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Things are changing for the LGPS.

Not only have market conditions changed significantly, creating surpluses that need protecting, there is also much focus on consolidation including having far fewer schemes.

Could employer-specific strategies help address both of these changes – by providing better risk management for funds and facilitate future mergers? We set out 8 clear reasons for considering employer-specific investment strategies below (together with supporting notes).

8 clear reasons for considering employer-specific investment strategies

If employers remain strong and solvent then members’ benefits will be paid in full. Effective risk management of employers is, arguably, the most important part of the LGPS’s sustainability and effective investment risk management is a crucial part of this.
There are three levers to maximising benefit security – cash funding, employer covenant management and investment strategy. Most LGPS funds only employ the first two of these. Having asked risky employers to pay more, funds should proactively consider de-risking their assets
The gap between equities and gilt returns is at its widest point since 31 March 2022. In most funds, some employers are now in a low-risk surplus with others still in deficit. If employers who would like to de-risk are not able to, there could be regret risk if markets revert.
Some employers are leaving as this is the only way for them to lock-in current surpluses, just when the LGPS has become affordable. Employer-specific investment strategies reduce the need for employers to exit fully or through alternative approaches such as “partial exit”.
Councils, particularly London Boroughs, fear losing control of their investment strategies through merger. With employer-specific strategies, they could retain investment control whilst benefitting from all of the wider operational efficiencies of merger.
There is already a postcode lottery for employers – their investment exposure depends on what fund they are in. This will be even more apparent when there are fewer funds. Employer-specific strategies will make new merged schemes easier to set up and fairer in operation.
Different employers will have different views on and needs in relation to the use of LGPS assets for levelling-up and UK investments. This can be managed more adeptly with employer choice.
A simple LGPS with a single investment strategy will look appetising to politicians, especially in the current climate. Individual employer strategies will be a clear reminder to politicians and to LGPS pools that the LGPS is a pension scheme and not a potential sovereign wealth fund.

There are some potential disadvantages. The main one is the extra complexity. However, the cost of implementing and running employer-specific strategies is small in relation to the size of scheme assets, especially if they merge. Some schemes already have employer-specific investment strategies and so we assume it can be done or otherwise the appropriate regulatory changes will be made.

Supporting notes

Traditionally each LGPS fund has had a single investment strategy, which applies to every employer.  This remains the case with a few exceptions. Less that 10% of LGPS funds offer their employers any alternatives and when they do it tends to be a single low-risk fund (made up of gilts and high quality corporate bonds).  There are a couple of examples of employers having bespoke investment strategies designed to meet their objectives and their liability profile.

The LGPS is both notionally segregated and “last-employer-standing”.  Each employer has its own notionally identified assets, which reflect their own contributions and liability cashflows. They are attributed a share of the investment returns of the investments they are invested in, normally alongside all other employers in the same LGPS fund.

In order to apply an employer-specific investment strategy (instigated by the fund or at the request of an employer), the investment returns need to be attributed appropriately according to the asset allocation. This is an operational challenge, but it follows the principals of notional segregation. Some funds have formally unitised their assets to allow more effective asset allocation, which should make employer-specific investment strategies more straightforward.

Despite some funds having done this already, some funds and advisers remain sceptical of the legality of having employer-specific investment strategies.

Employers such as universities and housing associations for example have become very aware of their surplus position as a result of their accounting positions improving very significantly. Many have approached their funds to see what the options are. Some funds are philosophically wedded to a single investment strategy. Others recognise the need, but are not able to respond quickly, with a common response that this will be considered at the next actuarial valuation, which will not be resolved for nearly two years. A few are responding to recent market conditions, for example the recent news that Cornwall Pension Fund is considering a medium and low risk strategy alongside their main strategy.

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