Pooling is well under way but there remains outstanding issues for some. Chris Buss argues funds should be allowed to shop around pools to find the best investment products.
When the facts change, I change my mind.
The quote above is attributed to John Maynard Keynes and is a warning against being dogmatic. As circumstances change what may have the right solution in the past is, perhaps, no longer the correct solution now, or in the future. Events move on, and solutions must keep up with events.
However, in the public sector we, perhaps, have a tendency not to move on but to stick to a single solution without considering whether it is out of date.
In my opinion, which may not count for much, this is where the LGPS, at least in London, now finds itself with regard to collective investment or, as the government like to call it, pooling.
Coming together
The birth of collective investment, as a concept in London, dates back some six years. It was clear from studies commissioned by the Society of London Treasurers that the then 33 borough-based funds had diverse performance levels, both in terms of fees paid and fund performance, and that between us we were paying the same providers different sums for the same product.
Room151’s Annual Conference – September 20th, 2018, London Stock Exchange
Local Authority Treasurers’ Investment Forum and FDs’ Summit
So, the concept of joining together to seek fee savings through collective investment was conceived. A little later, the idea that the then structure of each fund effectively doing their own thing was not the most effective use of resources took root nationally.
The government consulted and then issued regulations on pooling. As a consequence, a significant regulatory infrastructure has developed.
The national pooling arrangements have evolved into a system of pools in England that, in the main, do not have the tight fit for geographic identity that London has but, instead, have been formed from like- minded council’s being able to get together.
This was not the position in London. The London CIV has moved from a local voluntary initiative to a system of compulsion both at national and, if we are not careful, also at a regional level.
The borough funds have widely different investment strategies due to cash flow needs, funding levels and differing appetites for risk. This makes a rigid pooling structure difficult, if not impossible, to implement due, in part, to the wide range of funds in the pool.
This was far less of an issue with a voluntary scheme which would give inherent flexibility that the regulated CIV structure does not.
Rethink
The structure in London needs a rethink, which has happened.
But what is now being proposed fails to address the question of choice. Indeed, part of the issue lies elsewhere and needs a rethink by central government.
The voluntary arrangements envisaged funds opting in and, when originally conceived, would have enabled funds to buy into pools other than their host as further collective arrangements came into being.
This option of opting into products provided by other pools was denied by government despite strong representations by many funds and removes one of the key elements of any successful economic system: competition.
The pooling arrangement has effectively created a group of monopoly providers of products to the member funds within each pool.
Anyone who understands basic economics understands that monopoly providers are usually a “bad thing” for those who are forced to buy services from them, because a monopoly provider often provides what is easiest, cheapest and most convenient for them to offer rather than what the consumer needs or wants.
In the pools with a smaller number of fund members, the funds may have greater leverage over the provider.
However, the London arrangement, with more than 30 funds involved, means that the needs of individual funds are less likely to be heard.
Employing more client engagement officers is unlikely to improve matters but instead increase the costs to constituent funds.
Similarly, a new (allegedly) slimline structure reduces accountability for those that own the vehicle that runs the pool.
Alternatives
A few months ago, five London funds, who felt that the pool wasn’t listening to them, created their own pooled mandate for fixed income. I suspect other similar initiatives will happen if pools do not respond quickly and positively enough to their memberships.
Pools, both in London and elsewhere, need to remember that they were created for the sole purpose of serving the needs of their member funds and are not there for their own self-justification. The operators are servants of the funds.
However, the current structure, in London at least, could, in some scenarios, see the operator becoming the masters and the funds subservient. In my view, not a desirable outcome.
In London we have seen that there is the potential for the pool becoming more and more involved in investment decisions at a lower level, and the funds left holding the financial consequences of those decisions.
I realise that some funds may be content with this situation which, I accept, is particularly unique to London. But I am not sure that this outcome is what we need.
This is because of who picks up the bill when it goes wrong. I know in other parts of the country the link between the fund and the funder is much more diverse, but in many London boroughs more than 85% of a fund’s membership is linked to the borough hosting the fund.
There is, therefore, a direct link between performance levels and future council tax levels, which is less evident in the counties and the former metropolitan county funds.
This, to me, presents a real issue in accountability particularly for a well-funded fund, which may have investment needs that a single pool cannot meet and would clearly be at risk, in some scenarios, of dumbing down.
In my view, anything that leads either to a levelling down of performance, or cross subsidy between funds, weakens the link back to the host council tax payer and reduces accountability.
Shortly, funds will have to give an account to government for the reasons why they haven’t yet pooled some of their assets.
I suspect that some of the submissions will make interesting reading. Some will I suspect have the simple explanation: “My pool currently doesn’t have what we need to meet our strategy.”
If that is the case, what happens next? Will government force a pool to open a mandate to take the requirements of the fund, or will they force the fund to change its strategy to meet what the pool has on offer. I suspect it will be the latter, confirming my fear that pools will be the masters.
Shopping around
So, what is the solution? Ideally, I would like government to rethink two issues: The notion of compulsory pooling and the ability of funds to shop around between pools.
Realistically, I can’t see the former happening, but the latter does have some merit. It would create competition between pools and competition, despite what some might think, has greater economic merit than a monopoly.
Government think again.
Chris Buss is executive director, resources and assets Royal Borough of Kensington and Chelsea.
The views in this article are personal and may not reflect the views of my employing authority.
