How UK’s LGPS still has a long way to go creating a Canadian model

The winds of change are blowing for the UK’s £354 billion Local Government Pension Scheme, LGPS, one of the largest DB funds in the world. New Chancellor of the Exchequer Rachel Reeves has returned from a trip to Toronto where she went to glean ideas from Canada’s Maple 8 bosses on how to create a “Canadian style” pension model in the UK.

Reeves wants to unlock the investment potential of LGPS to “back Britain” and drive investment in productive assets. She also wants to speed up the pace at which the 86 individual funds that make up the LGPS pool their assets into eight larger groupings.

A process begun in 2018 but which has been slow to create the low costs and scale that underscores the analytical expertise, portfolio efficiency, liquidity management and access to private markets via partnerships and co-investment for which the Canadian model is celebrated.

“I want British schemes to learn lessons from the Canadian model and fire up the UK economy, which would deliver better returns for savers and unlock billions of pounds of investment,” she said.

Still much to learn

The UK’s LGPS still has much to learn from the Canadian model when it comes to the benefits of scale. Although the transition to pools began six years ago, progress has been piecemeal and industry body PLSA estimates that only around £145 billion (39 per cent) of total LGPS assets have been transferred from the pension funds to the pools to date.

Some of the pools have made huge progress. Border to Coast invests on behalf of 11 local government pension schemes with a combined £64 billion of which about £45 billion has been pooled into a suite of new portfolios able to scale and cut costs: the asset manager says it has managed to cut private market fees by nearly 30 per cent.

Elsewhere, 84 per cent of Brunel Pension Partnership’s 10 LGPS clients’ investments sit within the partnership pooled structure and Brunel estimates it is saving £41 million a year for its partner funds, putting it on track to significantly surpass its longer-term target of annual savings of £43 million by 2025.

But at others it has been much slower. Witness LGPS Central, the £55 billion asset manager for eight local authority pension schemes in central England where some of the funds in the partnership have transferred 90 per cent of their assets but others only around 20 per cent.

Slow progress is reflected in enduringly high costs. According to the latest LGPS report, in 2023 administration and governance costs as well as management fees and transaction costs all jumped. Government figures estimate the whole LGPS spends around £2 billion each year on fees, an increase of 70 per cent since 2017. In contrast, Canada’s CPP Investments’ most recent operating expense ratio was just 27.5 basis points (bps).

Governance

One reason pooling has been slow is because of governance, another area the two systems diverge. The Canadian system is built on clear government policy, but the original LGPS pooling criteria was vague, only stipulating a £25 billion ($32 billion) target AUM for each pool and a commitment to reduce costs and boost investment in infrastructure.

“The government needs to ensure it offers a clear steer, coupled with consistent policy that is properly enforced – it’s worth remembering the role of policy makers in creating the Maple 8,” says Laura Chappell, chief executive of Brunel Pension Partnership. [For a detailed history of the Canadian model, including the role of policy makers and the importance of governance, visit this story reflecting the views of four of its pioneers from this year’s Fiduciary Investors Symposium in Toronto].

The £18 billion West Yorkshire Pension Fund for local government employees in the north of England is an example of how some funds have taken their own approach to pooling. It has pooled its private equity and infrastructure allocations into Northern LGPS but continues to invest the bulk of its assets via its own 20-person in-house team.

The difference in governance between the Canadian and LGPS pension systems is also evident in the fact Canada’s funds are run at sufficient distance from the government. They have independent governance, all of which facilitates agile, independent decision-making.

The LGPS’ proximity to policy makers where elected councillors and union members sit on pension fund boards will particularly manifest around compensation, another tenet of the Canadian system.

At FIS Toronto Ontario Teachers’ Pension Plan inaugural chief executive Claude Lamoureux counselled on the importance of staff compensation to ensure funds can hire and retain the best people. According to IMCO’s Annual Report, generous incentive compensation on top of a base salary meant CIO Rossitsa Stoyanova received $3.1 million in 2023.

“We understand that it is hard for councillors to feel comfortable paying City salaries, when they are also cutting services,” says Chappell who says Brunel can offer acceptable industry levels of compensation but is also constrained. “It’s the same principle you come across in investing again and again – independent governance allows you to pay what’s right for the expertise and services required,” she says.

But for all the work ahead to align the two systems, Reeves’ Toronto trip also serves to highlight the progress and similarities.

Pools like Brunel and Border to Coast have created FCA-regulated asset managers and re-tendered portfolios, moved staff to shared offices and nurtured new cultures into life.

Similar to Canada’s newest pension fund, $12 billion University Pension Plan (UPP) set up in 2020 from scratch to manage the pooled assets of three university funds. “We didn’t even have a stapler!” recalls chief executive Barbara Zvan.

Cue another comparison. LGPS pools and Canadian funds often navigate the complexity that comes with managing assets for a range of individual partner funds with different priorities. Marlene Puffer, CIO of Alberta Investment Management Corporation (AIMCo), established in 2008, explains the challenge.

“We don’t have one pool of capital that we can easily manipulate,” she says. “We have 17 clients and 32 pools of capital, and we need to make sure we’re delivering what each client actually needs. Not just at the total portfolio or total fund level, but we need to pay attention to each of these clients individually.”

investing locally

The LGPS and their Canadian peers are also aligned in another way. The Maple 8 have a strong track record of investing in Canada but not by government decree. As Canadian and UK government pressure grows on pension funds to invest more at home, both systems are united in pushing back.

At FIS Toronto independent board member and former Canadian Pension Plan Investment Board chief executive officer Mark Wiseman, a high-profile pioneer of the $4.1 trillion Canadian pension industry, sounded the alarm on Canada’s cash-strapped government’s efforts to direct capital away from being invested for the purpose of maximising risk-adjusted returns – a key principle underscoring the Canadian system.

“It will come under a different guise, it’ll be said, ‘you should invest more in Canada’, ‘you should invest more in infrastructure’, ‘we should let people have access to their capital earlier’, or whatever excuse may be the fact of the day.”

In the UK where the new government has just announced a £22 billion blackhole in public finances, the LGPS is also pushing back.

Like their Canadian peers, Border to Coast chief executive Rachel Elwell and chair Chris Hitchen, said investing more at home should “only be delivered if there is no adverse impact on the delivery of pension fund objectives.”

Similarly, Brunel’s Chappell urges policy makers to recognise that Brunel is already investing meaningfully in the UK where assets range from affordable housing and infrastructure to UK focused private equity and debt allocations to support entrepreneurs.