LONDON -- A shakeup is likely in the management of British local authority pension funds starting in April, when local authorities will be obliged by government to scrutinize the costs and value-for-money of the services they receive and provide.
As a result, consultants expect Britain's nearly 100 local authorities to:
* launch asset-liability studies;
* follow plan-specific benchmarks;
* carefully weigh up the benefits of outsourcing mandates; and
* scrutinize the fees charged by external money managers.
Come April, local councils will have to review all levels of service by applying a set of specific criteria to ensure they are getting "best value." Britain's central government wants its local councils to ensure they are offering and receiving a competitive service. So local authorities will be expected to compare costs with other councils and service providers and consult with all parties involved in providing a service.
While this might sound like bureaucrat-speak, the process will have a tangible impact on the management and administration of the 82 billion ($131.2 billion) held in local government pension funds, according to Val Burdett-Callen, the head of the pension fund consulting division at Sector Treasury Services Ltd., London.
She thought the policy would necessitate a thorough review of a fund's structure, as well as the fund's managers.
She also thought asset-liability studies would increase under the best-value regime as fund administrators attempt to limit risk. Currently, fewer than half of Britain's local authorities use asset-liability studies, largely because local authority plans don't fall under the minimum funding Requirement, which was instrumental in the restructuring of Britain's corporate pension plans, she said.
As asset-liability studies were adopted, a shift to customized, plan-specific benchmarks and away from the use of peer group comparisons also would occur, Ms. Burdett-Callen added.
Most British local authority pension plans use The WM Co.'s U.K. Local Authorities Weighted Average index as a benchmark for their balanced managers. But the index is made up of a relatively small group of plans, most of which had mandates with Deutsche Morgan Grenfell Asset Management Ltd., London; Schroder Investment Management Ltd., London; or Phillips & Drew Fund Management Ltd., London.
As a result the benchmark is dominated by a particular style of management and other managers have been reluctant to take the commercial risk of moving too far away from the benchmark, she said.
Asset-liability studies also would encourage local authority funds to invest in corporate bonds and increase their exposure to emerging market assets in order to improve returns on capital, said Ms. Burdett-Callen.
Consultants, money managers and local authority plan administrators expect the best-value policy to accelerate a move to specialist mandates and away from balanced managers. It also would encourage local authority plans to make greater use of index management -- partly because index funds are cheap to manage, and technology allows them to be managed easily in-house by a local authority.
"A pattern of passive core, internally managed funds and active satellite, external management is going to appeal to most local authority funds," said Roger Moreton, director of Derbyshire Investment Services, Ashbourne, England.
Peter Swaby, county treasurer of the Derbyshire County Council, Matlock, England, where the 1 billion pension plan is managed in-house, believed best value would encourage councils to manage more of their money in-house.
Mr. Moreton, consultant to the Derbyshire County Council plan, agreed. The recent divergence and instability of returns from external money managers also would strengthen the move to internal management, he said.
But Ms. Burdett-Callen warned it is not cost-effective for pension funds with less than 500 million in assets to manage their assets in-house.
"It is not terribly economical for funds smaller than that due to the costs of deploying staff, buying access to information sources such as Reuters, and the potential loss on dealing costs due to the relatively small size of transactions," she said.
But for large plans, managing funds in-house can be considerably cheaper than using external managers, said Stuart Imeson, head of pensions investments at the 3.8 billion West Yorkshire Pension Fund, Bradford, England.
Recent research by the Chartered Institute of Public Finance showed that external manager fees were roughly double the cost of in-house managers employed by local authorities, he said.
Fee scale issue
Fee scales will be one of the more contentious aspects of best value, but it is a review most local authority plan administrators will relish.
"There is a culture in the City (of London) that does not lend itself to being completely open about the full costs of managing money," said Roy Wilson, chairman of the U.K. Local Government Pensions Committee, London.
Most funds pay their managers a certain percentage of the market value of the fund, and managers have done well over the past few years as the markets have grown despite relatively unexciting investment performance. Ms. Burdett-Callen expects to see funds combine flat-rate fees with a performance-related fee, using certain upside and downside limits. "The whole issue of fees is very difficult due to the lack of transparency between fees charged by the manager and the custodian," she said.
Iain Brown, U.K. equity fund manager for Norwich Union Investment Management Ltd., London, said fees are not an important issue so long as a money manager offers value for money in terms of good performance. Figures for 1999 showed the group's U.K. pooled funds had outperformed the U.K. FTSE All Share Index 24.2% return by eight percentage points, he said. Performance-related fees are not the norm with local authority clients, but the firm would be willing to accept such fees if a client asked, he added.