Pooling targets the fast lane

The Ministry of Housing, Communities & Local Government (the Government) has issued in January proposed statutory guidance to support further progress with investment management pooling of local authority pension scheme (LGPS) real estate and other assets. The Government recognises that “there is still a long way to go to complete the transition of assets and to deliver the full benefits of scale” with pooling.

The LGPSs have chosen to form 8 asset pools. The Government comments that their scale makes them major players at European or global level, and “significant annual savings have already been delivered, with the pools forecasting savings of up to £2bn by 2033”.

The Government’s consultation closes on 28 March 2019. Thereafter, we can expect the guidance to take effect.

Guidance Consequence

The pools must appoint a FCA regulated pool companies to implement their investment strategies including the selection of investment managers, the management of internally managed investments and Authorised Contractual Scheme (ACS) pool funds. The pool companies will decide which investment managers to use: whether in-house or external management – with the LGPSs continuing to decide if they wish to invest via in-house or externally managed vehicles.

The Government expects regular review of services as well as active and passive management. The service review goals target value for money and cost transparency. Where services are procured by the LGPSs, they are required to review regularly the rationale and cost-effectiveness of such arrangements (compared to procurement and management through the pool). The pools are encouraged to use the national LGPS procurement frameworks: click here. 

In addition, the balance between active and passive management - in the light of performance net of total costs – should be reviewed. The pools should consider moving from active to passive management “where active management has not generated better net performance over a reasonable period”. In addition, pool members should seek to ensure performance by asset class net of total costs is at least comparable with market performance for similar risk profiles.

Real estate continuing challenges

The overall expectation is that LGPS members should transition existing assets into the pool as quickly and cost effectively as possible: for example, the transition of listed assets should take place over a relatively short period. However, the Government appreciates that in exceptional cases, some existing investments may be retained by the LGPSs on a temporary basis. “If the cost of moving the existing investment to a pool vehicle exceeds the benefits of doing so, it may be appropriate to continue to hold and manage the existing investment to maturity before reinvesting the funds through a pool vehicle.” In this respect, the LGPSs may also retain existing direct real estate assets where these may be more effectively managed by the individual LGPSs.

For real estate, this raises challenges. Will the individual LGPS direct real estate investments sit comfortably within the pools’ real estate investment management goals? What is the scope for minimising the Stamp Duty Land Tax and other transaction costs, given the limitations of the current SDLT relief for the investments being transferred into the pool vehicle (assumed to be an ACS pool fund)? What are the implications for indirect real estate assets: transition or not to transition?

The Government expects regular review of retained assets, at least every three years, and of the rationale for keeping these assets outside the pool. The review focus will be on whether management by the pool company would deliver benefits. LGPSs should consider the long term costs and benefits across the pool, taking account of the guidance on cost-sharing: the presumption should be in favour of transition to pooling.

Infrastructure silver lining?

The Government helpfully states that “infrastructure investment has the potential to provide secure long term returns with a good fit to pension liabilities, and form part of investment strategies of authorities. The establishment of the pools was intended to provide the scale needed for cost- effective investment in infrastructure, and to increase capacity and capability to invest in infrastructure.” Pool companies are expected to provide access to a range of options over time including direct and co-investment opportunities.

The LGPSs should set an ambition on infrastructure investment. The Government expects pool companies to provide the capability and capacity for pools over time to move towards levels of infrastructure investment similar to overseas pension funds of comparable aggregate size. In defining infrastructure assets, the Government refers to guidance from the Chartered Institute of Public Finance and Accountancy: key sectors for infrastructure include health and education facilities, social accommodation and private sector housing. All residential real estate is included in this definition of infrastructure i.e. not restricted to social accommodation or private sector housing. However, conventional commercial real estate is not normally included, “but where it forms part of a broader infrastructure asset, helps urban regeneration or serves societal needs it may be”.

New investments

LGPSs should normally make all new investments through the pool company. Following the 2019 valuation, the LGPSs will review their investment strategies and put revised strategies in place from 2020. From 2020, when new investment strategies are in place, LGPSs should make new investments outside the pool “only in very limited circumstances”.

LGPSs may invest through pool vehicles in a pool other than their own where collaboration across pools or specialisation by pools can deliver improved net returns. During the period of transition (while pooling is being implemented), LGPSs may make new investments outside the pool, if following consultation with the pool company, the LGPSs consider “this is essential to deliver their investment strategy”.

Pooling to be accelerated: query real estate?

Fund managers and other LGPS service providers can expect the current pace of transition to pooling to be accelerated. However, there are continuing challenges with transitioning real estate mandates. The Government, LGPSs and our real estate fund industry should collaborate, and resolve these challenges – so real estate will also enjoy the benefits presented by pooling.

For more information, please contact Melville Rodrigues on +44 (0)20 7427 6403 or at melville.rodrigues@crsblaw.com.