The UK government announced this week the creation of six British wealth funds comprising the pooled assets of 89 local authority funds. Each fund will have assets of £25 billion ($38 billion; €34 billion) and a mandate to consider infrastructure investments.
The move is a win for those calling for UK pension fund consolidation in order to reduce costs and fees, and to create institutions of scale that can invest in higher yielding, illiquid assets.
The recent Lancashire and London Pensions Partnership (LLPP) merger was ahead of the curve, having been formed out of the Lancashire County Pension Fund and London Pensions Fund Authority (LPFA). The combined entity has assets and liabilities of around £10 billion, and is in the process of selecting a shared investment team.
The LLPP plans to reduce its fund of funds allocation and up its direct and co-investments, mimicking the revised strategy of the LPFA to invest in more illiquid assets. The forward-looking group stands in the vanguard of UK pension alternative assets investors.
But the LLPP and the new UK funds are still minnows compared with the giant pensions and wealth funds of Canada, the Middle East, Southeast Asia and the Nordics that lead the field in private equity direct and co-investments.
Lack of scale is one of the challenges facing the British plans. According to long-term pension consolidation champion Edi Truell, who heads the UK’s Strategic Investment Advisory Board that is helping the LLPP, a fund needs to have reached “tens of billions” of assets to realise genuine economies of scale. It will need £500 billion to invest in big upcoming infrastructure projects such as the second phase of London Crossrail, which is expected to cost £18 billion.
Speaking at the BVCA 2015 summit in London yesterday, Delaney Brown of the Canada Pension Plan Investment Board (CPPIB) estimated that UK pension funds have currently allocated a mere 2-5 percent of assets to private equity.
Although this exposure is likely to rise as yield-starved pension CIOs eye private equity returns that the CPPIB says are running at 250-300 basis points over public equities, allocations will take time to increase as many funds simply don’t have the expertise.
Another difficulty is staff remuneration. Like their US peers, UK public pensions operate as part of a government entity, tying them to a set of stringent rules. Canadian pensions, by contrast, are technically crown corporations, giving them the ability to operate at arm’s length from the government. They can pay top dollar for direct and co-investment expertise, while many of their US peers, constrained by civil service wages, frequently struggle to retain their most talented individuals. The new UK funds are likely to face the same issue.
To succeed they will need to nurture investment talent, their own and external, and forge new relationships, but salaries and fees for all of this will need to be commensurate with the expertise and returns they are looking for if they are to succeed.
And then there is the question of will. Using the example of infrastructure, it is one thing for the government to mandate funds to invest in infra projects, but quite another for funds to follow its instruction. The chancellor has forced local authority funds to consolidate. Asset allocation remains in their hands. That’s where it should reside – but now the onus is on them to make sure UK pension capital really will find its way into the illiquid opportunities that offer a better return on investment.
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