In 2015, the UK Government outlined ambitious plans to reform the Local Government Pension Scheme (LGPS) by consolidating its 89 funds across England and Wales into larger, more efficient pools. The goal was to satisfy four objectives; to achieve benefits of scale, to enhance governance, to cut costs, and to improve capacity to invest in infrastructure. After eight years of progress, eight pools have emerged, each pursuing distinct paths to achieve these objectives.
In the 2023 Spring budget, hints were dropped that the UK Government is keen on pushing LGPS pools to accelerate further asset consolidation. Chancellor Jeremy Hunt, in his July 2023 Mansion House speech and Consultation, further emphasised this by setting a provisional deadline of March 2025 for pools to reach £50 billion of AUM (Assets Under Management).
Alpha has played a pivotal role in the establishment of multiple LGPS pools and possesses extensive experience working with these pools and the broader Asset Owner industry. With the potential for further LGPS pool consolidation on the horizon, we wanted to share our thoughts and observations of what good looks like.
What are the aspirational benefits of pooling?
1) Enabling economies of scale through significant AUM
Large pools can benefit from economies of scale through streamlined operations and outsourcing arrangements, leading to cost reductions. Governance structures, especially for Authorised Contractual Schemes (ACS), can be optimised by consolidating complex processes to a single third-party service provider.
Greater AUM also enables further strategic and tactical diversification of asset allocation. A larger pool size enables investment into more illiquid assets e.g., infrastructure & Environmental, Sustainable and Governance (ESG) focused investments, without compromising on traditional asset classes or required rates of return – a key driver for the LGPS pooling initiative since its inception.
2) Enhanced resilience across the operating model
Recent macro-factors including Brexit, the Ukraine conflict, and the aftermath of Covid-19, have combined to create a high inflationary environment in the UK. The September 2022 mini-budget under Prime Minister Liz Truss further spooked markets, triggering an LDI (Liability Driven Investment) crisis for pensions, forcing intervention from the Bank of England to prevent mass defaults.
Larger pools benefited from mature relationships with their chosen Third-Party Administrators (TPAs) through the TPA’s robust processes and controls and understanding of strategic positions. Developed Operating Models that are able to leverage industry expertise both externally and in-house can lean on experience and agility to respond in times of crisis.
3) Ability to attract employee talent and enhance in-house capability
Larger pools are better able to attract high-calibre talent – both through their ability to be market-competitive on salaries and also due to the exciting opportunities to work across a wide range of asset classes, compared to smaller pools. A focus on internal development opportunities that foster employee professional growth support greater independence over the long term and decrease reliance on third parties as knowledge is retained in-house
What are the key characteristics of successful pooling?
Whilst there is no set model to achieve the aspirational benefits of pooling, there are certain key characteristics that we have seen when pooling is undertaken successfully.
1) A clear oversight model & strategic plan between pools and partner funds
For pools to attract the AUM required for economies of scale, partner funds need to be confident the pool is representing their interests, both in terms of investment requirements (strategic asset allocation, risk/return profile and investment universe) and through a suitable oversight model that provides assurance to the partner fund that the pool is executing on the strategic approach.
Clearly defining roles and responsibilities with well-established governance from the outset, including division of strategic planning and day-to-day investment management, is key to a functional relationship. With this in place and mutual trust between partner funds and the pool, focus can be placed on delivering the strategy & driving investment performance.
2) Broad investment management capabilities that harness in-house & outsourced capabilities
Unlocking diversified offerings for partner funds is vital to demonstrate tangible change through the pooling of assets and will enhance the pool’s attractiveness to partner funds – to achieve initial commitment and long-term success thereafter.
Successful pools follow a principles-based approach to investment management, focusing on launching new products or asset classes only when a minimum investment size is met. Gradually building these capabilities, with full partner fund buy-in, is essential for strategic growth.
3) Selecting the right outsourcing partner to enable long-term growth
During the inception phase of LGPS pooling, it is fair to say that some TPAs struggled to grasp pool-specific needs, offering only standard go-to-market solutions. However, leading TPAs now present increasingly tailored models that precisely meet pool requirements, creating a compelling rationale for outsourcing.
By partially or fully outsourcing back and middle office functions, pools harness best-in-class services and TPA scale, reducing costs, and sidestepping further in-house investment.
Successful pools analyse and identify outsource partners capable of; fulfilling detailed requirements which align with the wider strategy, nurturing close relationships, and developing a deep understanding of each other’s businesses, paving the way for future collaborative propositions.
What are the common pitfalls when pooling?
Although we would advocate that there is no set ‘formula’ to succeed in pooling, there are several pitfalls we have observed that should be avoided.
1) Trust and clarity are key between pools and partner funds
A successful LGPS pool consolidation hinges on trust and clarity, from execution of strategy to day-to-day operations. To ensure efficient and empowered operations, it is vital to establish well-defined boundaries. Legal agreements, clearly outlining terms and responsibilities, must be agreed upon by all partner funds for a seamless and fruitful collaboration. Without trust in their pool counterparts, partner funds risk a breakdown of the structure, hindering the realisation of the pool’s full potential. By prioritising trust and defining roles, pooling can thrive, unlocking benefits for all stakeholders involved.
2) Inefficient and fragmented operating models limit potential scale benefits
Pooling offers significant benefits through streamlined operating models, but certain examples in the market show that pools struggle to realise this across their entire operating model. If not done with careful consideration, outsourcing can lead to a loss of scale benefits and increased complexity with parallel operating models due to multiple outsourced partners. Over-reliance on in-house solutions, driven by legacy decisions or existing contracts, may hinder outsourcing opportunities for specialised services. Failing to outsource such services efficiently can result in preventable costs and inefficiencies.
To avoid this trap and optimise operational spending, periodic strategic reviews are essential. By assessing and aligning operating models with scalable requirements, LGPS pools can realise their full potential and capitalise on the benefits of consolidation.
Considerable progress has been made toward the criteria the Government laid out in 2015. Pooling has enjoyed a lot of success and when done well, can unlock a raft of benefits for all stakeholders that were not previously achievable. With an eye on the horizon, it is important for pools to continue to grow and adapt to not fall behind. With an opportunity for further consolidation possible, now is a good time to plan ahead.