The government’s ambition to consolidate the Local Government Pension Scheme further raises the question whether more in-house management – in the style of Canada’s funds – could be beneficial. So what are the pros and cons of internal management?  

The pension funds and asset pools in the LGPS vary hugely in how they manage their assets. Some outsource everything; others prefer to manage some assets or even the bulk in-house. With a focus on efficiency, cost and – the cynic might argue – easier control for central government, there could be a shift towards fewer funds, who outsource less.  

The problem, however, starts with trying to define in-house management. There are two ways to understand it, says Neil Mason, LGPS senior officer at Surrey County Council. One is to have a team directly managing the assets – a portfolio management team that makes the actual stock selection calls. Then there is another way to read it, which is the creation of portfolios managed internally. This might include both a team buying stocks and one allocating to funds and managers – the Canadian funds typically have a mixture of both.   

“We are part of the Border to Coast pool. Our position is, the [Surrey County Council] pensions committee will make the strategic asset allocation call, then we allow Border to Coast to implement that for us. Depending on your view, you might say we have internal management,” says Mason.  

He believes the government considers internal management a way to get scale and greater allocation to alternatives and private markets.  

“I wouldn't necessarily disagree, because we make all of our private market implementation through our pool,” he says, adding that this has enabled the fund to harness a team with a capability and capacity that would have been difficult to build.   

Previously, to gain private markets exposure, Surrey would allocate via funds of funds.   

“What the pool has provided is effectively the same at a much lower cost,” says Mason.  

Cost is one thing – performance is another. Mason says it is too early to say how the in-house managed portfolios perform compared with external ones, with Border to Coast not having enough of a track record yet.  

“There have been some studies carried out previously in the LGPS that state internal [active] management is broadly comparable with external,” he says, but as always, “it depends on the data you look at”.   

Mason adds that generally, in-house managers’ benchmark is “slightly less punchy” than that of external managers.  

For LGPS asset pools, building and maintaining in-house teams is not an easy task.   

“Pools are between the devil and the deep sea,” says Mason. They may not have to adhere to councils’ and funds’ pay and reward structure, yet they are quasi-public sector bodies and often viewed in that context. The halfway house that pools represent has generally meant that they have more generous reward packages than local government but not than the wider investment industry.  

However, Mason denies that they are missing out on top talent, as other aspects of the work can be attractive, whether it is being able to live and work outside London, working more flexibly than in traditional investment houses, or to be given the purpose of generating returns for former local authority employees. 

“The LGPS provides pensions for some of least well paid and predominantly part-time female workers,” he points out.  

Overall, he believes there is value in allowing a team with capability and resource to manage the fund's assets. Much value is also added by the committee that sets the high-level investment strategy, including the level of risk and investment beliefs, he says, adding: “Then internal team deliver that.”  

Sam Gervaise-Jones, head of client consulting at consultancy bfinance, says in the LGPS as it is today, “there may be some co-investments etc but the bulk is selecting funds – the pool becomes the fund of funds”.   

This is “better from a fee perspective to giving that money to a fund of funds”, he says.   

Most LGPS pools use this approach for private markets, he explains, while the Wales Pension Partnership and the Access pool take a slightly different approach, appointing a partner as fund of funds provider.  

On the public markets side, however, “quite substantial numbers” are fully internally managed, Gervaise-Jones says.  

To replicate full in-house management in private markets, “you’d hire more staff with a different skill set”, he explains, noting that this was done for UK infrastructure by the initiative that became GLIL, which has a team of people bidding on assets and projects.  

“It's resource and throwing money at it,” Gervaise-Jones remarks.  

Aside from the initial cost involved, there is a further potential difficulty, he notes, and one the Canadian funds have faced.   

While there is money to deploy when building the portfolio, the challenge arises when the allocation is more or less full, but there are in-house team members trained to deploy capital, as dealmaking and monitoring investments require different skill sets.  

“Managing that is quite challenging. What you don’t want is the staff that are dealmakers to twiddle their thumbs,” he says. Yet teams need these people, as if there are not enough dealmakers at the start or when required, “you haven't got staff to ramp up quickly”.   

The issue of maintaining a team of in-house private market dealmakers is exacerbated by rising salaries, Gervaise-Jones suggests.  

An in-house team brings with it all the people aspects that come with employees – absence cover, succession planning and more. This burden could be part of the reason why some large pension funds that used to have in-house teams have outsourced this to a delegated solutions provider.  

Others have gone the other way, perhaps reflecting the fact that performance between in-house and external management is not meaningfully different.  

However, underperformance is never cost-free – there is a cost to changing external managers, but if the internal team performs poorly, “that is a much bigger governance headache”, Gervaise-Jones says.