Consolidation of UK LGPS funds branded ‘hazardously ambitious’

The current timeline of the government’s plans to consolidate UK local government pension schemes (LGPS) into a handful of megafunds branded “hazardously ambitious”.

In her first Mansion House speech, Rachel Reeves, the UK’s chancellor of the exchequer, announced a number of different measures in what she dubbed as the biggest pensions reform in decades.

One of the measures includes changes to LGPS funds aiming to free up money for local public services in the long term and secure more than £20bn for investment in local communities.

Under the proposals, LGPS funds will manage assets worth around £500bn by 2030. These assets are currently split across 86 different administering authorities, managing assets between £300m and £30bn, with local government officials and councillors managing each fund – many of which use the UK’s existing eight investment pools.

The government said that consolidating the assets into a handful of ‘megafunds’ run by professional fund managers will allow them to invest more in assets such as infrastructure.

The ‘megafunds’ will be authorised by the Financial Conduct Authority (FCA) and the government said the governance of local schemes will also be overhauled to deliver better value from investment decisions.

The government added that each administering authority will be required to specify a target for a pool’s investment in their local economy, working in partnership with Local and Mayoral Combined Authorities to identify the best opportunities to support local growth. It added that if each administering authority were to set a 5% target, that would secure £20bn of investment in local communities.

A new independent review process will be established to ensure each of the 86 administering authorities is fit for purpose, the government added.

With the consultation closing today, Zoe Alexander, director of policy and advocacy at the Pensions and Lifetime Savings Association (PLSA), said that while the association “supports” the overall objectives of the reforms, proposals on strategic asset allocation and investment advice require further consideration.

She pointed out that setting the right asset allocation is “the most crucial factor” in driving long-term investment returns for a scheme.

She said: “Funds must remain accountable to members, employers, and taxpayers for performance. A pragmatic approach will also be essential to ensure compliance within the proposed timeframe.”

According to Anthony Dalwood, chief executive officer of Gresham House, the proposed changes to LGPS funds are likely to result in a period of stagnation for UK-focused investment.

He explained: “Delegating investment strategy implementation to pools will require substantial time, investment, and resources to attract and retain the necessary talent. Furthermore, the complexity of the transfer of assets should not be underestimated. The process will be costly and complex, as pools must familiarise themselves with the legacy strategies and liabilities of all their partner funds.”

Executing deals in the under £50m range in particular will require “significant resource and skill set”, according to Dalwood, who said that unless pools are “adequately” resourced to source and execute smaller deals, these “compelling” investment opportunities will remain at risk of going underfunded.

He pointed out that the drive for larger deals will likely increase the pools investing on a broader pan-European or global basis to satisfy allocation criteria which “runs counter to the government’s UK-focused growth ambitions”.

Dalwood added that it is “critical” that, through this consultation, the underlying administering authorities are not overlooked as the primary clients of the pools, stressing that their “input and oversight are essential”.

He said: “To provide a full-service offering across all public and private asset classes necessary to achieve an optimal, diversified, strategic asset allocation, the pools would need to replicate the depth and scale of the largest global asset managers.”

Dalwood noted that unless this is the end state “desired by the government” then it will be more effective to adopt a hybrid approach that would involve some internal management of assets within the pool and some outsourcing to the external managers and GPs that have the necessary depth of skill, experience and importantly deal flow to execute specialised local asset investments.

He pointed out that “even the largest global asset managers” outsource many specialised aspects of asset management to deliver better returns and diversification for their clients.

Disappointing

Robbie McInroy, head of LGPS client consulting at Hymans Robertson, said the consultation has implied funds are “inefficient, fragmented and not ‘fit for the future’.”

“We do not believe that this is the case. This has already raised frustration with the LGPS Funds and pools and ignoring these concerns would be detrimental to the Government’s ambitions to encourage change,” he said.

“We believe the proposed changes outlined in the government’s consultation would create a number of risks and unintended consequences for the LGPS,” he continued.

McInroy pointed out that the consultation recommendations for the changes to the scope and scale of the pools would be a “significant change” and huge undertaking with a proposed timescale that is “hazardously ambitious”.

He added that the pools are still developing their capabilities and are immature in asset/fiduciary manager terms.

“The proposed speed of change risk inefficient progress and poor outcomes – including irrecoverable build costs and investment losses resulting in increased cost to the taxpayer. We would instead like to see the government prioritise their objectives and focus on competing the asset transition to pools and building local investment capabilities,” he noted.

McInroy said Hymans Robertson is “supportive” of the policy direction on local investment. However, he said a realistic timeline is needed for LGPS to increase local investments to allow for a flow of newly originated local project opportunities to be created.

“This will avoid forcing capital into a small set of opportunities, ‘bidding up’ prices and pushing down returns. The investment will be incredibly important in the potential for improving local areas, but if delivered poorly it could do harm,” he said.

Tight deadline

In its response to the consultation, the Society of Pension Professionals (SPP) said that the government’s expectations for proposals to be submitted by 1 March 2025 “seriously constrains” the ability of pools to undertake a full assessment of the merits of the different options which government is intending to prescribe.

It said: “We are not at all convinced of any merit in forcing those pools to change their approach, incurring further unnecessary costs and fundamentally changing the relationship between partner funds that has built up successfully over the last decade.”

Kirsty McLean, chair of the SPP’s public sector group, added that while it is “right” for the government to challenge the sector to assess its progress, the type and pace of changes being proposed run the risk of derailing some of the good work of the last decade, as well as impinging on administering authorities’ fiduciary duties.

She said: “Within the LGPS it is not clear how these proposals will meet either of the government’s objectives of improving pension outcomes for members or increasing investment in the UK.

“As a result, we are urging them to carefully reconsider both the nature and pace of some of these proposals.”

Read the digital edition of IPE’s latest magazine