The government makes no secret of its desire to tighten its grip on the UK’s largest scheme and drive consolidation. The Local Government Pension Scheme in a new review, and recently, the chancellor said UK pension funds should be more like Canada's. So what could this look like? 

The LGPS in England and Wales is braced for Westminster putting its foot on the gas to travel faster down the consolidation road the scheme was set on in 2015. The most recent government wanted to get the eight LGPS asset pools to consolidate further into £200bn pools by 2040 and to bring all listed assets into the pools by 2025, something many expect the new government to top.  

 

In July, chancellor Rachel Reeves announced a pensions review - a call for evidence has now been published - talking of a need to “cut down on fragmentation and waste in the LGPS” and announcing that the review would “consider the benefits of further consolidation”. In early August, she followed this up saying the UK should look to emulate Canada’s pension funds, meeting with the country’s largest, the so-called ‘Maple 8’. 
 

    

 

Canada’s top eight funds represent about £1.2tn combined. Favouring direct investments and internal asset management, they tend to have a much higher exposure to private markets than the LGPS, with a lower equity allocation instead, according to Hymans Robertson. Their portfolios are globally diverse, which seems to contradict the UK government’s agenda of more domestic investment from pension funds.  

 

Given the differences in how they invest, trying to make the LGPS more like Canadian schemes would require “a fairly significant shift in asset allocation for most funds”, says Joanne Donnelly, secretary to the Scheme Advisory Board. 

 

The LGPS is relatively mature, so that without investment income it would be cashflow negative at scheme-level, Donnelly points out.  

 

“This obviously differs across funds, but income-generating assets are becoming more of a focus for funds as they mature and as membership growth levels off,” she notes. 

 

It is unclear what the cash flow position of the Maple 8 is in comparison. 

 

Operationally, there would also need to be change. About 60-80% of the assets of the Maple 8 are estimated to be managed in-house. Replicating this in the UK would be a considerable project, as different LGPS pools have different levels of in-house management, ranging from almost entirely outsourced to fully in-house. 

 

There has also been speculation that the 87 funds in England and Wales could be merged into fewer funds, rather than ‘only’ pooling their assets. This has been done in the past – Northumberland’s fund has been absorbed by Tyne and Wear, and Richmond’s fund by that for Wandsworth – but Donnelly says it should be “managed carefully” to avoid unforeseen consequences.  

 

Alignment and close cooperation are needed before a merger, she emphasises, as well as secondary legislation. “’Merger’ is the term used but it’s more of a takeover in practice,” she explains. 

 

Jeff Houston, senior pensions consultant at Barnett Waddingham, and Melanie Durrant, public sector consulting actuary at the firm, recently wrote that this is due to the regulations underpinning LGPS mergers.  

 

They suggested there could instead be “true mergers in the form of single purpose combined authorities, which could enable multiple funds to come together in a structure which suits them” and argued that “allowing voluntary merged structures may well go some way to achieving the government’s desired results without the need for mandation”. 

 

 

 

The operational aspect might be one thing, but there are also governance and legal questions. LGPS funds are part of a democratically elected body set up for specified beneficiaries. With central government increasingly directive on investments, could this be an issue in terms of accountability and acting in members’ best interests? 

 

Donnelly revealed that the SAB is thinking of getting an updated legal opinion from counsel on fiduciary duty. The last opinion was received almost 10 years ago, and since then, many changes have taken place – she cites ‘levelling up’, now rebranded ‘local growth’ plans, and the Mansion House compact. 

 

“Government is clear that it doesn’t believe that encouraging UK pension schemes to invest more in productive assets in the UK cuts across the fiduciary duty in any way; but we would like to test this with counsel,” Donnelly says. 

 

 

One who sees benefits in greater consolidation is Richard Tomlinson, chief investment officer at Local Pension Partnership Investments, although he stresses that consolidation is the means, not the goal. The goal is to provide a pension, from contributions and investments, he notes. 

 

“Consolidation is one way to achieve that – it gives you certain ways of delivering it, whether that’s economies of scale or a different governance model, different options for how you execute,” he remarks.  

 

However, “I think it’s a little bit of a trap people might fall into by just saying 'the Canadian model’. But what does that really mean?” 

 

He says the UK should not just copy what the Canadians have done but “look at what works and what doesn’t” and pick the best things. “Just being bigger doesn’t necessarily mean you get good outcomes.”  

 

Scale provides funds with more strategic options, Tomlinson says, but cautions that having slightly fewer options and better execution is preferable to having more options and poor execution.  

 

 

Alongside good execution, he also points to an aligned governance structure as a key ingredient for success. LPPI is vertically integrated, providing advice to the three pool clients and running “significant” sums in-house via a team of around 70 investment specialists, Tomlinson says. 

 

“Critically”, 100% of assets are pooled, he adds, meaning the portfolio can be managed in an integrated way, and “when there is a problem, the benefit is there is one phone call” the clients need to make, as opposed to phoning up numerous asset managers. 

 

This model is very centralised, but Tomlinson points out that the pension fund committees set the strategic asset allocation. However, he argues that this should cover only high level asset classes, rather than go into much detail. 

 

In-house management also means that asset types like infrastructure – which the government is pressurising the LGPS to invest in – can be done more cost efficiently, he says but notes there is tension in the cost saving argument brought up by government given the push towards higher-fee assets. 

 

Donnelly agrees internal management can help save costs. “But it’s important to build a good team, and that could require more flexibility around remuneration than is often seen in LGPS funds and pools,” she says.   

For Tomlinson, “it's not just the money, it's the purpose, it's the environment... I'd frame it in terms of having the right people and the right team involved”.
   

 

What are the pros and cons of further LGPS consolidation in your opinion?