Investors have locked horns over the respective merits of active and passive management for years, but the debate was reignited recently over a proposed series of radical changes to the investment strategy of the Local Government Pension Scheme (LGPS) aimed at saving the taxpayer millions of pounds a year.
In May the Department for Communities and Local Government (DCLG) published a consultation paper proposing two key changes to the scheme: moving its £89bn of actively-managed listed assets into passive management, to be accessed through a common investment vehicle (CIV); and replacing all LGPS funds of funds arrangements with a CIV for alternative assets.
According to analysis by consultant Hymans Robertson, published alongside the consultation, these two changes will save the LGPS £420m and £240m a year, respectively, if all of the funds adopt the proposals in full. The driver of these massive changes is cost: figures from the DCLG show the cost of the LGPS to employers in England alone has almost quadrupled from £1.5bn in 1997/98 to £5.7bn in 2012/13.
Other figures published as part of the call for evidence show the reported cost of investment in cash terms has risen from £340m in 2010/11 to £381m in 2011/12 and £409m in 2012/13, while data from Hymans Robertson identifies investment management fees could in fact be reaching in excess of £790m.
The desire to bring down costs is therefore understandable, but with 89 separate funds and some £178bn under management collectively, achieving collaboration and consensus across the LGPS has been a long-running battle. The government has already introduced a revised benefit structure which came into effect on 1 April this year, but it believes more can be done to reduce LGPS costs even further.
Four options
The consultation proposes four possible solutions to address this: funds could be required to move all listed assets into passive management; funds could be required to invest a specified percentage of their listed assets passively, or to progressively increase their passive investments; fund authorities could be required to manage listed assets passively on a “comply or explain” basis; or funds could simply be expected to consider the benefits of passively managed listed assets.
The DCLG consultation resonates with a paper published by the Centre for Policy Studies (CPS) think tank in November last year, which described the LGPS as “woefully inefficient” and comprising “101 opaque, predominately sub-scale, inefficient, funds, with excessive costs and lax governance”.
The paper outlined a strong negative correlation between administration costs per fund member and fund scale. Essentially, the larger the fund, the lower its expenses with investment costs ranging from £7.60 per member (West Yorkshire) to £317.30 (City of London). Among the think tank’s suggestions was a proposal to re-design the investment process, emphasising investment in passive rather than actively managed funds, which it said could save £860m a year.
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