I spoke on a panel on the subject of pooling at the excellent LGC Investment Conference held recently, and I shall be attending DG Publishing’s symposium on 25th April. Making pooling work so that costs are reduced is probably the no.1 priority for LGPS funds today, simply because many public employers are struggling to pay contribution levels, far higher than private sector enterprises with DC funds do.
It is five years since most pools were established, and it is no secret that some pools have made more progress than others. The journey will take many more years to complete, but pools should by now at least have clear objectives agreed by their partner funds – call it mission clarity – and governance structures which allow them some freedom to arrange their affairs to achieve those.
They should also be beginning to put together a cadre of staff who have the investment knowledge and experience to compete successfully in the investment jungle, or alternatively outsource this role to private sector experts as the Wales pool has done. Internal management will provide the greatest cost savings, but this also constitutes the greatest risk of subtracting value. For a current example, look no further than the Swedish pension fund, Alecta, investing a large sum in niche US banks for ESG reasons. When Silicon Valley Bank and the others failed, it cost the CIO his job.
I emphasise this point about investment knowledge because, ultimately, it is the single biggest factor whether pools add or subtract value to their partner funds. But pools will only be able to build up their expertise if they have the independence to make their own decisions on staffing, pay, etc, while being properly held to account by their shareholders.
To avoid the need to go through public procurement, most pools have been set up under the Teckal exemption whereby they have to show that they are controlled by the public bodies who established them. This is why there are so many matters reserved to shareholders in the constitutional agreements setting up the pools.
However, after BREXIT the Teckal exemption will be superseded by a new Public Procurement bill currently going through Parliament. I am no lawyer, but it is at least arguable that funds can use the exemption given to financial services rather than having to show control. This could have important implications for their governance because it allows scope for more independent arrangements to be put in place.
So, I have three challenges to address to the parties involved, which I list in ascending order of importance - i.e., the biggest comes last:
The first is to those pools and their partner funds who do not have governance clarity. By that I mean the structures whereby shareholders are effectively able to agree and set objectives, to hold pool Boards to account against them, and separately the pool Boards can hold their executives to account. If your pool CIO dropped US$2bn, like Alecta’s, could you fire them immediately if you wanted to? And are the representatives on your shareholder forums (or equivalent) sufficiently engaged and knowledgeable about investments to give the pools mission clarity?
My second challenge is to partner funds. If you have the structures to hold your pools to account and have been able to set clear and agreed objectives to your pool, how much independence are you willing to give them? The Teckal exemption noted above will have a bearing, but my strong impression is that all too often it is used as an excuse not to give independence. If you are doing that, you are effectively tying one hand behind the pools’ backs.
Best practice is to have a completely independent Board without executives or shareholder representatives on it. That makes it much easier for shareholders to hold it to account, and for the Board to hold executives to account. For example, the Alecta Board has no executives on it. That may be a step too far for today’s pool Boards, but my challenge to the partner funds is – could you?
My final and most important challenge is to Government. You are right to look to reduce costs in the LGPS. If you were designing the Scheme afresh, you wouldn’t end up where we are today. But please acknowledge that it is relatively well funded and managed and is among the leaders in investing responsibly and sustainably.
Pooling will be most effective in reducing costs if you keep your involvement to a minimum. Arbitrary deadlines or scale targets are not helpful. Some of pooling’s problems today are caused by the speed with which you forced funds to choose their pools. Global case studies do not make the case that scale is essential to keep costs down.
It would be helpful if you can provide us with a coherent framework which can be implemented in practical terms. Here are three examples where you have failed to do this: the passive investment you were so keen on in 2017 for cost reasons is incompatible with responsible investing, because index funds by definition invest in all companies regardless of their activities; data on climate change is highly subjective, and there is a serious risk that bad decisions driven by bad data are forced on funds by climate change disclosure legislation, (a result far worse than one of your predecessors’ championing of diesel in the early 2000s); levelling up is a worthy concept, but investments do not fit neatly into boxes.
We expect you to set the direction of travel, and pooling has enough momentum – and in some cases is beginning to show real savings – that the inclination to reverse it is limited. So my challenge to Government is to keep it simple. Set a maximum cost level, say 50bps, to be achieved by a set date, say 2033 and let those at the coalface work out how best to deliver that.