Transition management agreements are big step in creation of megafunds
As the first deadline for the pooling of England and Wales' local government pension scheme funds fast approaches, pension pool and money management executives are working hard on transition management arrangements.
The U.K. government announced in July 2015 that it wanted the 91 LGPS funds across England and Wales to pool their investments, with a goal of achieving cost savings and greater economies of scale. The deadline for these eight pools to be formally set up is April, with liquid assets expected to transfer "over a relatively short timeframe" from that date, said guidelines by the government.
Moving these assets from individual plans to a megafund is no small task: the LGPS funds are collectively investing about £218 billion ($305.8 billion) of assets. Some of the pools are further ahead in their transfer plans than others, although all have their transition management arrangements — and the associated costs — high on their agendas.
"It is going to be a major exercise," said Mark Mansley, chief investment officer at the £28 billion Brunel Pension Partnership, Bristol, England. "We are extremely conscious that, in terms of the business case for pooling, the biggest cost item, outweighing the cost of setting up (the pools), is transition."
Cost is particularly important, given that the government's key rationale for pooling was savings: In a 2014 paper, the government estimated pooling could save £660 million per year.
"There's no doubt about it — transition costs will be by far the biggest expense they'll incur in putting these pools together," said Steve Webster, senior adviser at asset management consultancy MJ Hudson Allenbridge in London.
While cost is always a consideration in transition management, there are some aspects that are specific to the LGPS pooling project.
'Two things that are difficult'
"There are two things that are difficult about the transitions from a pooling perspective," said Mr. Mansley. "Firstly, these aren't the sorts of transitions people are doing because they want to, in an investment sense, but (they) have to. As a consequence, there is more focus on cost and especially strategic structuring to minimize costs — so there are slightly different ways of doing the transitions, such as phasing them (in) over a longer period."
Mr. Mansley said executives are doing a lot of work on that area of the project.
Pool executives also need to ensure each of the LGPS funds involved in the pools is treated fairly when it comes to costs, so a transition cost framework has been agreed. "The intention is that the majority of the initial costs will be pooled or shared, but how that will absolutely work in practice is something we need to work through with clients and ensure it is a transparent and fair process. That involves bespoke work, so we are looking to the transition advisers for support," Mr. Mansley said.
While the first deadline is approaching, executives at the pools said it is just the start of a set of long-term projects to transfer their assets. They are at different stages in the process.
One of the furthest along is the £13 billion Local Pensions Partnership, London, which operates under an asset and liability management arrangement among its three LGPS member funds. The pool has been operational for almost two years and received Financial Conduct Authority authorization for investment subsidiary LPP Investments Ltd. in April 2016. About 75% of the assets of the three funds that make up the partnership are managed in new LPPI-managed strategies, and the rest remain on the respective shareholder's balance sheet said Susan Martin, CEO at LPP.
"As LPP stands today, we have completed two significant transitions that required a transition manager. If a third-party transition manager is required in the future then we would expect to carry out a review of the marketplace in order to identify the best manager for the job," Ms. Martin said.
Executives at LPP might also make use of an LGPS national framework for transition management — a panel of transition managers and consulting firms designed to ease the procurement of these firms. For private market transitions, LPPI "has managed these in-house," Ms. Martin added.
Established an office
The Brunel pool has established an office and is approaching a fairly complete team. It is also close to achieving FCA authorization. "Until then there is actually very little we can do in an investment context. But that's not stopping us moving forward with various things," said Mr. Mansley.
Executives envisage a two-year transition process ending April 2020. "We are at the start of that process, and now thinking a lot more actively about the details of this transition and how we will use transition managers," Mr. Mansley said.
Executives are "at the moment moving forward on our passive manager selection process" — a big chunk of the pool's assets at £7 billion. "With the passive transition it is almost entirely sensible to use your passive manager to do the transition. However, the transition still involves lots of technical details so we are using the (national) framework to find a transition adviser to ensure we get the best results. Experience here will help us assess whether these transition advisers will add value for us going forward," he added.
The Border to Coast Pensions Partnership, South Shields, England, "made it clear quite a while ago that we would begin pooling assets probably three months later than the April kickoff date — late June or early July," said John Harrison, interim chief investment officer at the pool. The £43 billion pool's individual member funds have both internal and external management of assets, and will first transfer the internally managed assets, following up with a second wave toward the end of the year for some of the external allocations.
"The entire process of moving from where we are now to the fully formed pool will take a couple of years. One would expect the amount of transition activity along that journey to be higher in volume for externally managed assets than internally — one reason is there are many more individual portfolios which will then be rationalized into (a) smaller number of managers. We are now starting to engage with the transition management community," said Mr. Harrison.
The pool also is waiting for FCA approval, is in the process of building an investment team of 35 people, including transferring investment staff from the individual LGPS funds, and also is defining the order of the initial group of investment strategies it will run. "But in terms of defining the assets to move and particularly who will help us, that is still work in progress. My expectation is that, to the extent that the national framework exists, we're more likely to draw on that than create something ourselves. But that's not a decision we have taken," he said.
And for the about £32 billion ACCESS pool of 11 LGPS funds, recent emphasis has been on choosing its "rented operator," an external provider of its investment vehicle.
Economies of scale
"In the meantime, the funds themselves have been working on identifying commonality of assets, suitability for initial transfer to the pool," said Alexander Younger, investment and accountancy services manager at the £2.9 billion Norfolk County Council Pension Fund, Norwich, England, which is part of the ACCESS pool. "But that first stage for us is emphasizing early economies of scale and a powerful fee negotiating position. We have not put huge emphasis at this stage on identifying transition partners." Executives expect monies to begin transferring this summer.
While the pool has not acted specifically with transition managers, individual funds have existing relationships. "We expect over the short and medium-term to maintain (those relationships), working on our behalf as we move those assets across to the pool. It will be for the pool operator considering the needs of the constituent funds ... to find an appropriate appointment for the larger scale transition piece where actual restructuring of assets is required," said Mr. Younger.
Whatever stage the pools are at, there is significant work ahead for executives and providers. "At its core, this activity is a significant asset management exercise, and cannot be simply defined as a large trade," said emailed comment by James Sparshott, head of local authorities, and Catherine Darlington, transition manager, at Legal & General Investment Management in London. "The complexity of stakeholders, investment vehicles, ensuring a transparent and auditable process are all things transition managers are adept at dealing with but will be placed in a particular context through pooling."