Scale is important for the LGPS pools
The Department of Levelling Up, Housing and Communities (‘Leeds United, Hull City’ is my favoured mnemonic) has made it clear that they see greater scale as an important objective for the eight LGPS pools. The LGPS has around £340bn of assets, which means that it will be a challenge for all eight pools to reach the minimum £40bn scale mentioned in a recent DLUHC speech.
Given the cumbersome governance structures and differing objectives of the various pools, the constraints of geography, and a more difficult market environment - what might be a realistic way forward? In this article, I look at some of the constraints and the implications of what DLUHC is saying. The opinions expressed are my personal ones.
The most obvious route is some form of pooling between the pools, whether through formal mergers, or collaboration through joint-owned vehicles, such as the creation of GLIL by LPPI and Northern Pool partner funds. Indeed, in the same speech DLUHC encouraged the latter and hinted at the former. However, the barriers to mergers in particular are formidable.
The owners of the eight pools have differing objectives, ranging from keeping costs to a minimum and ceding as little control as possible through those which are more aligned with DLUHC’s aim of better value for money. They are operating against a background of on-going problems with governance and ownership structures, with recruitment, and in some cases with investment performance.
Governance structures are a barrier to pool mergers
Governance is a key issue. Fixing problems and coming to any decision is difficult with two owners and almost impossible with 31, especially given differing political agendas, infrequent meetings, and the lack of resources at both pools and funds to support good decision-making. Would partner funds ever be able, whether individually or collectively, to make an objective decision that joining forces with another pool is more aligned with their fiduciary duty than carrying on with their own pool?
Perhaps it is even more difficult for funds in those pools which are making headway. They would have to suffer all the disruption and expenditure of cost and time which any merger with another pool would take. In the private sector, the profit motive would provide an incentive, but that is not the case here. Why should they take on new partner funds from a failing pool, even under government pressure?
If they do choose to, they will almost certainly be able to dictate their terms: the joining partner funds will have to accept what they are being offered. Depending on the pool, these new arrangements may be quite different in terms of product choice, cost, or governance. S101 committees may find them difficult to stomach.
Freedom to invest through a different pool
Ownership is another issue. From the beginning of pooling, I have advocated the case for being a client rather than owner of a pool, but in practice almost all funds have chosen ownership. It means that if they choose to move, they will now have sunk costs to write off. Neither ownership nor a place on the governing body is likely to be on offer, and that may well be a further psychological hurdle to jump.
I have long said that DLUHC would do well to make it explicit that a fund could use pools other than its own. It doesn’t make me popular with anyone, but it is in accordance with Darwin’s theory of species. Those pools which evolve to succeed will attract clients; those which don’t will fail.
It also has the advantage that a fund could choose either to place all its assets with a different pool, or alternatively cherry-pick where there is a particular product or expertise elsewhere which they cannot find within their own pool. GLIL is an example where six funds are collaborating in investing in UK infrastructure. Where funds are in pools which have not yet set up private equity vehicles or sustainable sub-funds, why reinvent the wheel? Why not, whether at pool or at partner fund level, arrange to use one of the other pool offerings?
Scale can help solve the recruitment problem
Staffing and recruitment is another barrier to mergers. It is no secret that in many pools staff turnover has been high. Any firm takes time to establish its culture, but if a firm is unable to pay the market rate for staff in its industry, it will struggle to keep good people. That is particularly important after the COVID pandemic, as staff explore different ways of working.
Asset management is not alone in offering high remuneration levels for talented staff. We can look everywhere, from the legal to the footballing worlds and see similar pay structure shapes where pay is skewed towards the top performers. The pools do not need the equivalent of Cristiano Ronaldo, but they do need to pay competent investment managers the market rate. It is especially true in the much more difficult investment environment we are now in, where a simple buy and hold strategy may well not deliver the required returns. Partner funds need to accept that the pools are not operating in local government, and free them from formal pay constraints.
This is one of the reasons why greater scale is important, and why DLUHC is right to encourage it. Scale can spread the costs of hiring and make it easier to offer competitive remuneration packages. Funds will still need to hold pools to account for their investment costs, but the pools would be able to compete with private managers more or less on an even playing field.
Does ‘half a dozen’ still mean eight pools?
Back in 2015 the then DCLG announced ‘half a dozen’ new pools. When eight emerged, it transpired that half a dozen did not necessarily mean six. Despite geography and the barriers I have alluded to above, it seems inevitable to me that there will be more collaboration and, I venture to suggest, pool mergers.
To make pooling a success on DLUHC’s terms, I make three suggestions. One is that DLUHC in its autumn consultation asks whether funds should explicitly be given freedom to move to other pools. The second is that pools are freed from local government pay restrictions. The third is that all partner funds which have not already done so, take a formal and structured look at the overall performance of their pool. If it is not providing value for money, they should consider what needs to be done. First on that list is the question of scale.
Perhaps half a dozen did mean six after all?