Why did LGPS funds recently turn down the opportunity to invest in housing assets? Jonathan Bunt argues this is an area where pools could offer real value, if they can learn to move quickly and put the right mandates in place.
In recent years, there has been an absence of good quality index linked products and, as a result, those that are available are very expensive. The demand for such instruments from funds has driven up the price and driven down the value they offer. Similarly, I have recently read a number of articles in the housing press about the attractiveness of housing assets to investors for their predictable real returns.
It is against that backdrop that we recently offered a range of funds an—albeit relatively small—long-term, housing-backed investment with a direct inflation link, to which we received a very mixed response.
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The large city institutions took an immediate and serious interest understanding the nature of the investment and competed to become preferred bidder. This was reflected in their pricing with offers in the range that will enable the local authority sitting behind the deal to beat the Public Works Loan Board rates over the same period.
By contrast, the same investment opportunity received little, or no, interest from the local government pension scheme funds that were approached. The small number of funds that gave it some consideration priced it very significantly higher than the city institutions and were, therefore, never a realistic contender.
LGPS questions
This type of index linked product fits squarely in to an LGPS portfolio as a matching asset offering a real return which, based on the offers from the large city funds, meets common actuarial assumptions. The questions that therefore followed were why LGPS funds were not interested, or competitive, plus what does that mean for the planned pools for the future?
For smaller funds, the limited capacity on pensions investments results in a restricted ability to analyse and evaluate opportunities that are directly presented. In such roles, where pensions may only be part of a role, to have the time to consider such ad hoc proposals is challenging.
In larger funds, where there is greater investment capacity, other issues were flagged. For some, whilst being very experienced managing certain types of investments, this was a different product and one they did not immediately recognise. Accordingly, one of two things then occurred.
Firstly, the knowledge, understanding and experience of the indexed linked market was missing and the fund either did not know how to price it, or priced it way off the institutional investors. Alternatively, the offer was viewed as a property investment rather than an alternative form of indexed linked credit and it was therefore scrutinised in the wrong light leading to incorrect pricing assumptions. The final issue that arose was that the governance of (many of) the funds was such that it could not even attempt a decision in the approximate one month timeframe that the process was working to.
The offer was also discussed with one of the pools and this was a very positive conversation. The gathering of investment professionals in a single place enabled a much more focussed debate on how it would fit in to an LGPS portfolio and offered indicative pricing in line with the market. The issue for the pool was that it had no mandate for such a product as they had not been instructed by the individual funds to consider it at this point.
As a local authority finance director I was always relatively neutral about pools but it is clear to me that here is an area where they can add real value. The challenge for a pool will be to get in to a position quickly where it can gather mandates from the funds and have the authority to place investments directly. To do this successfully, pools will need to ensure it can replicate, or better, the skills, knowledge and processes of an institutional investor and respond with their agility to opportunities. Most local authorities would be much happier to seek funding on the sorts of terms that we have been able to achieve from LGPS schemes but to do so, the pools and the funds have to become market normative.
