Increase in LGPS pension contributions directly linked to poor investment recommendations.

CLERUS today released a report revealing that more than 60% of Local Government Pension Schemes (LGPS) performance variation is directly linked to investment recommendations, which are not being measured and assessed by more than 90% of Schemes. These are:

1. The performance of manager selection relative to the Scheme specific benchmark
2. The percentage allocation to assets classified as “alternative”

For the majority of Schemes, investment decisions have become little more than the implementation of recommendations made by their investment advisors. However, neither recommendations nor their impact (on investment performance and contribution levels) are being measured or assessed by most Schemes.

“Our research show that the increase in employer contributions is, to a large extent, due to the crystallisation of the £17.3 billion ‘hidden cost of poor advice’ that has not been measured or reported in the past”, said Henrik Pedersen, Managing Partner & Co-Founder of CLERUS

The report also evaluated the current LGPS reform proposal that it could be beneficial if schemes were ‘forced’ to adapt a high percentage of passive management for traditional assets, while still being allowed to invest in alternative investments. CLERUS finds that this is unlikely to yield the desired results because the overall investment governance issues will remain unresolved.

Henrik Pedersen added “It is the improvement of investment outcomes rather than potential ‘cost-savings’ alone that really matter for the taxpayer. In our view this will be best achieved by the proactive enforcement of Myners across all Schemes, by the Government”

Report Summary:

  • CLERUS two-factor explanatory model reveals that more than 60% of performance variation between LGPS is directly linked to the outcome of manager selection and alternative asset allocation
  • Up to 50% of LGPS performance outcomes can be explained by the performance of manager selection activities (average impact of -1.1% over the last 5 years)
  • Up to 35% of LGPS performance outcomes can be explained by their alternatives allocation. For each 10% allocation to this asset class, investment performance was reduced by 0.5% per annum over the last 5 years
  • CLERUS’ analysis suggests that the current LGPS proposal of ‘forcing’ Schemes to adapt a higher percentage of passive management, while still being allowed to invest actively into alternative investments, is unlikely to deliver the intended results

Conclusion:

  • Direct link between the performance drivers identified in this report and the failure to measure and assess the effectiveness of investment decisions and advice
  • The results will make it difficult for Schemes to claim good stewardship of funds without full performance measurement in accordance with Myners
  • Expected ‘cost savings’ achieved by increasing the percentage of passive management will most likely be offset by additional risk-taking in ‘active’ alternative investments
  • Making transparent performance assessment and reporting a regulatory requirement is the cheapest and most effective way to improve investment performance in LGPS