Persnuffle and LGPS

The inclusion of the LGPS in the PSNFL (persnuffle) and what that could mean has taken up rather too much of my time over the last week and a bit. I thought I would write down where my meandering thoughts have taken me so as to not make them a complete waste of my week.

Does inclusion of LGPS increase the chance of LGPS needing to manage risk?

The LDI element of this is mentioned in this useful Hymans Robertson piece. To a certain extent I agree with the conclusion on LDI

The OBR essentially assumes all (give or take) LGPS assets are in equity (probably a bit too high but the sentiment is probably fair).They point out that just a 2% underperformance of equity (below GDP) reduces headroom for the government by ￡10bn (see B.23 here). This has meant people have asked me whether options might be used by LGPS to stay in equity whilst limit some of the downside risk.

When you think about a 20% shock to equity implying a ￡100bn impact on headroom I think managing this risk must surely be in the government (and LGPS’s mind). Related to this the OBR is only assuming equity returns move in line with GDP growth so there is certainly room to sacrifice some (but not all) upside return to pay for that protection.

Does the absolute level of the persnuffle matter?

From what I have read (apologies if I have got this wrong) the fiscal rule relates to the trend in the persnuffle (as a % of GDP) at the end of the forecast period (a rolling window). The OBR numbers I saw (B.1 in the above link) show this happening before the end of the period as falling from 84.1% ish to just below 83.4%.

It made me wonder though does the fiscal rule differentiate between the above and if it falls from 104.1% to 103.4%? If not then you have this perverse logic where a shock to equity values early in the forecast might actually be ok so long as they recover later in the forecast. Through that (quite narrow, technical reporting) lens I think the argument for managing the LGPS risks is weaker.

The government must be considering how to manage LGPS risk surely?

I struggle to believe that volatility in the persnuffle from LGPS is not on the governments radar. An important point here is obviously that that volatility could be positive – i.e. if the funding improves then this provides more headroom. As a result the government has to be considering how to manage that impact and maybe even use it to help the government agenda.

What could the government do to LGPS?

Pre-budget there was lots of talk of growth and the budget was significantly lacking in growth talk. Add to this the trailed admiration of a Canadian type model / mega pension fund. Then add the story in the Times at the weekend about a rumoured LGPS merger and it seems almost certain the government will do something along those lines in a big reveal to support the growth agenda.

Indeed this was the hot topic the Room151 annual investment forum and there is nice coverage here. This seemed to dampen the thought of a single pension fund but the desire to be “ambitious” and highlighting that some pools “have embraced pooling with the same enthusiasm” definitely feels like a shrinking number of pools.

Something not covered that I am interested in is the likelihood of merging of funds (which is actually what the Times article seemed to be talking about). My understanding is that the LGPS is created in statute and so a government with a large majority must be able to redefine the LGPS - essentially move from 90 ish administering authorities to 1. This would obviously provide a single body that can make decisions on strategy.

How could the government achieve the investment in growth aims quickly using LGPS?

Firstly I think the consolidation here is a means to an end as I think was the case with pooling. The end being to become a larger (more Canadian like for example) fund that invests in things that has more impact. Therefore the first question is how can the government get LGPS to invest how it wants quickly? The obvious answer here is to mandate it and worry about consolidation later. The challenge to mandating (as is touched upon in the r151 article) is the LGPS fiduciary duty (and related elements) of LGPS. In my inevitable naivety this seems like something that can simply be changed with regulation. On top of that if the end game is LGPS becoming a single government pension fund and the liabilities of that fund sit on the governments balance sheet then ultimately that fiduciary risk falls on the government anyway. A thought that came to me was could that mandate be as simple as LGPS need to invest [x]% in the newly created National Wealth Fund.

The follow on thoughts would be if that happens what do LGPS sell in order to invest as they are told and will that be part of the mandate? Clearly selling UK equity would not be a great look.

?What could a consolidated LGPS investment pool(s) look like?

A mega fund of the order of hundreds of billions will inevitably need managing in sub-teams anyway. So a situation where some (the ones that have embraced the spirit of pooling, maybe those set up as a fully regulated asset manager) of the pools remain as those sub-teams. So perhaps a full merger isn’t required and actually what is required is an overarching investment function that decides on asset allocation and manages the sub-teams. Closer to home for me here is how I think most (if not all) mega funds will have in-house derivatives capability. This is lacking in LGPS at the moment so how they develop that capability will be fascinating (you won’t be surprised to hear I have some ideas on this).

Who loses out?

I think this is quite simple. Asset managers. The creation of a bigger fund inevitably means more in house teams and less use of external managers. This really good article (with some cool graphics) from Toby Nangle actually summarises it perfectly.

My (clearly biased) view here is that whilst it might hurt traditional (and lazy) asset managers but could be an incredible opportunity for new and innovative asset managers and provide the disruption required in the asset management industry.

What about private sector DC and DB?

I haven’t really been thinking about this too much but if the government can create this investment powerhouse I think a really interesting angle would be for it to offer its services beyond LGPS. The PPF has already been discussed as a consolidator of funds at a total level so why would the new mega fund not aim to offer asset management to private sector schemes (DB and DC) as well?

Right. Back to some proper work.