LGPS warned against 'value destruction' when pooling property
The fund management industry has been warned it needs to ensure reforms of local government pension schemes (LGPS) do not lead to “value destruction” in real estate.
The LGPS in England and Wales are being merged into eight pools as part of government reforms designed to increase scale, cost efficiency and the capacity to invest in UK infrastructure.
But an unintended consequence could be greater cost and complexity for their real estate investments. It was one of the messages to emerge during an event organised by the Investment Property Forum (IPF) and the Association of Real Estate Funds (AREF).
David Walker, head of LGPS Investments at Hymans Robertson, said: “Cost savings is one of the key criteria for pooling [but] the cost of moving into the pools can wipe the savings out for quite a [long] period of time if it’s not managed correctly”.
Walker was one of a number of speakers at the IPF/AREF seminar in London, the second event of its kind in recent weeks, organised in response to a property fund management industry striving to understand the full implications of the LGPS pooling reforms.
The 89 pension funds are significant investors in real estate, estimated to own approximately £15bn (€17.3bn) of assets, based on 2015 figures, through a mixture of direct holdings and fund investments.
As reported by IPE Real Estate last year, the consolidation of the funds into larger entities is expected to encourage them to favour direct investments – with obvious implications for managers of pooled funds.
At the IPF/AREF event, Melville Rodrigues, a lawyer, whose firm CMS played host, said: “The local government pension schemes are on a journey, a journey which presents strategic challenges for us in real estate.”
He implied that the “greater challenges” were “associated with indirect”, and that the “LGPS reforms could well represent a game change” – especially for the UK’s universe of core open-ended funds, most of which count the LGPS as important investors.
One member of the audience said that if LGPS were forced to sell out of these funds it would lead to massive “value destruction”.
In response, Walker said: “My assumption is that the pools [will not just sell] all their indirect and destroy lots of value.
“There will be carefully thought-out processes for transitioning, and I think the pools will be looking for managers to work closely with them to work out how to do that.”
Jeff Houston, head of pensions at the Local Government Association, who liaises with the LGPS and central government, added that the government was also explicit from the beginning that the exercise was also about “maintaining investment performance”. He said: “This is not just about cost savings.”
The LGPS are already allowed to keep existing direct property holdings from the pools – on the basis that their portfolios have been built up with their unique liabilities and requirements in mind. But any new investments must be made through the new pooling structures.
One of the pools, the Local Pensions Partnership (LPP), which includes the Lancashire County Pension Fund, the London Pensions Fund Authority (LPFA) and Berkshire Pension fund, has already pooled equity investments and is close to doing the same for private equity and infrastructure.
Richard Tomlinson, formerly an investment manager at Lancashire and now in charge of real estate and infrastructure investments at LPP, admitted that real estate “probably poses the most difficult questions”.
“I am at the coalface of trying to work out how we are going to practically pool real estate in an efficient, cost-saving manner,” he said. “Equities is a no-brainer – there are real cost savings to be had – but real estate is a real challenge to get any cost saving from pooling.”
That said, the pooling of Lancashire and LPFA’s £1.2bn of property assets last year had “led to competitive fee quotes”.
John Forbes, an independent consultant who moderated the event, raised the issue that some higher-return real estate strategies inevitably incur higher costs. “Some of the assets that are relatively costly to run,” he said, “actually deliver higher returns. So are you looking at absolute cost savings?”
Tomlinson confirmed that LPP’s property portfolio “included space” for higher-return value-add and opportunistic strategies – and that the fund recognised that these could cost more to run.
The main take-away from the event was a need for communication and engagement between the LGPS, property fund managers and central government.
Rodrigues urged the audience to help develop a dialogue over the next 12 months and to “create solutions” through “thought leadership”.
Walker said now is the time to be talking to the LGPS pools – while they are still working out how to pool property – rather than after decisions have been made.
“The more the industry can come back through to the pools and to central government to explain the situation better,” said Houston. “There is limited understanding [of the specific challenges associated with pooling property] within central government.”