouraged to pool on the basis of either geographical proximity or like-minded investment behaviour, and following the consultation 8 pools emerged. On the basis of 2015 asset values, only 5 of these have met the threshold requirements; these were the London CIV, the Northern Powerhouse, the Midlands pool, SE Access, and the Border to Coast pool. The Wales pool, the ALM Partnership and the Brunel (CAP) fell short, with total assets of £13bn, £12bn and £23bn respectively.
A key objective of the reform was to reduce costs, through economies of scales and a greater use of internal asset management teams. Our analysis of each of the individual scheme annual reports has allowed us to show that economies of scale are indeed evident within the LGPS sector. On average, schemes with less than £2bn in assets faced total costs of 48bps, of which 38bps constituted investment costs. In contrast, the average investment cost for schemes with over £5bn in assets was 20bps, of an average total cost of 25bps.
Although larger schemes are likely to be able to negotiate lower fees with managers, they are also more likely to have the internal investment expertise, which is itself associated with lower investment costs. The average investment cost of a scheme which outsources over 75% of its assets to external asset managers was 40bps, while the schemes which outsourced less than 50% of their assets paid just 7bps on average.
By looking at the pooling proposals of each of the schemes, as well as the current investment behaviour of the individual schemes, we have also been able to gain an indication of what the future behaviour of the pools might look like.
The proposed pools differ dramatically in terms of the proportion of their total assets that is outsourced to external managers. The pool which is most likely to use internal asset management is the Northern Powerhouse, which will comprise the Greater Manchester Pension Fund, the West Yorkshire Pension Fund and the Merseyside Pension Fund. Overall, 44% of the assets of their schemes are allocated to in-house managers. The large number of sub-scale pension funds that will make up the London CIV, SE Access and Wales pools are far less likely to have internal capabilities. Only 4%, 2% and 3% of the assets of these schemes are invested through internal asset management teams respectively. Overall, 22% of LGPS assets are managed by in-house investment teams.
There are also significant differences in asset allocation. The Lancashire Pension Fund, London Pension Fund Authority (LFPA) and Berkshire Pension Fund, which will merge together into the ALM Partnership, have a far lower allocation to equities than most other LGPS funds. While on average 57% of LGPS assets are invested in equity, equity makes up 42% of the assets of the funds making up the ALM Partnership. Perhaps with a greater focus on liabilities management, these funds also have a greater allocation to LDI and fixed income than average. In contrast, the Welsh schemes have the highest exposure to equities: 66% of the assets of Welsh LGPS schemes are invested in equity.
While the implications for asset managers remains largely uncertain, winning LGPS mandates will become more competitive and more difficult. While there will be winners – for instance, with BlackRock winning a £2.8bn passive mandate for the Welsh pool – the use of internal management, the increased cost focus and the smaller number of potential clients means that many more will lose out. Arguably it is the smallest schemes which will face the most significant changes, and therefore the managers who have a small number of (often very healthy) relationships with these clients are most likely to be at risk.