Commenting on DCLG’s latest call for evidence, CPS research fellow Michael Johnson said the Hymans Robertson analysis (see table above) revealed that, on average, any additional performance generated by active management (relative to the benchmark indices) is insufficient to overcome the additional costs, adding it is better to invest passively, tracking the appropriate index.
Johnson added: “Active fund management has finally been revealed for what it is: a web of meaningless terminology, pseudoscience and sales patter. For too long, active managers have been allowed to shelter behind their standard disclaimer concerning the long term nature of investing.”
Missing the target
In the capital, plans are underway for a London CIV, which is expected to launch in May 2015. According to Richard Greening, pensions sub-committee chairman at the Islington Council Pension Fund, the current powers-that-be have put forward passive equity as the first asset class to invest in, but he does not believe this is the best place for the CIV to start.
He explains: “A guy in our Treasury team consistently beats the index so why would we want to mess with that? It’s the last thing I want to mess with. Basically I am getting good, low-cost performance from our in-house team, which a CIV is unlikely to beat.”
Greening believes it would be better for the CIV to begin with more complex asset classes which certain funds lack the governance budget to be able to invest in. “We are interested in infrastructure and property,” he says.
“Doing it through a CIV is an excellent way of sharing costs and accessing assets with the right profile – stable, long-term inflation- matching. I am keen they begin to focus on some of these difficult areas where we want the assistance.”
Greening also believes the government should consider allowing LGPS members to build up in-house teams for investing in less demanding asset classes, such as passive equity, because in-house teams often perform better than external fund managers. At £918m, the Islington Council Pension Fund is not a big fund compared to some of its LGPS peers, but if a scheme of its size can manage a degree of in-house management then potentially other others could as well.
“You can’t be ridiculously ideological about that, but for the basic stuff like passive equity, you should manage it in-house,” says Greening.
More than costs
Crucial to the debate around investment reform is governance, levels of which vary across the LGPS from smaller schemes with smaller governance budgets to bigger players who manage all or some of their assets in-house, or have investment committees dedicated to investment which can better research managers. Using CIVs is one way to address economies of scale and reduce costs, but there are many different interests vested in such schemes.
Russell Investments head of the pensions solutions group Shamindra Perera says: “Having CIVs is one way, but the governance of those vehicles needs to be properly thought through – who manages them? Who is accountable?”
Perera also feels the consultation focused too much on costs when the real issue is whether or not local government schemes have the adequate governance in the first place. “You can’t look at whether something works or not unless you review the governance,” he says. “If you have the wrong governance that is the problem rather than the cost of the services. Cost is one side of the coin – what are you getting from that cost?”
Meanwhile, Aon Hewitt principal Colin Cartwright believes while the cost of fund management contributes to increasing deficits and is therefore important, it only goes a small way towards plugging them and ultimately the long-term aim of LGPS reform should be to address deficits through smarter investment strategies.
“It is also important to look at returns net of fees, because it is those that will close any deficit,” says Cartwright. “We do think active management net of fees adds value, but it is about the governance you put around that.”
Part of the issue around value is that many so-called ‘active’ fund managers are hugging benchmarks by investing in hundreds of stocks and taking tiny positions versus an index. In doing so, many managers are delivering little, if no, added value to schemes.
In fact, research by Aon Hewitt has found UK pension schemes are losing out on £1.7bn in potential annual returns by accepting passive-style performance from actively managed funds. It found at the end of 2013 £460bn of UK pension funds’ £840bn of equities was actively managed with around 75% of this active money allocated to core active funds, which, it said, do little more than track their benchmark.
This, it added, results in UK pension schemes receiving sub-optimal returns on approximately £350bn of assets. If these assets could deliver an extra 0.5% a year either through better returns or lower fees that would be an extra £1.7bn in the real value of pension plan assets per year.
Aon Hewitt partner Tim Giles says: “We still think there is money made from active, but we think a lot of that is being missed because you are going into pseudo-passive managers who track the benchmark too closely and will struggle to outperform net of fees. If you are going to do active, do it properly.”
Think small
This often means selecting managers who have a long-term investment horizon, focus on one asset class and favour limiting capacity in their funds rather than growing them until they become too big.
According to Jon Little, partner at Northill Capital a firm that provides equity and seed capital to early stage asset managers – there is a right size for each manager, but people get “obsessed with growing”.
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