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Minimum size constraints mean local authority pension schemes often struggle to justify investing in small infrastructure projects that deliver a social benefit for their stakeholders and communities. The problem can only get worse as their assets get pooled into larger Collective Investment Vehicles over the coming years.
As well as only representing a very small part of a larger scheme’s assets and therefore having a limited impact on total returns, the administrative costs could put a disproportionate burden to CIVs. Furthermore without full agreement on the balance between social and environmental impact there is a danger that some CIV partners will feel that they are cross-subsidising those who favour greater social impact for their investments.
To continue backing projects which offer a positive social impact, on a fair basis, there is only one solution, which is cost effective, to allow local schemes to forge partnerships with specialist managers that combine a professional process with discretion for local authorities to direct funds where they are needed.
The average size of Britain’s 89 local authority pension funds is £2.3 billion. The UK local government pension scheme pools will dwarf this sum. For instance, the central CIV, a collaboration of nine funds across the centre of England, will have assets of around £34bn, a similar size to the northern pool, a collaboration of four sets of scheme assets across northern England.
The aim behind consolidating local government pension schemes (LGPS) goes beyond pooling the assets of a significant number of small schemes to save on management costs and fees, and encourage greater diversification. It is part of the government’s wider plans to invest more money in infrastructure projects across the UK with a ticket size typically of £100 million. Small local pension schemes ‘lack the expertise’ to invest in infrastructure, the government said in 2015.
While there is some truth to this, especially in terms of local authorities not having the financial resources to employ experienced managers to oversee such projects, the outcome of pooling will inevitably undermine small scale, local infrastructure projects. For a local authority with a large degree of separation from the fund manager, directing £20 million or less to a local housing scheme or electric car charging points will not be a viable option. But these are projects which can generate a good return and benefit local residents.
To access small infrastructure investments, the pooled funds would also need to hire a specialist team, thereby increasing management costs. Even if they did invest in small scale projects, a local authority would have no guarantee that the pooled funds, and therefore a percentage of their own pension pots, would invest in enough local projects to benefit their constituents.
All of this goes against a trend which favours an increase in socially or environmentally beneficial investing for pension funds. A recent survey by the Local Government Association showed that 67% of respondents believe that councils should not invest their pensions in areas that had a negative social or environmental impact or do not match their values.
For instance, in 2016 Waltham Forest Pension Fund in London committed to being the first UK fund to go fossil free while many more have increased their investments in low carbon and ethical funds. It may not be easy to persuade a pooled fund to buy into local initiatives like these.
According to research by State Street, local government pension managers in the UK have increased their allocations to alternative investments such as infrastructure, innovation space, and specialist housing recently – by as much as two-thirds in three years from a low base.
There is untapped potential to do more.
Herein lies the opportunity for partnership.
Following their pooling, local authority schemes can retain “local” assets outside the pool and co-invest in local projects, through a partnership with a specialist entity. They would need to access research teams and fund managers that can facilitate onerous due diligence processes, allocate capital to smaller scale infrastructure projects, and drive value through expert management. This kind of co-investment would also allow increased discretion on a deal-by-deal basis so local authorities can choose to add funds to projects that sit in their own back yard.
Earlier this year Royal County of Berkshire Pension Fund confirmed that it would be the cornerstone investor to specialist asset manager Gresham House’s British Strategic Investment Fund. This fund is part of a platform designed specifically for local government pension schemes and other institutions to generate sustainable attractive returns through smaller scale alternative and illiquid infrastructure and housing investments.
The British Strategic Investment Fund answers a question that until now has been left unanswered within the current pooling discussions: Will pension pools mean the end of investing locally and regionally? It doesn’t need to be the case.